What Is A Recession And What Are Its Consequences?

The media are scaring about economic recession, which should inevitably appear as a consequence of persistently high inflation and a radical increase in the main interest rates. Even in private conversations, you can often hear that many other countries in the world are threatened with recession. What is this?

Definition

In the economic literature, there is also a definition of recession as a decrease in GDP in two consecutive quarters, where annual dynamics in individual quarters are used to qualify the state of recession without removing the impact of price changes and the impact of seasonal factors.

According to John R. Meyer and D. H. Weinberg, a recession is "a period of decline in the general activity of the economy, having a wide impact on various areas of economic life, which lasts at least a year".

The terms recession, crisis and depression are synonymous and often used interchangeably. Economists who study business cycles consider the first two terms to be synonymous. After World War II, the term "recession" was often used instead of the term "crisis" (which was initiated by the NBER). However, it is believed that this is mainly due to psychological reasons (less negative reception of "recession"). On the other hand, "depression" is in practice a deeper phenomenon, defined as long-term and very severe recessions.

Types

Recession is often compared by researchers to the letters of the alphabet, which corresponds to the appearance of this stage on the business cycle chart, and at the same time helps to visually determine its duration and course.

Recession types:

"V" - the most common type: quick exit from the collapse, return to the growth rate before the recession in no longer than the period of falling into it,

"W" - after reaching the bottom of the cycle, the economy quickly recovers, only to collapse again (often deeper) and only after the "second bottom" go into recovery mode,

"U" - rapid entry of the economy into a recession, followed by a slowdown in further decline and remaining at a low level of development, it usually takes several years to return to the rate of economic growth before the recession

"L" - after reaching the lowest level, the economy is unable to return to a higher growth rate,

inverted letter "L" - a relatively quick, but short-lived recovery of the economy is interrupted by a long-term phase of stagnation.

In practice

From the point of view of economics, recession is a macroeconomic phenomenon that involves a significant slowdown in economic growth.

In general, a recession leads to a decline in domestic production, employment, investment and real wages. Instead of growing, the country's GDP is decreasing.

Mainly, the recession is visible from the side of entrepreneurs, where it manifests itself as disturbances in financial liquidity, downtime in production due to the lack of orders or materials needed for its implementation. At the level of individuals, i.e. natural persons who do not run a business, recession means higher unemployment and lower wages as well as impoverishment of the society. During a recession, the average citizen begins to spend less, which results in a decline in consumption across the country.

Causes

The causes of a recession can be very different. The most common causes of recessions include bad monetary policy and excessive state interference in the economy, and in particular in the financial system. War and natural disasters also have an impact on the occurrence of recessions.

Consequences

The most serious effect of the recession is the decline in gross domestic product (GDP). There is also a decrease in the value of goods and services. GDP decreases, which leads to negative economic growth. Among other, equally serious consequences related to the occurrence of recession, the following can also be distinguished: lowering real wages and incomes in society; decrease in capital expenditures; increase of unemployment; reduction in the level of labor productivity and growth rate; lowering consumer demand.

At the same time, along with the decreasing demand for consumer goods, a recession most often leads to a slowdown in price growth, and thus to a reduction in inflation.

What comes after a recession?

Many experts consider the recession to be the first phase of the economic cycle. According to this theory, a recession is followed by a depression, i.e. low levels of output, prices, interest rates, and employment.

How to prevent?

When anticipating a recession, stabilization (anti-recession) policy tools can be used, e.g. lowering taxes on enterprises (thus increasing the amount of investment in durable goods), reducing social spending (to stop the budget deficit from growing) or lowering interest rates (assuming that appropriate mix). During the beginning of the recession phase, it is possible to temporarily increase budgetary accidents, influence the weakening of the national currency exchange rate (which allows for a temporary increase in the competitiveness of export goods) or increase the protection of the internal market against the influx of imported goods, in a situation where it does not violate international agreements. Thanks to stabilization policy tools and properly conducted fiscal and monetary policy, recession can be prevented or mitigated.

Source: Begg D., Fischer S., Dornbusch R. (1997) Ekonomia. Makroekonomia