A complete guide to Recessions: what are the Consequences on the Economy

A recession is a phenomenon that can have serious consequences on the economy of a country and on the lives of its people. During a recession, economic activity slows down, consumption falls and companies lay off their employees, creating a negative spiral that can last a long time and lead to dramatic consequences.

In this guide, we will explain clearly and in detail what is an economic recession, how it manifests itself and what are its main causes. We will also analyze the consequences that a recession can have on a country’s economy and on people’s lives, such as unemployment, decrease in wages and an increase in poverty.

For this reason, it is of paramount importance to understand the complex dynamics of the economy during a recession and how one can try to avoid or mitigate its effects. Knowing these issues can help you make informed decisions about your investments and your business life in general.

What is the economic recession

A recession is a period in which the economy of a country contracts and there is a decrease in demand for goods and services, leading to a reduction in sellers’ earnings and the decrease in production. This can happen due to various factors such as financial crises, decreases in exports and imports, reduction in the supply of goods and services and even wars or natural disasters on a global scale.

During an economic downturn, reduced demand for goods and services results in decreased economic output, sales, and investment. This leads to a widespread decline in economic activity, with a significant impact on the employment rate and household incomes.

Identifying the moments of recession is crucial for adopting the most appropriate policies to combat its negative effects on the economy.

An economic recession is generally considered to be a period of at least two consecutive quarters in which a country’s Gross Domestic Product (GDP)) decreases. This criterion was proposed by Julius Shiskin in 1975 and still today represents one of the most universally adopted theories by economists to determine when a country enters a recession.

In the United States, the National Bureau of Economic Research (Nber) plays a key role in determining the recession, using various factors, such as unemployment levels and the trend of sales of goods on the market.

Recession has negative effects on a country’s economy, such as a reduction in household income and a decrease in investment due to low confidence in the future of the economy. Furthermore, a recession can lead to an increase in the rate of inflation as the decrease in production leads to a decrease in the supply of goods and services in the market.

Causes of the economic recession

An economic downturn can be caused by several factors, including economic events, financial, political or environmental.

Among the economic causes we can include the decrease in the demand for goods and services in the market, a reduction in the supply of goods and services, excessive speculation in the market and the increase in the prices of raw materials.

Financial crises can cause an economic downturn, as they can lead to reduced bank lending and funding for businesses and consumers, limiting the ability of businesses to invest and create jobs.

Political crises can also cause an economic downturn, for example when there are problems of political stability or instability in trade relations between countries. This can lead to a decrease in exports and imports, causing a decrease in demand and economic output.

In addition, natural events on a global scale, such as natural disasters, pandemics or wars can cause an economic downturn, as they can lead to disruptions in the supply of goods and services and create uncertainty in the markets financial.

The causes of the economic downturn are often interconnected and can have waterfall effects, as a financial crisis can lead to a reduction in the demand for goods and services, which in turn can lead to a reduction in economic output and jobs. For this reason, it is important that governments and economic institutions take steps to prevent economic crises and mitigate their negative effects when they occur.

Consequences of the recession on the economy

As we have seen, an economic downturn can have significant consequences on a country’s economy. Among the most common consequences are:

• Increase in unemployment: During a recession, businesses tend to reduce their workforce in order to save costs. This can lead to a rise in unemployment and a decrease in household income, creating a cycle of reduced consumption that can further worsen the recession. Employees who manage to keep their jobs during economic downturns may be subject to wage and benefit reductions. Additionally, they may find it more difficult to negotiate future salary increases due to declining company profits.
• Reduced production and corporate profits: During a recession, the demand for goods and services decreases, leading to a reduction in corporate production and profits. Firms in the greatest difficulty could go bankrupt, fueling unemployment and a drop in consumption.
• Reduced investment and business, as businesses become less willing to spend money on new projects or expansions during times of economic uncertainty. This can limit long-term economic growth and increase pressure on governments to provide incentives for investment and growth.
• Increase in public debt: to stimulate the economy during a recession, governments can adopt public spending policies. This can lead to an increase in public debt and the tax burden.
• Decrease in consumer confidence: During a recession, consumers can become more cautious in the way they spend money, thus creating a vicious cycle in which decreased demand for goods and services leads to decreased output and economic growth.
• Increased risk of loan default: During a recession, businesses and consumers may find it more difficult to pay their debts. This can lead to an increased risk of loan defaults and increased default rates.
• Increase in interest rates, as central banks may seek to raise the cost of credit to limit inflation. This can make it harder for businesses and households to obtain loans, further hampering economic growth.

Signs of economic recession

Predicting the arrival of a recession is not easy, but it is possible to consider some indicators such as the increase in the unemployment rate, the inversion of the yield curve, the decline in consumer confidence and the sudden changes in the stock market. Paying attention to these signs can help you prepare for a recession before it hits.

The increase in the unemployment rate can be a strong indicator that an economic recession is on the way. When companies start laying off or cutting staff, it means they are experiencing financial difficulties and the economy may be in trouble. Furthermore, the unemployment rate can have a significant impact on consumer spending, as the unemployed have less money available to shop. An increase in the unemployment rate can therefore lead to a decrease in consumer spending and a downturn in the economy. For this reason, it is important to closely monitor the unemployment rate data and consider it as a possible sign of an impending economic recession.

The inverted yield curve is one of the most important signs that economists monitor to understand if an economic recession is imminent. This means that if short-term returns are greater than long-term returns, there is a strong possibility that there is economic instability to come. This phenomenon occurs when investors are unsure of the future and prefer to invest for the short term to reduce risk. Furthermore, yield curve inversion has often preceded past economic recessions, so it is an indicator that cannot be ignored. Closely monitoring the inversion of the yield curve can help predict the arrival of a recession and take the necessary preventive measures.

The fall in consumer confidence is a leading indicator of an impending economic downturn. Since consumer spending makes up a large part of the economy, a significant drop in confidence can negatively impact economic growth. This happens when consumers feel insecure about investing their money due to concerns about the future of the economy, and they cut back on spending as a result. This in turn leads to a decrease in production, sales and investment, which can cause an economic downturn. Therefore, it is important to regularly monitor the level of consumer confidence to understand whether it is necessary to take preparedness and mitigation measures in the event of a possible recession.

Stock market crashes can be an indicator of an impending economic downturn. Investing in stocks is a risky but potentially profitable business and investors may decide to sell their shares if there is uncertainty about the future of the economy. When there is a sudden significant decline in the stock markets, investors may perceive this event as a sign of a possible impending economic crisis and decide to sell some or all of their share of shares. However, it is also important to consider other factors than stock market crashes to assess whether the economy is going through a recession or not.

Phases and forms of the economic recession

Economic downturn can come in different forms and stages, which can affect the severity and duration of the event. In general, recessions last around 10 months on average, but their duration can vary greatly depending on circumstances.
There are different types of recession curves, each of which differently describes how the economy behaves during a recession.

A common form of recession is a "V" recession, in which the economy experiences a sharp contraction followed by an equally rapid recovery. This type of recession can be caused by temporary events such as a financial crisis or a pandemic, and the recovery can be propelled by stimulus economic policies. The recession caused by the Covid-19 pandemic is a recent example.

Another form of recession is a U-shaped recession, in which the economy experiences a long period of contraction before gradually recovering. This type of recession can be caused by structural problems in the economy, such as a debt overhang or a reduction in innovation. An example of a U-shaped recession is that of Japan in 1993-1994.

A third form of recession is an "L" recession, in which the economy experiences a sharp contraction and then remains stagnant for an extended period. This type of recession can be caused by serious structural problems such as a sick banking system or high structural unemployment.

Finally, there is the "W"-shaped recession, characterized by a first slump, followed by a small recovery and a second (usually heavier) slump.

Whatever the cause, an economic recession is always a difficult time for a country’s economy, but the timely identification of the recession phases is essential for adopting the most appropriate policies to combat its negative effects on the economy.

How to avoid an economic recession

Avoiding an economic recession is a very ambitious goal, as many of the causes that lead to an economic crisis are beyond the control of individuals or single companies. However, there are some actions that can be taken to minimize risk and protect the economy. Among the economic policies that governments can use are:

Monetary policies: Monetary policies concern central bank action on the credit conditions of the economy. In the event of a possible economic downturn, the central bank can reduce interest rates, in order to make loans more accessible and to stimulate investment and household spending.

Public Spending Policies: During an economic downturn, governments can adopt public spending policies to stimulate the economy. These policies may include investments in infrastructure, tax incentives for businesses, support for research and development and welfare programs for families in difficulty.

Regulatory policies: Regulatory policies concern government action to regulate economic activity. In the event of a possible economic downturn, the government can adopt regulatory policies to stabilize the financial market, reduce loan default risks and protect consumers from unfair trading practices.

Trade policies: Trade policies concern government action to regulate international trade. In the event of a possible economic downturn, the government can adopt trade policies to protect domestic industry, incentivize exports and reduce dependence on imports.

Fiscal policies: Fiscal policies concern government action on public revenues and expenditures. In the event of a possible economic downturn, the government can adopt fiscal policies to reduce the tax burden, increase social transfers and incentivize business investment.

Companies and consumers can also implement actions to prevent crises. Specifically, businesses can maintain a constant focus on their balance sheets, avoid accumulating excessive debt and maintain sound financial management. Furthermore, companies should try to diversify their activities and expand their markets, in order to reduce their exposure to any crises in one sector. Consumers can do their part by not accumulating excessive debt and by trying to save for any difficult times.

Original article published on Money.it Italy 2023-04-06 06:56:00. Original title: Cos’è la recessione, (spiegata bene)? Le conseguenze sull’economia