Basics of a Recession and FAQs
What is a recession?
The standard definition of a recession is when a country’s GDP decreases for two consecutive quarters. Technically speaking, the U.S. reached that point in 2022. However, its statistical significance was negligible for the National Bureau of Economic Research, or NBER, to consider the US to be in a recession. A recession is a decline in productivity, not necessarily a measure of GDP. The NBER’s Business Cycle Dating Committee decides if we are in a recession.
What are the causes of recession?
Many factors and variables are considered reasons behind a recession: demand not meeting supply, high unemployment, stock market crashes, over-speculation, conflicts between nations, and more. Fundamentally, all these reasons lead to lower productivity among people. Inevitably, a decrease in consumer spending leads to a weaker economy. When unemployed, people make less money, resulting in businesses lowering prices to generate revenue. This results in items that are not necessities losing value. When accounting for GDP, economists prefer real GDP over nominal GDP as it accounts for inflation. When aggregate demand decreases, real GDP decreases due to falling price levels. It may sound good at first, but falling price levels present economic problems. When consumers are not stimulating the economy, central banks decrease interest rates, and there are more job layoffs as businesses struggle to make profits.
What was the Great Recession of 2008?
The most consequential recession the U.S. faced since the Great Depression was the Great Recession, lasting from 2007 to 2009. When housing prices began to fall in 2007, subprime mortgage borrowers defaulted, which caused the banks to also fail, and in conjunction with other factors, the economy crashed. Its magnitude was severe: unemployment rose from 5% to 9.5%, house prices fell approximately 30 percent, and GDP fell 4.3 percent. Programs such as the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009 were enacted to increase consumer spending and provide tax cuts. Thus, millions of jobs were created, tax relief was provided, and consumers spent more. Tax rebates were offered for up to $600 plus $300 for every child.
What happens in a recession?
A recession often starts after a period of high interest rates, which results in consumer spending declining. This starts a chain reaction where, because consumers spend less money, businesses receive less income. During a recession, consumers spend less, and inflation decreases. Businesses produce less profit and therefore have fewer available funds for employers, which in turn causes increasing unemployment and a shrinking GDP. Additionally, reduced consumer confidence in times of recession can increase unemployment. A fear of high prices results in less consumerism, and thus the supply of money circulating in the economy decreases. Central banks address this issue by reducing the supply of currency, making it more expensive, and thereby lowering interest rates—higher interest rates would lead to less spending and less demand. When price levels drop, central banks reduce interest rates to stimulate the economy and cause an increase in spending.
What is the difference between stagflation and recession?
During stagflation, the GDP decreases or stagnates, and inflation occurs, which means price levels increase. The difference in a recession is that inflation decreases or price levels fall; however, productivity or GDP still decreases.
Are we currently in a recession?
On February 1st, 2023, the Federal Reserve raised the interest rate benchmark from 4.5% to 4.75%, the highest in 15 years. During the pandemic, a substantial upsurge in cyclical unemployment caused businesses to struggle to generate profits. Due to a stagnant market, the Fed printed more money and set lower interest rates. By establishing lower interest rates, there was a lot of money and spending in the economy, leading to inflation. The increase in the money supply led to an increase in the price of goods. More recently, the GDP has decreased for two consecutive quarters. The Fed aspires to lower inflation to 2%, which could be unrealistic given the current rate of 5%. It’s plausible that economic stability is within reach, but only time will tell.
What are the solutions to a recession?
Economists have a shared, broad view on solutions to tackle a recession. The Fed sets a benchmark for interest rates. Central banks often seek security by lowering short-term interest rates and increasing assets. When prices go down in an economy, aggregate demand increases due to consumers being able to buy more. Real GDP rises as a result of businesses making more profit, leading to a strong economy. Demand allows firms to expand, thus increasing employment and causing a series of positive reactions. On the other hand, less government intervention and tax cuts would increase firms' investment in their businesses, thus increasing productivity. In contrast, more government intervention could allow for greater productivity. If spending is low, the government can intervene by decreasing interest rates, thus allowing for more investment in businesses and increasing productivity.