A recession is a period in which economic activity declines across the economy. This decline can last from a few months to a year.
In the United States, the National Bureau of Economic Research defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
The theory of inevitable recessions
Recessions are a natural part of the financial cycle. They happen when market imbalances make it harder for companies to grow.
Rather than trying to avoid recessions, businesses should prepare for them in advance. That way, they can prevent the most common pitfalls and minimize their impact on their business.
In the United States, the Fed has a strong hand in controlling recessions, especially by easing monetary policy and limiting inflation. It may also prevent the next one by engineering a “soft landing,” which is when interest rate hikes gradually lower the economy instead of pushing it into recession.
Another important factor is how companies manage their debt. Recessions can force companies with too much leverage to cut costs through layoffs. This can lead to a decline in productivity and profitability, so having enough cash on hand is critical.
Causes of recessions
Several factors can cause an economy to enter a recession. These include monetary policy, fiscal policy, and private sector decisions.
A central bank’s monetary policies can affect the economy by controlling interest rates and the money supply. This can change consumer demand and economic growth.
A government’s tax policies can also affect the economy by decreasing the amount of disposable income. This can cause a decline in spending and lead to a recession.
Manufacturing jobs: When manufacturers stop hiring new workers, it can be a sign that the economy is starting to go into recession.
Retail sales adjusted for inflation: This can be a sign that consumer spending is slowing.
A sudden economic shock, like a price rise for commodities such as oil or gas, can trigger a recession. Excessive debt can also be a major factor that leads to recessions. A rise in interest rates can make it more expensive for businesses and consumers to borrow money.
Signs of a recession
A recession is a period of economic decline that involves a fall in GDP, rising unemployment and declining incomes. It’s also usually associated with a drop in retail sales and an increase in government borrowing.
During a recession, businesses cut jobs and production, and consumers spend less. This decrease in demand leads to a reduction in productivity, which causes firms to lose profits.
When economists say that the economy is in a recession, it’s often based on the National Bureau of Economic Research (NBER) definition, which takes into account a range of data points, including GDP growth.
However, the NBER isn’t always able to determine whether a recession is imminent, and it often doesn’t make an official call until a few months or even a year after a recession starts.
The NBER’s decision to declare a recession is made based on the duration and strength of an expansion following the trough, and it uses six indicators, including real personal income minus transfer payments, nonfarm payrolls and industrial production.
The economic recovery process after a recession begins when people and businesses start spending more money again, and businesses have room for growth. This happens after a period of adjustment in the markets and through government stimulus programs such as loans, grants or assistance to businesses.
Recessions are characterized by a variety of indicators, such as declines in component measures of GDP, a fall in the unemployment rate, and a slowdown in government spending. These are all influenced by underlying drivers such as employment levels and skills, household savings rates, corporate investment decisions, interest rates, demographics, and government policies.
Recessions can last for a variety of durations and depths, depending on the underlying cause. Recessions following financial crises are often longer than average and characterized by slower growth.