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In economics, a recession is a business cycle contraction, a general slowdown in economic activity.[1][2] During recessions, many macroeconomic indicators vary in a similar way. Production, as measured by gross domestic product (GDP), employment, investment spending, capacity utilization, household incomes, business profits, and inflation all fall, while bankruptcies and the unemployment rate rise.
Recessions generally occur when there is a widespread drop in spending, often following an adverse supply shock or the bursting of an economic bubble. Governments usually respond to recessions by adopting expansionary macroeconomic policies, such as increasing money supply, increasing government spending and decreasing taxation.
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In a 1975 New York Times article, economic statistician Julius Shiskin suggested several rules of thumb for defining a recession, one of which was "two down consecutive quarters of GDP".[3] In time, the other rules of thumb were forgotten. Some economists prefer a definition of a 1.5% rise in unemployment within 12 months.[4]
In the United States, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) is generally seen as the authority for dating US recessions. The NBER defines an economic 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."[5] Almost universally, academics, economists, policy makers, and businesses defer to the determination by the NBER for the precise dating of a recession's onset and end.
In the UK recessions are generally defined as 2 successive quarters of negative growth. (or 6 months)[6]
A recession has many attributes that can occur simultaneously and includes declines in component measures of economic activity (GDP) such as consumption, investment, government spending, and net export activity. These summary measures reflect underlying drivers such as employment levels and skills, household savings rates, corporate investment decisions, interest rates, demographics, and government policies.
Economist Richard C. Koo wrote that under ideal conditions, a country's economy should have the household sector as net savers and the corporate sector as net borrowers, with the government budget nearly balanced and net exports near zero.[7] When these relationships become imbalanced, recession can develop within the country or create pressure for recession in another country. Policy responses are often designed to drive the economy back towards this ideal state of balance.
A severe (GDP down by 10%) or prolonged (three or four years) recession is referred to as an economic depression, although some argue that their causes and cures can be different.[4] As an informal shorthand, economists sometimes refer to different recession shapes, such as V-shaped, U-shaped, L-shaped and W-shaped recessions.
The type and shape of recessions are distinctive. In the US, V-shaped, or short-and-sharp contractions followed by rapid and sustained recovery, occurred in 1954 and 1990–91; U-shaped (prolonged slump) in 1974–75, and W-shaped, or double-dip recessions in 1949 and 1980–82. Japan’s 1993–94 recession was U-shaped and its 8-out-of-9 quarters of contraction in 1997–99 can be described as L-shaped. Korea, Hong Kong and South-east Asia experienced U-shaped recessions in 1997–98, although Thailand’s eight consecutive quarters of decline should be termed L-shaped.[8]
Recessions have psychological and confidence aspects. For example, if the expectation develops that economic activity will slow, firms may decide to reduce employment levels and save money rather than invest. Such expectations can create a self-reinforcing downward cycle, bringing about or worsening a recession.[9] Consumer confidence is one measure used to evaluate economic sentiment.[10] The term animal spirits has been used to describe the psychological factors underlying economic activity. Economist Robert J. Shiller wrote that the term "...refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people."[11]
The bursting of a real estate or financial asset price bubble can cause a recession. For example, economist Richard Koo wrote that Japan's "Great Recession" that began in 1990 was a "balance sheet recession." It was triggered by a collapse in land and stock prices, which caused Japanese firms to have negative equity, meaning their assets were worth less than their liabilities. Despite zero interest rates and expansion of the money supply to encourage borrowing, Japanese corporations in aggregate opted to pay down their debts from their own business earnings rather than borrow to invest as firms typically do. Corporate investment, a key demand component of GDP, fell enormously (22% of GDP) between 1990 and its peak decline in 2003. Japanese firms overall became net savers after 1998, as opposed to borrowers. Koo argues that it was massive fiscal stimulus (borrowing and spending by the government) that offset this decline and enabled Japan to maintain its level of GDP. In his view, this avoided a U.S. type Great Depression, in which U.S. GDP fell by 46%. He argued that monetary policy was ineffective because there was limited demand for funds while firms paid down their liabilities. In a balance sheet recession, GDP declines by the amount of debt repayment and un-borrowed individual savings, leaving government stimulus spending as the primary remedy.[7][12]
A liquidity trap is a Keynesian theory that a situation can develop in which interest rates reach near zero (ZIRP) yet do not effectively stimulate the economy. In theory, near-zero interest rates should encourage firms and consumers to borrow and spend. However, if too many individuals or corporations focus on saving or paying down debt rather than spending, lower interest rates have less effect on investment and consumption behavior; the lower interest rates are like "pushing on a string." Economist Paul Krugman described the U.S. 2009 recession and Japan's lost decade as liquidity traps. One remedy to a liquidity trap is expanding the money supply via quantitative easing or other techniques in which money is effectively printed to purchase assets, thereby creating inflationary expectations that cause savers to begin spending again. Government stimulus spending and mercantilist policies to stimulate exports and reduce imports are other techniques to stimulate demand.[13] He estimated in March 2010 that developed countries representing 70% of the world's GDP were caught in a liquidity trap.[14]
Although there are no completely reliable predictors, the following are regarded to be possible predictors.[15]
Most mainstream economists believe that recessions are caused by inadequate aggregate demand in the economy, and favor the use of expansionary macroeconomic policy during recessions. Strategies favored for moving an economy out of a recession vary depending on which economic school the policymakers follow. Monetarists would favor the use of expansionary monetary policy, while Keynesian economists may advocate increased government spending to spark economic growth. Supply-side economists may suggest tax cuts to promote business capital investment. When interest rates reach the boundary of an interest rate of zero percent conventional monetary policy can no longer be used and government must use other measures to stimulate recovery. Keynesians argue that fiscal policy, tax cuts or increased government spending, will work when monetary policy fails. Spending is more effective because of its larger multiplier but tax cuts take effect faster.
Some recessions have been anticipated by stock market declines. In Stocks for the Long Run, Siegel mentions that since 1948, ten recessions were preceded by a stock market decline, by a lead time of 0 to 13 months (average 5.7 months), while ten stock market declines of greater than 10% in the DJIA were not followed by a recession.[21]
The real-estate market also usually weakens before a recession.[22] However real-estate declines can last much longer than recessions.[23]
Since the business cycle is very hard to predict, Siegel argues that it is not possible to take advantage of economic cycles for timing investments. Even the National Bureau of Economic Research (NBER) takes a few months to determine if a peak or trough has occurred in the US.[24]
During an economic decline, high yield stocks such as fast moving consumer goods, pharmaceuticals, and tobacco tend to hold up better.[25] However when the economy starts to recover and the bottom of the market has passed (sometimes identified on charts as a MACD[26]), growth stocks tend to recover faster. There is significant disagreement about how health care and utilities tend to recover.[27] Diversifying one's portfolio into international stocks may provide some safety; however, economies that are closely correlated with that of the U.S. may also be affected by a recession in the U.S.[28]
There is a view termed the halfway rule[29] according to which investors start discounting an economic recovery about halfway through a recession. In the 16 U.S. recessions since 1919, the average length has been 13 months, although the recent recessions have been shorter. Thus if the 2008 recession followed the average, the downturn in the stock market would have bottomed around November 2008. The actual US stock market bottom of the 2008 recession was in March 2009.
Generally an administration gets credit or blame for the state of economy during its time.[30] This has caused disagreements about when a recession actually started.[31] In an economic cycle, a downturn can be considered a consequence of an expansion reaching an unsustainable state, and is corrected by a brief decline. Thus it is not easy to isolate the causes of specific phases of the cycle.
The 1981 recession is thought to have been caused by the tight-money policy adopted by Paul Volcker, chairman of the Federal Reserve Board, before Ronald Reagan took office. Reagan supported that policy. Economist Walter Heller, chairman of the Council of Economic Advisers in the 1960s, said that "I call it a Reagan-Volcker-Carter recession.[32] The resulting taming of inflation did, however, set the stage for a robust growth period during Reagan's administration.
Economists usually teach that to some degree recession is unavoidable, and its causes are not well understood. Consequently, modern government administrations attempt to take steps, also not agreed upon, to soften a recession.
The full impact of a recession on employment may not be felt for several quarters. Research in Britain shows that low-skilled, low-educated workers and the young are most vulnerable to unemployment[33] in a downturn. After recessions in Britain in the 1980s and 1990s, it took five years for unemployment to fall back to its original levels.[34] Many companies often expect employment discrimination claims to rise during a recession.[35]
Productivity tends to fall in the early stages of a recession, then rises again as weaker firms close. The variation in profitability between firms rises sharply. Recessions have also provided opportunities for anti-competitive mergers, with a negative impact on the wider economy: the suspension of competition policy in the United States in the 1930s may have extended the Great Depression.[34]
The living standards of people dependent on wages and salaries are more affected by recessions than those who rely on fixed incomes or welfare benefits. The loss of a job is known to have a negative impact on the stability of families, and individuals' health and well-being.[34]
There is no commonly accepted definition of a global recession, although the International Monetary Fund (IMF) regards periods when global growth is less than 3% to be global recessions.[36] The IMF estimates that global recessions seem to occur over a cycle lasting between 8 and 10 years. During what the IMF terms the past three global recessions of the last three decades, global per capita output growth was zero or negative.[37]
Economists at the IMF state that a global recession would take a slowdown in global growth to three percent or less. By this measure, four periods since 1985 qualify: 1990–1993, 1998, 2001–2002 and 2008–2009.
The most recent recession to affect the United kingdom was the late-2000s recession.
According to economists, since 1854, the U.S. has encountered 32 cycles of expansions and contractions, with an average of 17 months of contraction and 38 months of expansion.[5] However, since 1980 there have been only eight periods of negative economic growth over one fiscal quarter or more,[38] and four periods considered recessions:
For the past three recessions, the NBER decision has approximately conformed with the definition involving two consecutive quarters of decline. While the 2001 recession did not involve two consecutive quarters of decline, it was preceded by two quarters of alternating decline and weak growth.[38]
Official economic data shows that a substantial number of nations are in recession as of early 2009. The US entered a recession at the end of 2007,[41] and 2008 saw many other nations follow suit. The US recession of 2007 ended in June, 2009[42] as the nation entered the current economic recovery.
The United States housing market correction (a possible consequence of United States housing bubble) and subprime mortgage crisis has significantly contributed to a recession.
The 2008/2009 recession saw private consumption fall for the first time in nearly 20 years. This indicates the depth and severity of the current recession. With consumer confidence so low, recovery will take a long time. Consumers in the U.S. have been hard hit by the current recession, with the value of their houses dropping and their pension savings decimated on the stock market. Not only have consumers watched their wealth being eroded – they are now fearing for their jobs as unemployment rises. [43]
U.S. employers shed 63,000 jobs in February 2008,[44] the most in five years. Former Federal Reserve chairman Alan Greenspan said on 6 April 2008 that "There is more than a 50 percent chance the United States could go into recession."[45] On 1 October, the Bureau of Economic Analysis reported that an additional 156,000 jobs had been lost in September. On 29 April 2008, nine US states were declared by Moody's to be in a recession. In November 2008, employers eliminated 533,000 jobs, the largest single month loss in 34 years.[46] For 2008, an estimated 2.6 million U.S. jobs were eliminated.[47]
The unemployment rate in the US grew to 8.5 percent in March 2009, and there were 5.1 million job losses until March 2009 since the recession began in December 2007.[48] That was about five million more people unemployed compared to just a year prior,[49] which was the largest annual jump in the number of unemployed persons since the 1940s.[50]
Although the US Economy grew in the first quarter by 1%,[51][52] by June 2008 some analysts stated that due to a protracted credit crisis and "rampant inflation in commodities such as oil, food and steel", the country was nonetheless in a recession.[53] The third quarter of 2008 brought on a GDP retraction of 0.5%[54] the biggest decline since 2001. The 6.4% decline in spending during Q3 on non-durable goods, like clothing and food, was the largest since 1950.[55]
A 17 Nov 2008 report from the Federal Reserve Bank of Philadelphia based on the survey of 51 forecasters, suggested that the recession started in April 2008 and will last 14 months.[56] They project real GDP declining at an annual rate of 2.9% in the fourth quarter and 1.1% in the first quarter of 2009. These forecasts represent significant downward revisions from the forecasts of three months ago.
A 1 December 2008, report from the National Bureau of Economic Research stated that the U.S. has been in a recession since December 2007 (when economic activity peaked), based on a number of measures including job losses, declines in personal income, and declines in real GDP.[57] By July 2009 a growing number of economists believed that the recession may have ended.[58][59] The National Bureau of Economic Research announced on 20 September 2010 that the 2008/2009 recession ended in June 2009, making it the longest recession since World War II.[60]
Many other countries, particularly in Europe, have undergone decreasing rates of GDP growth. Some countries have been able to avoid a recession but have still experienced slower economic activity, such as China. Australia was able to maintain positive growth throughout the late-2000s (decade) recession.
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