Understanding Recession

Asevere or long recession is referred to as an economic depression. A devastating breakdown of an economy (essentially, a severe depression, or a hyperinflation, depending on the circumstances) is called an economic collapse.

What causes recession?

The reasons behind economic downturns remain largely unsolved. However, there are several traditional explanations to the phenomenon.

The traditional explanation Economy-wide changes

The traditional explanations postulate that recessions are caused by events that have an economy-wide impact, such as:

* an increase in interest rates;

* decline in consumer confidence;

and,

* firms reduce output and lay off workers, which further decreases demand, and the economy slows even more.

Caused by events that hurt particular firms or industries

Economic recessions can be caused by events that would have an impact on specific companies or industries. For instance, a major innovation can adversely affect some firms, causing them to reduce production. This would in turn lead to a retrenchment of workers. On the other hands, positively impacted companies would need extra hand and seek additional workers.

It naturally takes time for displaced workers to find new means of employment. During this phase of “reallocation” a situation of recession may occur.

What happens during recession?

Rise of Unemployment rate

During a recession, there is a general trend of rising unemployment rate and decreasing overall output.

With fewer people contributing to the economy, the overall economy is bound to be affected. Income growth would be stalled. While there would be more people in the market looking for employment, the demand for recruiting people is far lesser.

When people are earning lower incomes, their spending power decreases. As such, there is a reduction in spending. Businesses are limited in their ability to pass along any increases in expenses in the form of higher prices. In order to move goods off the shelves, businesses are more likely to reduce prices. This eventually causes deflation.

With prices drifting downward and commodities becoming more affordable, consumer spending will once again kick off and increase. The increase in consumer spending, over time, leads to an increase in industrial production. This in turn improves corporate profits leading to increased employment and improved earnings, etc. This is how the economic cycle takes place.

That’s why people say economy won’t grow continuously without recession.

Stock market plummets

People are generally conservative during recession. Those who lose their jobs because of recession start selling off their investments because they need money to sustain while they get another job. The increased number of people selling their stocks causes the stock market to fall sharply.

Real Estate plummets

During a recession, people turn to fiscal conservatism. This affects the real estate industry as well, as there is less demand in the real estate market. People put off buying and selling of property during an economic recession. Another scenario is where increasing levels of unemployment during a recession cause affected homeowners to sell their home to accommodate changing job demands.

On the other hand, because of the higher supply of houses on sale as compared with the low demand, an economic recession will forcefully reduce the selling prices of homes. As such, the economic recession has a positive impact on potential homebuyers. This is also because there are lower mortgage rates that are caused by changes in interest rates.