Recession (economics)

Recessions have punctuated the growth of the major economies from time to time since the 18th century, causing losses of productive capacity and of human capital. Various remedies have been tried, and it was thought for a time in the late 20th century that a cure had been found. The Great Recession has put an end to that belief and has created a renewed interest in the phenomenon.

Terminology

The terms recession and depression are used colloquially to describe any deep or persistent decline in economic activity, (and sometimes to a persistent reduction in the rate of growth of ouput). More precise definitions have been adopted the statistics authorities. In the United States the National Bureau of Economic Research defines a recession as

a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale retail sales

Other authorities have not adopted a formal definition of recession but most commentators and analysts use

a period of of negative growth of real (inflation-adjusted) GDP lasting for at least two quarters.

The term double-dip recession refers to a second fall in economic growth following an aborted recovery from a recession, such as occurred in the 1937-39 phase of the Great Depression. The terms downturn, and "trough" are used to denote the onset of negative growth, and the point at which positive growth resumes.

Before 1930, what are now termed recessions were referred to as "depressions". That term is nowadays reserved for exceptionally severe or prolonged recessions. Again there is no formal definition, but it has been suggested that the term be applied to a decline in real GDP that exceeds 10%, or one that lasts more than three years.

The causes of recessions

The causation of recessions is a topic of continuing controversy among economists, and is at the heart of the study of macroeconomics, but there is general agreement concerning some of their common characteristics. By common consent a recession is generally triggered by a failure of the market mechanisms that normally keep supply in line with demand. The result is a deficiency of demand, meaning that suppliers are unable to sell their output - and that, in particular, many people find themselves unable to get employment (a simple explanation of its occurrence is provided Richard Sweeney's baby-sitting analogy). The breakdown of the market mechanism is often triggered by an economic "shock" that reduces consumer confidence.

Recessions have commonly been brought about by sudden increases of commodity prices, or by credit shortages resulting from financial crises. As a result, consumers and firms are prompted (or forced) to cut back on their spending. The fall in spending then prompts suppliers to run down their stocks, which depresses activity among their suppliers and causes a further fall in aggregate demand. Previously employed resources of capital and labour fall out of use and a growing output gap develops between actual and potential output (which is reflected in a gap between the growth rate of GDP and its former trend) and there is an increase in unemployment. A recovery normally follows as prices fall in response to the reduction in demand, and as benefit payments and other social security payments rise. As consumer demand recovers, re-stocking by suppliers tends to speed the recovery in economic activity. (According to the "Zarnowitz rule", the steeper the initial downturn in activity, the more rapid will be the subsequent upturn (but that rule may not hold for balance sheet recessions).

A more persistent form of recession (termed a balance sheet recession ) can develop when consumers and firms find themselves unable to roll-over their debts because the bursting of anasset price bubbles had reduced the value of the collateral at their disposal. The reductions in spending required to achieve the necessary debt reductions (sometimes called deleveraging) continue until sustainable debt levels have been restored.

Remedies

Until the 1930s, the prevailing attitude to recessions was passive acceptance - in accordance with the teaching of the Austrian School of economics. Harvard's Joseph Schumpeter argued that "depressions are not simply evils, which we might attempt to suppress, but forms of something which has to be done, namely, adjustment to change.". In the 1930s, limited use was made of public expenditure to counter the Great Depression, and the use of fiscal stimuluses as proposed by John Maynard Keynes gained general acceptance in the 1940s. That remedy was widely abandoned in the 1980s in favour of the use of monetary policy to regulate the output gap by varying short-term interest rates. In the course of the Great Recession of 2007-10, that form of monetary policy was augmented by the use of quantitative easing o expand the money supply, and there was a temporary return to the use of fiscal policy.

The costs of recessions

Recessions impose costs on the community in terms of loss of output, and of reductions in the well-being of its people.

The loss of output that occurs during a recession may be accompanied by a loss of productive capacity, because of reductions in physical capital, human capital or social capital, leading to a drop in the level from which output growth resumes.

Workers that lose their jobs have suffered psychological damage as well as losses of income, and it has been estimated that the psychological harm may have been as much as three times as important to them as the loss of income . Fear of unemployment is also psychologically harmful, even to the extent of being an important predictor of psychological symptoms. The loss of employment by family wage earners has been found to be particularly burdensome because it cuts deeply into their sense of obligation, their identity, and their status; and unemployment after marriage has been found to increase the incidence of divorce. . It has also been found that unemployed men are less healthy and have a higher mortality than employed men .

The social costs of recessions are increased if governments reduce social security spending in order to offset the inevitable fall in tax revenues without increasing their borrowing. Such was the common practice before the second world war. It is unavoidable for a country whose government cannot increase its borrowing because its level of debt is already near the limit of fiscal sustainability, and it happens to any country whose government is ideologically debt averse.

The fiscal effects of recessions

(further treatment of this topic is available in the article on fiscal policy)

The component of a country's budget deficit that arises from recession-induced falls in tax revenues and increases in social spending is termed its cyclical deficit, to distinguish it from the structural deficit that persists in the absence of recessionary influences. However, there is often a recession-induced increase in a country's structural deficit as a result of a permanent loss in productive capacity. A country's fiscal sustainability depends upon the product of its public debt as a proportion of its GDP, and the difference between its GDP growth rate and the interest rate payable on its bonds. Consequently it can be improved by measures that reduce the public debt, by measures that increase GDP growth, and by measures that reduce the fears of default on the part of bond market investors.

Recessions in history

The nineteenth century

There are reported to have been eleven recessions of varying severity in the United States between 1865 and 1900 the worst of which was the panic of 1893 in which a monetary crisis led to the failure of 500 banks and an unemployment rate of over ten per cent.

In Britain there were credit-related recessions in 1826 and 1847, and an exceptionally severe downturn in 1858 which was partly a reflection of events in the United States , and a downturn in 1890 triggered by the failure of the Barings bank due to losses affecting its Latin American investments.

The episode that was colloquially known as the "Great Depression of 1873" may not even have been a recession as that term is now defined, but only a protracted reduction in economic growth that continued intermittently until 1895 (although, according to definition used by the United States National Bureau of Economic Research, there were several recessions during that period ). Its distinguishing feature was its length rather than its depth, and also the fact that it had an unprecedented international impact

The twentieth century

The only major international recession in the inter-war years was the global Great Depression that followed the American stock exchange crash of 1929 the triggering of which has variously been attributed to the bursting of a speculative stock exchange bubble and to a monetary shock administered by the United States Federal Reserve System, leading to persistent deflation. From its origin in the United States, it spread to other industrialised countries, resulting in massive unemployment and human suffering. It lasted in the United States from 1930 until the outbreak of the second world war in 1939.

The most important of the international recessions that occurred in the post-war years of the twentieth century were the global recession of 1973, triggered by the sudden rise in the price of oil, and an Asian recession in the 1990s triggered by the bursting of a real-estate bubble and the consequential development of the Asian banking crises.

In addition to the international recessions there were numerous national recessions .

The twenty-first century

The Great Recession of 2007-2010 is largely attributable to the banking and credit crash of 2008 which was triggered by the bursting of a speculative real-estate bubble in the United States, and the following subprime mortgage crisis.