Tuesday, April 1, 2008

A Simple Guide To Recessions

Definition of Recession: A recession is a period of negative economic growth (falling Real GDP) for two consecutive quarters (6 months)

In practise people may feel the economy is in recession, even before it becomes 'official'. For example, if growth is very low or falls for 1 month, people will consider that to be a recession.
  • E.g. the US economy is currently not officially in a recession (as of April 1st 2008) but many analysts talk as if the economy is already in recession. See also : Is US economy in Recession?.
More on: What Happens in a Recession

Causes of Recession

The main causes of a recession is a fall in Aggregate Demand. In the US 2008 recession, the main causes of falling aggregate demand have been:
  • Falling House Prices. This reduces consumer wealth and prevents equity withdrawal through remortgaging. Also when house prices fall, people lose confidence in spending as their main asset is declining in value.
  • Mortgage Defaults. Many homeowners were sold mortgage products that became unaffordable when their introductory period ended and interest rates increased. This lowered their disposable income and caused many to default on their mortgage payments.
  • Financial Crisis. The prospects of banks like Northern Rock and Bear Sterns in the US going bankrupt have made people less confident about spending and investing.
  • Credit Crunch / Difficulty of Borrowing Money. Because of high mortgage defaults in US, many banks lost money. Therefore financial institutions have become very reluctant to lend money, this has led to a shortage of funds in the money markets. This has caused borrowing to be more expensive and difficult to arrange leading to lower investment and consumer spending.
  • Rising Costs. Rising oil, energy and food prices have caused an increase in the cost of production. This causes the aggregate supply curve to shift to the left; it leaves lower discretionary income for the average consumer.
For simple AD/AS diagrams on the causes of Recessions

See also: more reasons on Why the US economy is facing a recession

At other times the causes of recessions have been different see:
Other Questions and Answers on Recessions
  1. Why Do some economists argue a recession can be a good thing?
  2. How To Survive a Recession - Tips for consumers and firms to deal with an economic downturn
  3. How Long Do Recessions Last? - There is no precise answer. It is difficult to predict how the forthcoming recession will last. An important factor may be how prolonged the housing price falls are.
  4. On a related theme an essay on the Difficulties of Recovering from Recession
  5. Did the Iraq War cause a recession?
  6. Can Tax Cuts Avoid A recession?

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