Germany, the largest economy in Europe and the fourth largest in the world has officially entered recession, screamed the news headlines not long ago. The threat of recession has been looming large ever since the world emerged from the global covid-19 pandemic. The continuing Russia-Ukraine war has only added to global economic woes.
The IMF (International Monetary Fund) had predicted that recession will strike only in Germany and Britain in Europe in 2023. This prediction held true as Germany saw a decline of 0.5% in its GDP in the fourth quarter of 2022 and again a decline of 0.3% in the first quarter of 2023 as it succumbed to the pressure of high inflation.
The economic stability of a country is heavily dependent on the goods and services it can produce, armed conflicts, health crisis, market trends, and consumer confidence. These are also the many reasons that can lead to a recession. Here is an in-depth look to understand the concept of recession and how and why economies succumb to it.
What is Recession
Economics defines a recession as a business cycle contraction that occurs when there is a general decline in economic activity. In the world of business, however, recession is defined as a period of contraction in two consecutive quarters. The main reasons behind a recession could be a financial crisis, an external trade shock, an adverse supply shock, an economic bubble burst, or even a large-scale natural disaster. Recession and its effects are most commonly seen in the GDP (Gross Domestic Product) of a country, income, employment, industrial production, and wholesale and retail business. When any economy is threatened by a recession, its government usually responds by adopting expansionary macroeconomic policies that include increasing the money supply and decreasing interest rates or increasing government spending and decreasing taxation.
Causes for a Recession
The exact causes of a recession are not always possible to understand. However, a deeper insight into what are the causes that can trigger a recession can help understand the recession better.
- Causes that shock an economy, be it a country or the entire globe, like a war or a health-hazardous pandemic can cause sudden and unexpected disturbances in the supply or demand of certain products and services
- Major, and, often unexpected, stock market crashes can cause an economy to suddenly collapse as big money is suddenly lost. This can push an economy into a recession, very similar to the Great Depression
- Changing fiscal policies of any government, like raising or lowering of taxes to influence an economy can also trigger a recession. This also includes the monetary policy of any government
- When any industry grows at a rapid pace, it creates a bubble, which, when crashes leaves devastation which can trigger a recession. The prime example of this housing loan bubble that triggered the 2007-2008 recession
- Investors making risky investments during an economic boom and then cutting back on spending in anticipation of a downturn are also psychological factors that can have very real consequences and trigger a recession
Characteristics of a Recession
Earlier, an economic recession was determined solely based on the GDP of the economy it affected. However, over time the determining factors that characterize a recession have broadened to include various other factors. Some important characteristics of a recession are –
- A decline in the real GDP of an economy for two consecutive quarters
- A drop in high-value retail sales and a decline in even essential purchases
- Rising unemployment with businesses laying off employees to cut costs
- Supply and demand equilibrium witnesses a disruption
- Businesses reduce production due to decreased demand
- Increasing inflation affects the purchasing power of consumers
Types of Recession
Even with a general definition and understanding of recession, it takes different shapes and forms. Based on the factors causing a recession and their recovery path, recession can be broadly classified into a few basic categories.
Commonly known as a ‘boom and bust’ recession, it basically means that the economy expands at a much faster rate than planned. Such an economy faces a recession due to inflation. The government supervisory body, in an effort to contain the over-expansion, implements measures like increasing taxes, decreasing government expenditure, or even increasing interest rates. This leads to a general limiting of expenditure as consumer focus shifts to conservation and debt clearance leading to a ‘bust’ or a recession.
Balance Sheet Recession
Just as the name suggests, this occurs when an economy is overextended due to debt. As debt increases, spending patterns shift and reduce in an effort to clean up the balance sheets. This leads to a stagnant economy leading to a recession.
This is a recession in its severest form when a country’s GDP decline is in excess of 10%. The greatest example of this is the Great Depression of the 1930s.
Supply Side-shock Recession
This kind of recession occurs when the domestic or international supply chains are disturbed due to global events like wars, natural disasters, or even a public health crisis. If the supply chains are restored and the supply is replenished, these types of recessions do not continue for a long time. However, such recessions can last for a few years if the supply is not replenished and restored. It can also bring about a change in the way the product is utilized.
There is no guaranteed way to predict a recession. However, keeping in mind the various causes and how they apply to any current economic scenario of any country, can help in understanding the chances of an impending recession. There are many ways and means by which an individual can prepare for a recession like building savings, becoming debt free, keeping to a budget, and also keeping the personal resume current. It can also help to learn a new skill that can be a huge help in case unemployment strikes.
Recessions are an economic reality. The severity of it depends on multiple factors. However, history teaches that most recessions last for a span of approximately one year. It helps to know how recessions can trigger and what they can impact. The more one knows the better one can prepare.
What is recession?
Economics defines a recession as a business cycle contraction that occurs when there is a general decline in economic activity. In the world of business, however, recession is defined as a period of contraction in two consecutive quarters.
What are various types of recession?
Recession can be broadly classified into a few basic categories-
- Inflationary Recession
- Balance Sheet Recession
- Supply Side-shock Recession
What could be the main reasons behind recession?
The main reasons behind a recession could be a financial crisis, an external trade shock, an adverse supply shock, an economic bubble burst, or even a large-scale natural disaster.