Across the world, our economies are struggling with inflation, soaring energy prices, and the impact of Russia’s war in Ukraine! It is likely the many countries will enter a recession. But… what exactly is a recession? What causes recession? And how can we reverse a shrinking economy? Let’s answer these questions today, while learning some useful economic vocabulary!
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Market (n) – is the business or trade in a particular type of goods or services
The job market is strong right now
To shrink (v) – to become smaller, or to make something smaller
The company’s profits have shrunk from $10 million dollars last year, to just $2 million this year
Decline (n) – when something becomes less in amount, importance, quality, or strength
There is a decline in the number of unemployed people this month
Quarter (n) – one of four periods of time into which a year is divided for financial calculations
I pay my rent every quarter
Holistic (adj) – dealing with or treating the whole of something or someone and not just a part
My doctor takes a holistic approach to disease
Bubble (n) – a temporary period of very successful economic performance in a particular country or sector, often followed by sudden failure
There are worries that the current housing bubble may soon burst
Inflation (n) – a general, continuous increase in prices
Inflation in the UK has now reached 10%
Deficit (n) – the total amount by which money spent is more than money received
The country’s deficit is around $500 million
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What is a recession? You would think this should be an easy question to answer – they happen relatively regularly after all. Global recessions occurred in 2020 due to the outbreak of COVID-19, and famously in 2008 due to the US housing market crisis. I even recorded an episode on the Great Depression a few months ago – probably the most famous recession in history.
Now, it seems likely that some countries are already in recession, or will be in recession, by the end of the year. In Britain, for example, the Office of National Statistics announced the economy had shrunk in the second quarter of the year. The Bank of England predicts the UK will enter recession – and this recession will last around a year and a half.
Talk about recession is everywhere – so it must be easy to answer the question “what is a recession?” In reality, however, it is not so straightforward. The technical or academic defintion of recession often differs between countries and economies. The USA is currently experiencing a political fight over whether the country is, or is not, in recession. And Wikipedia have banned people from editing their page on “recession” because people kept changing the defintion.
Let’s take a look at a few different definitions.
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What is a Recession?
The simplest and least technical defintion of recession is a period of significant decline in economic activity. The National Bureau of Economic Research (NBER), the organisation responsible for determining whether the US is in recession or not, defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
A healthy economy is a growing economy. The value of the products and services produced by an economy gradually increases, and this makes the citizens of the country slightly richer on average. This is measured in terms of Gross Domestic Product or GDP.
When an economy is doing badly, GDP stagnates (so doesn’t increase) and perhaps even decreases. Rather than being a cause of economic problems, a declining GDP is a signal or indicator that something is wrong. When the economy is growing there is more money and people become slightly richer on average; when the economy is shrinking there is less money available, and people might stuggle financially
In some countries, including the UK, a recession is defined in terms of GDP. If the economy shrinks for two quarters (which is two three-month periods) in a row – then we say the country is in recession. When the Bank of England predicts that the UK will be in recession, they are predicting the GDP will fall for two consecutive quarters. Simple… right?
Well… not exactly. This is the conventional defintion used in some countries, but not all countries. Let’s think back to the defintion from National Bureau of Economic Research – a recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” Economic activity is far more than just falling GDP.
Many economists believe that just using GDP to determine recessions is an oversimplification and not matching with the reality of a country’s economy. A good metaphor is to think of a country as a person. If a person is sick how does a doctor diagnose them? Do they just take the patients temperature?
No – they ask questions about pre-exisiting health conditions and recent activity, and if needed have hundreds of different tests they can do. If they just check temperature, they won’t be able to accurately understand the problem. And the same in true for an economy – if you just check GDP, you might not be able to understand the real situation.
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How Do Economists Determine When an Economy is in Recession?
So, how do economists determine when an economy is in recession? Countries like the USA and Japan use a more holistic approach to examine data. In Japan, for example, recessions are determined by looking at things like employment, factory production, and retail sales as well as GDP.
The National Bureau of Economics in the US considers industrial production, personal income, consumer spending, employment, and more to determine recession. And, in these countries, there is no fixed and static rule that immediately qualifies the economy to be in recession. Instead, they consider the whole economy.
Therefore, the US is not technically in recession. Their GDP has fallen for the first two quarters of this year – which would be a recession in Britain, France, and Germany. When looking at the whole economy, however, the situation is more complicated. Unemployment is low and the US added 528,000 jobs in July. That seems healthy.
Another difference between definitions of recession is when the determination of recession takes place. The US, for example, does not predict recessions or even determine them right now. They wait until later when there is more evidence. Why would you do this? Well economic data is incomplete until months, sometimes years, later. Britain announced they were in recession in 2012, but in 2013 updated GDP figures revealed they never entered recession!
The debate over definitions of recession that is happening in the USA right now is mainly political. Recession is generally a bad thing, and a powerful tool in elections. The party in power usually loses during recession – Trump lost during the 2020 recession and the Republican candidate John McCain lost during the 2008 recession. Republicans in the USA are claiming the country is in recession, while the Democrats are stating that the US is not. And while the Democrats are correct – the US is not in recession based on the country’s defintion of recession, the economic situation is not good!
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Why do Recessions Happen?
Why do recessions happen? And why is there possible going to be a recession this year?
There are a lot of different reasons, causes, and factors that can contribute to recessions. Loss of confidence, stock market crashes, credit crunches, poor economic management, asset bubbles (like a housing market bubble), deflation, manufacturing slowing down, or the end of a war: all of these can and have caused recessions.
Often there is a mix of different factors that combine together to push an economy into recession. You can listen to my episode on the Great Depression of the 1930s to understand the causes behind the most devastating recession in history.
The 2008 “Great Recession” was triggered by the subprime mortgage crisis. Basically, banks allowed people to take out large loans and buy houses they couldn’t afford, and the investors, banks, and hedge funds invested in these mortgages (which were essentially junk or worthless).
And the 2020 recession was what is known as a “black swan event.” The outbreak of COVID-19 and the spread of a global pandemic shut down most countries’ economies. Shops closed, factories stopped production, people lost their jobs… the recession was caused by a unique crisis.
How about now? What is causing the current economic problems? There are a few factors, but massive increases in energy prices are a serious concern. Russia’s invasion of Ukraine has increased fuel prices as countries stopped buying Russian oil and gas, and increased food prices as Ukraine could no longer export grain. People’s incomes are falling relative to the soaring prices
China has also experienced an economic downturn which has had global ramifications, inflation is much higher than expected, and there are still the effects from COVID-19! It is likely economic problems will continue for a while.
What is the Impact of a Recession?
What happens in a recession? What are the impacts? How could it affect you and me?
When the economy is growing, this is good for most people. More jobs, more profitable companies, higher salaries, more money for the governemnt to spend, and better returns on investments – sounds great, right? The opposite of this happens when the economy is in recession.
The consequences of recessions depend on who you are and what type of job you do. But some people will lose their jobs. Pay rises will probably decrease, and it may be harder to get promoted. And people leaving school or university may stuggle to find a job. This is concerning for me, as I will probably start a job search in the next few months (unless I start making money from Thinking in English).
Importantly, the impacts of recessions are not universal or equal. They hit certain people harder than others. Inequality usually increases, and people with fixed incomes tend to stuggle more than people with salaries. People who rely on government support – like the disabled – are also negatively affected.
How Do We End Recessions?
There is no quick fix or easy solution to a recession. The methods used to return economies to growth vary depending on the cause of the recession and the political ideology of the politicians in charge!
One approach is cutting taxes. If people have more money in their pockets, they may be tempted to spend this, adding more money to the economy, creating jobs, and stimulating production. However, with inflation so high right now many governments are reluctant to reduce taxes.
Government spending is often at the heart of recession plans. One side believes government spending should be reduced – if the government spends less money and cuts services then they need less taxes and the deficit is reduced. The other side believes the government should spend more – public money can be used to generate jobs and increase salaries so that people feel confident to go out and spend more money.
Quantitative easing is another approach – basically adding more money to the market so that banks have more cash to lend to customers. With more money in the economy, this can be spread through businesses and individuals. However, it doesn’t always work that way – most banks just kept their extra cash in 2008 because it was too risky to increase lending.
And finally, the central banks could reduce interest rates. People and businesses with debt will have to pay less back every month, and loans are cheaper to borrow, meaning that there should be more free money to spend in the economy. This is what would usually happen… but in the UK the Bank of England has just increased interest rates because prices were increasing so fast.
It remains to be seen how governments around the world attempt to navigate the next few months of economic troubles!
Today I have tried to explain recessions. I talked about the different definitions of recession around the world and how economists determine whether a country’s economy is in recession. I discussed the causes, effects, and potential solutions to the problem of recession.
Even if your country won’t go into recession this year, it is quite likely it will do so at some point in the next decade – our economies grow and shrink fairly regularly. So, learning about recessions and how to talk about economic issues is important!
Will your country go into recession this year? What is the current state of your country’s economy? How should we define recession? What is the best approach to reverse the effects of recession?
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