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What is a Recession?

What is a Recession?

Recessions are phenomena that can significantly impact societies, businesses, and individuals. A recession is a term that often makes headlines, provoking concerns and discussions about the state of the economy. Now, let’s understand the concept of a recession, its causes,  and the effects it has on various aspects of our lives.

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What is a Recession?

A recession is an economic downturn characterized by a significant decline in economic activity across the entire economy, which can last for months or even years. This decline is measured by a contraction in the gross domestic product (GDP), a broad indicator of a country’s economic health. It is generally defined as two consecutive quarters of negative GDP growth, meaning the economy is producing less than it did in the previous quarter. During a recession, key economic indicators such as employment, consumer spending, industrial production, and business investment often experience negative growth.

During a recession, businesses may cut back on production, leading to layoffs and rising unemployment rates. Consumers, facing economic uncertainty, tend to reduce their spending, further worsening the downturn. Governments often implement monetary and fiscal policies to stimulate economic activity, such as lowering interest rates or increasing public spending.

Recessions are a natural part of the economic cycle, and their severity and duration can vary. Governments, central banks, and policymakers closely monitor economic indicators to implement measures to mitigate the impact of recessions, which later boost recovery. The 2008 global financial crisis is a notable example of a severe recession that had widespread implications for economies worldwide.

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What Causes Recession?

What Causes Recession

Several factors can contribute to the onset of a recession, and often, a combination of these factors interacts to create economic downturns. Here are some common causes of recessions:

  • Contractionary Monetary Policy: When the central bank raises interest rates, it makes borrowing more expensive. Higher interest rates discourage consumer and business spending, which can slow down the economy and lead to a recession.
  • Supply Shocks: Unexpected events that suddenly reduce economic output and increase prices, like natural disasters, wars, or oil price spikes. These shocks force consumers and businesses to cut back on spending, leading to a recession.
  • Excessive Debt Levels: High levels of household and corporate debt make the economy more vulnerable. As interest rates rise or the economy slows, many borrowers have trouble repaying debts, forcing cutbacks in spending and potential bank failures. This can turn a slowdown into a recession.
  • Asset Bubble Bursting: Speculative bubbles in assets like real estate or tech stocks can lead to overinvestment. When bubbles inevitably burst, wealth is destroyed, and spending declines, causing a recession.
  • Financial Crises: Problems in financial markets like the housing crisis of 2008 can halt credit supply and severely damage economic output. Lack of credit causes businesses and consumers to cut back on spending, creating a recession.
  • Wealth Effects: When asset prices fall, consumers tend to cut discretionary spending because they feel less wealthy. This slowdown in spending can lead firms to lay off workers, deepening an economic downturn.

Historical Examination of Recessions

A historical examination of recessions provides valuable insights into the economic patterns, causes, and consequences of downturns in various periods. Recessions are typically characterized by a significant decline in economic activity, including factors such as GDP growth, employment rates, and industrial production. Here’s a brief overview of some notable economic meltdowns in modern history:

1. The Great Depression (1929-1939)

The Great Depression (1929-1939) was a devastating economic downturn that originated with the U.S. stock market crash of October 29, 1929, known as Black Tuesday. The collapse of stock prices led to a cascade of events, including bank failures and a severe contraction in economic activity. By 1933, the U.S. GDP had fallen by about 30%, and unemployment had soared to approximately 25%.

Internationally, the depression had widespread consequences. India’s economy faced a decline in agricultural and industrial output. The country experienced a contraction in GDP, with estimates suggesting a decline of about 5.6% annually between 1929 and 1931. Global trade contracted sharply, intensifying the economic troubles of many nations. The Smoot-Hawley Tariff Act of 1930, aimed at protecting domestic industries, contributed to a further decline in international trade.

The period was marked by severe social hardships, with millions of Americans losing their homes and jobs. Hoovervilles, makeshift communities of homeless people, emerged in major cities. President Franklin D. Roosevelt’s New Deal programs, initiated in the 1930s, aimed to alleviate the crisis through public works projects and social reforms.

It wasn’t until the industrial mobilization for World War II in the late 1930s and early 1940s that the global economy experienced a significant recovery. The Great Depression remains a climactic event in economic history, shaping policy approaches to financial regulation and social safety nets for decades to come.

2. Oil Crisis Recession (1973-1975)

The Oil Crisis Recession of 1973-1975 was primarily triggered by the Organization of Petroleum Exporting Countries (OPEC) imposing an oil embargo in response to geopolitical events, including the Yom Kippur War. This led to a quadrupling of oil prices, from $3 to $12 per barrel. The United States, heavily reliant on oil imports, experienced a sharp rise in inflation and a decline in economic activity.

During the recession, the U.S. GDP contracted by about 3.2% in 1974, and unemployment rose to 9%. Inflation soared to double digits, peaking at around 12% in 1974.  India faced economic challenges, with GDP growth dropping to around 0.3% in 1973-74 and negative growth of approximately -0.5% in 1974-75. The country grappled with rising inflation and a significant trade deficit due to increased oil prices, worsening its economic difficulties during this period. The combination of high inflation and high unemployment, known as stagflation, posed a significant challenge for policymakers.

Governments responded to the crisis by implementing strategies like wage and price controls, coupled with central banks raising interest rates. The primary goal of these measures was to mitigate inflation, but they also played a role in heightening the economic downturn. This recession emphasized the susceptibility of economies to external shocks, especially those tied to energy, emphasizing the importance of diversified energy sources and well-thought-out energy policies.

3. Early 1980s Recession

The early 1980s recession, often associated with the policies of U.S. Federal Reserve Chairman Paul Volcker, was marked as the severe economic downturn. To combat high inflation, Volcker pursued a tight monetary policy, raising interest rates significantly. The prime interest rate peaked at around 20% in 1981, contributing to a contraction in economic activity.

The U.S. experienced a sharp rise in unemployment, reaching a peak of 10.8% in late 1982. GDP growth turned negative, with a contraction of 1.9% in 1980 and 1.9% in 1982. The manufacturing sector was particularly affected, facing challenges such as high-interest rates and a strong U.S. dollar.

Internationally, the effects were felt as well, with many developed economies entering into recession. India, for instance, faced a downturn in economic growth, with real GDP growth dropping to 5.2% in 1980-81 and further to 3.6% in 1982-83. The period witnessed challenges such as high inflation, reaching double-digit figures, and rising unemployment.

The early 1980s recession marked a departure from Keynesian economic policies, with a shift toward monetarist principles emphasizing the role of controlling the money supply. The U.S. and other affected nations eventually saw a recovery as inflation was brought under control, setting the stage for a period of sustained economic growth in the latter part of the decade.

4. Dot-Com Bubble Burst (2000-2001)

The Dot-Com Bubble Burst of 2000-2001 was a significant economic event characterized by the collapse of high-flying technology stocks and the correction of inflated valuations in the dot-com sector. During the late 1990s, there was a speculative frenzy surrounding internet-based companies, leading to soaring stock prices. However, many of these companies were operating at a loss and had questionable business models.

The bubble burst in March 2000, marked by the Nasdaq Composite Index’s sharp decline. From its peak in March 2000 to its trough in October 2002, the Nasdaq lost about 78% of its value. Companies that had once been market darlings faced bankruptcy, and investors suffered substantial losses.

India experienced a downturn in its stock markets, with the BSE Sensex witnessing a decline of about 56% from its peak in February 2000 to its trough in September 2001. The burst had a notable impact on Indian IT companies, leading to a reassessment of the sector’s valuation.

The burst was fueled by factors such as the overvaluation of stocks, excessive speculation, and the realization that many dot-com companies were not financially sustainable. The fallout included the bankruptcy of prominent companies like Pets.com and Webvan. While the Dot-Com Bubble Burst had a significant impact on the technology sector, it also led to increased scrutiny of financial markets and a reassessment of investment strategies.

5. The Global Financial Crisis (2007-2009)

The Global Financial Crisis, often referred to as the Great Recession, was a worldwide economic downturn that began in late 2007 and lasted until about 2009. It originated in the United States with the subprime mortgage crisis, as banks had been lending money to high-risk homebuyers who often defaulted on their mortgages when housing prices began to decline. 

This caused the values of mortgage-backed securities held by major financial firms to plummet, and several large banks like Lehman Brothers and Bear Stearns collapsed. The crisis quickly spread globally as credit markets froze up and stock markets crashed, causing sharp declines in consumer wealth and plunging many nations into recession. 

India experienced a slowdown in economic growth, although it was relatively more resilient compared to many other economies. India’s GDP growth, which had been robust in the years leading up to the crisis, decelerated from around 9% in 2007-2008 to approximately 6.7% in 2008-2009. The country’s export-oriented sectors faced challenges due to declining global demand, impacting industries like information technology and manufacturing.

Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion, and institutional bailouts in an attempt to stabilize the financial system. The crisis led to the Great Recession, resulting in high unemployment and large drops in economic output, as well as increased government intervention in the economy. Though the recession officially ended in mid-2009, the global economy continued to feel its effects for several more years.

6. COVID-19 Pandemic Recession (2020)

The COVID-19 Pandemic Recession of 2020 was a global economic crisis triggered by the widespread outbreak of the novel coronavirus. In the first half of 2020, the world experienced an unprecedented contraction, with global GDP shrinking by 3.5% according to the International Monetary Fund (IMF). Advanced economies, such as the United States and Eurozone countries, saw output declines of 4.9% and 7.2%, respectively.

The recession was characterized by severe disruptions across various sectors, including travel, hospitality, and retail. Global trade contracted sharply, with the World Trade Organization (WTO) reporting an estimated 5.3% decline in merchandise trade volume for the year.

In India, the COVID-19 pandemic significantly impacted the economy in 2020. The country experienced a contraction of about 7.3% in its GDP during the fiscal year 2020-2021, according to data from the Ministry of Statistics and Programme Implementation. Lockdowns and disruptions in sectors such as manufacturing, services, and construction contributed to a decline in economic activity, leading to job losses and income disparities.

Governments worldwide responded with unprecedented fiscal stimulus packages to support businesses and individuals affected by the economic fallout. Central banks also implemented monetary policies, including interest rate cuts and quantitative easing, to stabilize financial markets. The economic recovery began in 2021 as vaccination efforts progressed, leading to increased confidence and easing restrictions in many regions. 

As we have discussed what a recession is, it’s important to note that there might be confusion about whether depression and recession are the same. Let’s see the differences between them in the next section.

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Difference Between Recession and Depression

A recession and a depression are both economic downturns, but they differ primarily in their severity and duration. While a recession is a significant decline in economic activity that lasts for a relatively short period, depression is a prolonged and more severe economic downturn characterized by widespread unemployment, financial distress, and a sustained contraction in economic output.

Here’s a table summarizing the key differences between a recession and a depression:  

DurationGenerally shorter in duration compared to depressionTypically longer in duration, lasting for several years
SeverityLess severe than a depressionMore severe, with a deeper and prolonged economic contraction
UnemploymentUnemployment rates may increase, but not as sharply and extensively as in a depressionHigh and persistent unemployment, often with widespread job losses
Government InterventionGovernments may implement stimulus measures to revive the economyGovernments may need to implement extensive intervention, including large-scale fiscal and monetary policies, to address the severe economic downturn
Stock MarketStock market declines, but the extent of the decline is generally less severeSevere stock market declines with a prolonged period of low stock values
Consumer SpendingDeclines, but the decrease is not as drastic as in a depressionSignificant and prolonged decline in consumer spending, impacting various sectors of the economy
Global ImpactOften localized or may affect specific regions or countriesGlobal economic impact, with multiple economies experiencing simultaneous downturns
Social ImpactSocial challenges, such as increased poverty and inequality, may emerge.More pronounced and widespread social challenges, including increased poverty, unemployment, and social unrest.
RecoveryRecovery is generally faster, and economic growth eventually resumes.Recovery is slow and may take many years to return to pre-crisis levels.

How Does a Recession Affect Us?

How Does a Recession Affect Us

The effects of a recession can be widespread and impact various aspects of individuals, businesses, and the overall economy. Below, we have mentioned some ways in which a recession can impact various aspects of our lives:

  • Employment: One of the most direct and immediate effects of a recession is a rise in unemployment. During economic downturns, businesses may cut costs by reducing their workforce, leading to layoffs and job losses. Individuals may find it more challenging to secure new employment during a recession. In 2023, notable examples of this trend include major corporations such as Meta (formerly Facebook), Macy’s, and Ford Motor Company, which implemented multiple rounds of layoffs. These measures affected thousands of employees across diverse departments, illustrating the real-world impact of economic challenges on the job market.
  • Income and Wages: For those who remain employed, there is often pressure on wages and income levels. Companies may freeze salaries or offer minimal wage increases. Overtime opportunities may decrease, and bonuses may be reduced or eliminated.
  • Consumer Spending: During a recession, consumer confidence tends to decrease. People may become more cautious with their spending, prioritizing essential purchases and cutting back on discretionary spending. This might negatively affect businesses, particularly those in the retail and entertainment sectors. A prominent example of a country facing economic challenges is Sri Lanka, which experienced state bankruptcy due to difficulties in repaying foreign loans, leading to a default. This situation further eroded consumer confidence, prompting people to reduce their spending, thereby impacting the overall economy.
  • Investments: The stock market often experiences volatility during a recession. Investment portfolios may decline in value, impacting individual’s retirement savings and overall net worth. Investors may become more risk-averse, leading to changes in investment strategies.
  • Government Services: Governments may face reduced revenue during a recession due to lower tax collections. This can result in budget cuts and reduced funding for public services, affecting areas such as education, healthcare, and infrastructure.

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Understanding what a recession is and its underlying causes is crucial for individuals, businesses, and policymakers alike. While recessions are a natural part of the economic cycle, proactive measures can be taken to mitigate their severity and duration. By staying informed and adopting appropriate strategies, societies can navigate through these challenging periods and emerge stronger on the other side.

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About the Author

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With an MBA in Finance and over 17 years in financial services, Kishore Kumar boasts expertise in program management, business analysis, and change management. Notable roles include tenure at JPMorgan, Nomura, and BNP Paribas. He is recognized for commitment, professionalism, and leadership.