From UPSC perspective, the following things are important :
Prelims level : Recessions, Depression
Mains level : Not Much
The Eurozone is almost certainly entering a recession, with surveys showing a deepening cost-of-living crisis and a gloomy outlook that is keeping consumers wary of spending.
What is Recession?
- A recession is a significant decline in economic activity that lasts for months or even years.
- Experts declare a recession when a nation’s economy experiences negative GDP, rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time.
- Recessions are considered an unavoidable part of the business cycle—or the regular cadence of expansion and contraction that occurs in a nation’s economy.
What causes Recessions?
These phenomena are some of the main drivers of a recession:
- A sudden economic shock: An economic shock is a surprise problem that creates serious financial damage. The coronavirus outbreak, which shut down economies worldwide, is a more recent example of a sudden economic shock.
- Excessive debt: When individuals or businesses take on too much debt, the cost of servicing the debt can grow to the point where they can’t pay their bills. Growing debt defaults and bankruptcies then capsize the economy.
- Asset bubbles: When investing decisions are driven by emotion, bad economic outcomes aren’t far behind. Investors can become too optimistic during a strong economy.
- Too much inflation: Inflation is the steady, upward trend in prices over time. Inflation isn’t a bad thing per se, but excessive inflation is a dangerous phenomenon. Central banks control inflation by raising interest rates, and higher interest rates depress economic activity.
- Too much deflation: While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and business stop spending, which undermines the economy.
- Technological change: New inventions increase productivity and help the economy over the long term, but there can be short-term periods of adjustment to technological breakthroughs. In the 19th century, there were waves of labour-saving technological improvements.
What’s the difference between Recession and Depression?
- Recessions and depressions have similar causes, but the overall impact of a depression is much, much worse.
- There are greater job losses, higher unemployment and steeper declines in GDP.
- Most of all, a depression lasts longer—years, not months—and it takes more time for the economy to recover.
- Economists do not have a set definition or fixed measurements to show what counts as a depression. Suffice to say, all the impacts of a depression are deeper and last longer.
- In the past century, the US has faced just one depression: The Great Depression.
The Great Depression
- The Great Depression started in 1929 and lasted through 1933, although the economy didn’t really recover until World War II, nearly a decade later.
- During the Great Depression, unemployment rose to 25% and the GDP fell by 30%.
- It was the most unprecedented economic collapse in modern US history.
- By way of comparison, the Great Recession was the worst recession since the Great Depression.
- During the Great Recession, unemployment peaked around 10% and the recession officially lasted from December 2007 to June 2009, about a year and a half.
- Some economists fear that the coronavirus recession could morph into a depression, depending how long it lasts.
How long do recessions last?
- Gulf War Recession (July 1990 to March 1991): At the start of the 1990s, the U.S. went through a short, eight-month recession, partly caused by spiking oil prices during the First Gulf War.
- The Great Recession (2008-2009): As mentioned, the Great Recession was caused in part by a bubble in the real estate market.
- Covid-19 Recession: The most recent recession began in February 2020 and lasted only two months, making it the shortest US recession in history.
Can we predict a recession?
Given that economic forecasting is uncertain, predicting future recessions is far from easy. However, the following warning signs can give you more time to figure out how to prepare for a recession before it happens:
- An inverted yield curve: The yield curve is a graph that plots the market value—or the yield—of a range. When long-term yields are lower than short-term yields, it shows that investors are worried about a recession. This phenomenon is known as a yield curve inversion, and it has predicted past recessions.
- Declines in consumer confidence: Consumer spending is the main driver of the US economy. If surveys show a sustained drop in consumer confidence, it could be a sign of impending trouble for the economy.
- Drop in the Leading Economic Index (LEI): Published monthly by the Conference Board, the LEI strives to predict future economic trends. It looks at factors like applications for unemployment insurance, new orders for manufacturing and stock market performance.
- Sudden stock market declines: A large, sudden decline in stock markets could be a sign of a recession coming on, since investors sell off parts and sometimes all of their holdings in anticipation of an economic slowdown.
- Rising unemployment: It goes without saying that if people are losing their jobs, it’s a bad sign for the economy.
How does a recession affect individuals?
- We may lose your job during a recession, as unemployment levels rise. It becomes much harder to find a job replacement since more people are out of work.
- People who keep their jobs may see cuts to pay and benefits, and struggle to negotiate future pay raises.
- Investments in stocks, bonds, real estate and other assets can lose money in a recession, reducing your savings and upsetting your plans for retirement.
- Business owners make fewer sales during a recession, and may even be forced into bankruptcy.
- With more people unable to pay their bills during a recession, lenders tighten standards for mortgages, car loans, and other types of financing.