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The Recession: Causes and Effects

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Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Published: Tue, 20 Feb 2018

Executive Summary

Introduction

There was a recession in United States in the late 2008 which carried away in the 2009 as well making an impact on the entire world. The inflation rate soared high with all the things expensive around the corner. A person’s earning power and purchasing power, everything reduced and in fact in some countries it ended. People started saving and cost cutting on almost all the objects and almost in all the aspects of life. The demand for the goods reduced and thus the supply which impacted on many jobs around the world. People were fired from the job without any prior notice. A majority of the population went unemployed. Every consumer started saving in the maximum way they can. There was a situation of panic in almost all the houses in different parts of the world. The stock market got crashed and so as the banks. Banks lost their clients, people started living and enjoying inside their house. Corporate reduced their expenses in the form of salaries and job cuts. People travelling in business class started travelling in economy. It was a major blow for the world all over. Money lost its value. Developed nations were the worst affected. No investors were ready to invest further money. But there was also few countries like china and India where this panicked situation did not occur. Although, it did reduced their balance of payment and trade but it did not made much impact on the people living in these countries. They were much relaxed in comparison with different parts of the world. India has developed its own domestic market which never tried to made an impact of the recession. Exports were reduced and so does imports, There were jobs cuts for the BPO’s but there were many alternatives to the people for the jobs. US economy did made around 60 percent of the impact on India but the impact were actually not seen anywhere in India.

India has developed its domestic market quite strongly. It has all the local tradesman and local customers. Although there were price rises in some of the few products but they were never taken seriously by the Indian people because the country is used to high and low prices because of the changing government on random basis. The living standard of people in India were still increasing at the time of the recession when the rest of the world were affected by the high rising costs of everything and were into the “Saving Mode”. In another words there was an economic downfall in India and could not be called as “Recession”.

Recession:

The standard text book definition of a recession is:

“Negative Economic Growth for two consecutive quarters”. This means there must be a fall in real output for a period of 6 months.

However, not all of them as analyst/economists are happy with this definition. The reason being this are:

  1. Rise in Population: If the population increase is by a single percent in a year. The Real GDP growth of a half percent will mean the decline in the GDP per Capita. Therefore, a country like USA, where the population is increasing day by day, it is really important to have a check on it.
  2. Inaccurate Statistics: Generally Gross Domestic Product statistics are not accurate and they need to be amended. So, In consequence of that, if there is a growth of 0.4%,that actually means the growth is declining by 0.3%. Sometimes, the economist rounds up the figure and use it in the practical calculations.
  3. Growth under incline Rate. If dimension is growing by an average of 3 percent every year, this means there is an economic growth of 0.9 percent every year, which means there is an increase in spare capacity and hence, it is likely to raise the percentage level of unemployment. Hence, Few economists suggests, there is a recession if there is a rise in spare capacity. But, its a confusing statement as it means growth in the economy of about a percent means a phase of the recession. Also, according to some economist, it refer to a beginning phase of the recession and deep decline in growth rate are the special features of the recession.
  4. Level of Unemployment. The most important discussion and the area of concern at the time of recession is the rise in the percentage level of unemployment. If there is a sharp increase in people’s losing jobs and getting unemployed, this shows an economy is in recession. It might be quite controversial to say about this situation that it is not in recession if the unemployment level has risen up by half a million in spite of the country’s positive growth. A point of consideration here is about the level of unemployment rise which is caused by the supply side and not the demand side factors.
  5. Result of Survey: Give a thorough research on the topic with the world’s economists and it will be quite interesting to find their subjective response. According to few economists, a figure less than fifty percent decline to accept the economic recession in USA and vice versa.

NBER Definition of Recession- NBER announces the occurrence of the recession in USA. The definition by NBER is: 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.

NBER further tells us that:

“There is no fixed rule about what weights are assigned to the various indicators, or about what other measures contribute information to the process.”

This statement is quite clear about the recession but it is not certain about the time period or its occurrence time and what exactly can cause the recession.

Recession – My personal View

According to my personal view, recession occurs when there is a decline in real GDP. If there is a small growth of say,0.4 percent we can expect a recession or at least we can say that the economy is well behind the trend growth. However, we should always consider the point that a recession does require a decline in Gross Domestic Product for at least one quarter. Also, in brief, we can say, recession is a steep decline in Real GDP per Capita.

Depression is defined as:

‘Depression is when a person looses his job and he do not have any money flowing into his account to support his family.’ Drastic decline in the real GDP causes a situation of depression. It is when the productivity of the output falls for more than eighteen months or by more than, four percent. There was a steep decline in the great depression of 1929-33 of almost eighteen percent.

so there is a difference between A recession and A depression. And the idea behind this ,is, the scenario between recession and depression is known as Economic Downturn.

Therefore, an economic downturn is the balanced structure of recession and depression.

Indicators of Recession

The economist involved in the financial and advisory fields generally mention the stock market situations as an indicator of recession. According to them, In Western Europe and North America, the prediction of the recession can be made by sudden and sharp decline in the average performance of the share market. These performances can be checked by DowJones or Standards & Poor’s 500 index.

However, this definition seems to be quite insufficient. By looking into the history of the stock market, about their high and low stock indicators, gearing up with the past seventy years of the analysis report nothing has been found that could be relevant with the definition or is even closer to the definition of the recession.

Moreover, if we analyse the current recession or the recessions of the past two decades, it does demonstrate a downfall of the stock market. But if we analyse it carefully we will find all the stock market crashed after the recession came in. Therefore, we can’t take it as the indicator of recession rather than it just tell us one factor responsible and effected at the time of recession.

To measure the inbound recession, the best measurable indicator is an inverted yield curve. Inverted yield curve shows the point on which the investments in long term fall (specifically, those holding a period like as term deposit) under the yields on the deposit of short term. This shows the utmost importance of the identification of the market itself. The yields and pricing on investments generally relates to the demand and supply models. If the value of the money is going to decrease in the future, it is going to be a problem for the borrowers and lenders as well. No one will borrow the money on high rates and the lenders will have the affect of it. No person will ever borrow money when the value of the money will depreciate. Therefore, when we calculate and formulate the risk, it makes sure that the market observes a decline in the upcoming value of money, which includes the rate of the price and rate of the yield.

Market yield is determine by the expectations of the investors, risk prising and knowledge about risk and if in long term the yield gets shortened, the economy is going to be in the same level. Therefore, the further market expectations can be predicted on the basis of the yield curve. According to the experimental data, this works in the reality as well and not only theoretically. Although, the yield curve is not so perfect but the little knowledge and understanding of it by the borrowers, investors, and individuals give them enough understanding to handle the market in a better position than anyone else. They are likely to make few rational decisions on based of these calculations. On the basis of the calculations figured out of the above yield, five out of the six inverted yield curves in the past thirty years have predicted a weak economic environment, which is said to be an informal decision about the recession. Quite interesting to see this theory of risk pricing is in correlation with the quality of the recession predicted. At the time of recession, say, at the present scenario, most of the investors are not ready to take risk and trying to withdraw the money from the invested market. There is no investment at the moment where the investors can expect a good return and so they are trying to sell off their /shares and have control on their money. Due to the risk involve at the moment for loss off all the money invested, they are particularly thinking to invest in the best safest place which they can think off so that the money can be in circulation. These safe investments are called as “quality investments”.

At the end, NGO’s along with the conference board has published an index of leading economic pointers which can be used in the prediction of the economic activities and the business cycles. This index has the listing of ten itemised observance and many more subjective metrics in consumer’s behaviour with the calculations of the hours per week they work. This index made an experiment of the recession which tried to figure out the recessions of the past fifty years and was successful enough to predict around two hundred percent of the times of the economic withdrawals which had actually been in the past. This helps them in getting a solid base knowledge of the occurrence of the recession and their indicators. This knowledge can help investors in knowing the correct time of investing money and coming out of it and they can predict accurately about the business cycles, recessions occurrence time and other effective economic metrics can help them to move out or stay decisions to rent profits from the investments which they make to generate their revenue and income with a strong level of prediction of the uncertain cause of the economic recession. However, most of the experts say, that the current knowledge of this is not going to give any outcome in the near future as the situations differ from time to time and it will be of no use by predicting from the historical data’s. This might be wrong and investment decision can still be risky in the future, if by using the same method of historical dates.

Causes of Recession-

Fall in the aggregate demand also commonly known as AD is one of the important cause of the recession. Following are the causes of decline in AD in United States in the recent time:

  1. Credit Crunch: there has been lots of difficulty of borrowing the money in the US because of the high mortgage defaults. Many banks and financial institutions lost their money and after that they were quite reluctant in lending money. This made borrowing a very expensive method which leads to the less investment by the consumer. Investments were quite low which made the shortage of the money in the market.
  2. Defaults in Mortgage: companies introduced introductory offers for the people taking mortgage instantly and when this introductory offer ended, the interest rates increased which made it quite expensive. People’s disposable income got reduced and which lead to default in the payment of mortgage rates by the people.
  3. Rising Costs: There has been an increase in the oil prices, energy rates and food prices which increased the production cost in almost all the things which lead the Aggregate Supply (AS) curve to shift from right to left. Lower income consumer can’t afford the costly and expensive times due to which the demand got reduced and became a cause for the recession.
  4. Decline in the House Prices: Loosing the value of assets is quite trouble giving situation to the households. This situation reduces consumer’s wealth and it prevents equity withdrawal through remote gagging. With decline in house prices consumers tend to spend less because of the depreciating value of their money and assets.
  5. Bankruptcy: The financial institutions and banks like Bear Sterns and Northern Rock going bankrupt made people fear of spending the money. They were now, more into savings and prefer staying at home rather than moving out.

According to Keynesian theory-“ Fall in AD will result in Fall in Real GDP.” Real GDP effects depends upon the slope of the Aggregate Supply curve. Lets assume, the economy being very close to the highest level, then the lower Aggregate Demand curve would shift a bit and cause a very small fall in Real GDP.

Decline in any of the constituent can cause economic crisis.

Example, Say-MPC= x, cost of borrowing=y

If “X” increases the interest rate by 4%, “Y” would also increase which in turn will make saving quite attractive. Therefore, the consumers will save more and spend less. Spending will be only done on the basic requirements which will benefit them in lots of savings. On the other hand, if the government increases the tax rate and lower its spending, Aggregate Demand would fall as well.

Let’s see the above figure. If we assume, there is a decline in Aggregate Demand then the multiplier effect may magnify the initial downward movement in the point “A”. Let’s take an example of the factory where the production of the factory reduces, then definitely, the company would try to cut its cost and would reduce the labour from its factory because that will save them extra money. Now, as these workers are jobless, they are going to spend very less which will cause a secondary decline in Aggregate Demand, which will make the fall in Real GDP to a great extent.

A positive rate of economic growth can be determined by consumer satisfaction level and the business growth level. If everything goes positive and there is a satisfied market then there won’t be any reduction in the demand even if the interest rates are hiked by the banks and the government.

Moreover, if people are unsecured about their job and finances, they will start saving and spend the minimum they can, Which will cause the Aggregate Demand to decline or may be move at very slower rate. Hence, the consumer’s predictions and expectations of the future should be safe and secure which might be very helpful in the circulation of money and the well balanced demand and supply curve.

Example: Let’s assume a country, say -United Kingdom. The most important feature of the country is based on International trade. Therefore, if there is a recession in other parts of the world the country will get affected as demand for their products will decline, and the export margin for the country will also decline due to the very less demand from the international boundaries. And this cycle will repeat in the UK’s economy as well, where people’s demand will also reduce leading to the economy into the crisis.

According to the classical economist’s beliefs, If there is any decline in Real GDP, they won’t be permanent and will come to the finishing point when the labour markets get set themselves to the new price margin. They also argue on the point, If there is a decline, no matter big or small, in the Aggregate Demand, there will be fall in Real GDP. Hence, with a small shift in the price margin, wages will fall and finally SRAS will have a positive shift towards the right and gradually it will benefit in the economy returning to the original level at YF and the recession will come to an end.

But, speaking harshly on these above valuations about the great depression of 1930, Keynes said, the long period of negative growth points about the markets show that they can’t get clear automatically. He argued on the following reasons:

  1. Whenever there is a situation of recession, people have the tendency to save more rather than spend. They try to do savings as much as they can as they are really unsecure about the upcoming days, this is known as “Paradox of Thrift”.
  2. The factories or the business segments cut the wages and salaries to reflect downward movement in the prices but originally the workers are really harsh on it because a reduction in the salary/wages does not give them enough purchasing power and saving power.
  3. Now, if the salaries are deducted of the employees/workers, they would have less purchasing power, therefore, the demand will fall which will make the total impact on the AD curve, which will continue to decline at a rapid pace.

Keynesian policies: An inspirational success

Keynes introduced the power of elimination of the fear of people of depression with the practical examples.

Before the Second World War, there were 8 U.S. recessions which got transformed into the situation of depression (1807, 1837, 1873, 1882, 1893, 1920, 1933, and 1937). Since the Second World War, there were 9 recessions (1945-46, 1949, 1954, 1956, 1960-61, 1970, 1973-75, 1980-83, and 1990-92) – out of which not a single recession transformed into the situation of depression.This is a wonderful gift to the world by Keynes.

Supply and demand factor

When there is an excess of supply and demand in the market, a recession can take place within an international boundary which can later spread to the entire world. When the industries hire more and more labour and start the production at maximum level with the perception of the high demand in the market, they get a set back if the taste of the consumers has changed. When this situation arises supply in excess can cause the company loss and can be forced to reduce the prices. The companies then try to regain the loss by cutting employment and getting rid of the produced items. So in this case the excess supply factor would reduce and can be very slow.

Along with this there is another situation which does occurs frequently from the side of the consumers. When the consumers demand is more than the supply side, the industries take benefit of it by increasing the prices of the products and by reducing the production of its products. And at this time, the products prices will be higher than it used to be because of the scarcity of the products in the market. Now, the consumers think, that the prices can exceed further, therefore, they buy the products in lots of quantity to satisfy their needs and excess demand. These poor industrial balances start giving a hint of industrial recession which spreads in the market affecting everyone. The supplier as well as consumers gets affected by this.

Inflation

A smaller amount of increase in the price value can click the beginning of the recession in the world market. The price value of all the domestic products like sugar, oil, wheat, rice, fruits, vegetables increases and become very costly which are not easily affordable.

Not only the domestic products prices, but the price of oil also increases with rapid speed. At the moment, if we check the oil prices in the world, they have increased to huge height. The United States makes an impact on the entire world and the economists have warned them to stay in a planned economy to escape the recession or else they along with themselves will carry the entire world into the recessions. This warning should be the wake up alarm for all the countries including the USA.

Crash in the Stock Market

The crash in the stock market leading to fall of all the share prices is also one of the main reasons for the recession. The United States attacked Iraq which caused a major country’s revenue and put the entire country in the pressure of monetary problems also led the country lead into recession. According to the local people and share brokers, this war made an impact on the share market of USA which led to the decline in the prices value of the shares. The anti protection team were made against terrorism causing again the huge revenue for the country which resulted in the sharp decline in the share prices. Due to terrorism not only USA but the entire world’s share market is going down which is an issue of major concern.

Selling of the Stocks

By the alarming situation of the war, inflation, deflation, hyper inflation, catastrophe people start trading their shares on the large basis. The large investors sell out their shares at very cheap rates and get their money back due to the fear of loosing them. This also marks the factor of the inflation. In the year 2008, there was maximum trade of shares and the value of all the shares were at the bottom level.

Saving factor of House Holds

Most of the consumers are saving the money which is not allowing the money to rotate in the current market. The money is kept safely under their respective homes. Middle class families are quite resisting in going out and spending rather than keeping their pockets in tacked for the future. Majority of the money is owned by rich class people and even they are not exposing their money. This means, the money’s rotational nature is stopped and hence, the situation of recession is getting worse day by day.

High consumption

One of the major causes of the recession is over consumption. People’s attitude of taking the life into a luxurious manner makes them overspend in the form of getting more and more luxury items. They want to build their standard of living and want to show off in the society. Everyone tries to compete with each other in terms of fashion and high status. Along with this the purchases of the luxurious health beauty costumes also make them spend on these products and the reason behind this is just “Show Off” in the society. Going to the expensive restaurants and having the most expensive food with lesser and higher quality also marks their standards. This excessive consumption of money has leaded the world fall into recession and poverty. United States invested billions of dollars into its war with Iraq which made economists alarmed them to be cautious about their future planning and also the consumption of the money in a more better and organised manner.

Contamination in the Asian market

The terrorism threats in Asia are causing the United States under an absolute pressure of recession. USA is taking major steps to avoid the terrorist attacks and threats in Asia and implementing its policies towards it to control the situation otherwise which can make a huge negative impact on the world. The major economic activity in the continent has been on the diminishing line on the graph which can cause the world a very huge burden of the recession which may be later converted into the situation of depression. Dirty environment, poverty, deflation, flood, hyperinflation, stock market downfall are some of the factors which are the areas of concerned in the continent. All these has made the United States quite interested in the enquiries towards the factors of recession and trying to take control of the difficult situation which may be very harmful to he world.

The money supply’s expansion is the work of the Chairman of the Federal Reserve Board. He is the one who can influence the economy without much notice. He can take immediate decisions on the raise or drop of the interest rates which can be even by fifteen percent. He makes the economy run by developing the movement of unemployment or the balance of the demand and supply. There have been many chairmen who were quite successful in managing the floatation of the interest rates but some were not successful as well. It has been agreed by all the economist, the person who can control the money supply should be enough influential and enough intelligent to handle it.

On contrary, President of the United States has influence only on the long term on the economy. The decision taken by him at the time of his rule, they are implemented on a long term which may come into action even after his term gets over. Borrowing and spending decisions also take considerable time to pass through all the stages of confirmation and then getting it implemented in the economy.

Therefore, the president is not at all responsible for the recessions as many people point the situation towards them. It’s the chairman of the Federal Reserve who is responsible for the economic imbalances in the country. Many economists have agreed on this and has announced as injustice done to the presidents. There have been examples in the US economy where actions have been taken against the then presidents at the time of recession, which actually is not correct at all. Carter was punished for that high unemployment and inflation in the country and so as George Bush. However, if it was the president who was controlling the money supply they will be considered into the merit list.

Impact of Recession

The people’s purchasing power reduced as the companies reduced their labour and the workers still with them got cuts in their salary. Therefore, when the demand was low, production was low. All the prices of the small to big things became costly and people started saving rather than spending. Frequent flight travellers used trains as an alternative and similarly, in all the things in the market, consumers started opting for the cheaper substitutes which made a heavy impact on the business industry. The stock prices crashed down and people lost their life time savings in the stock market. Banks announced their loss or some banks did announce their bankruptcy as well.

Historical review of recessions

Recessions in the world

Due to the unavailability of the proper acceptance of the definition of a global recession, IMF considers global recessions when the global growth is less than 3%. According to the estimates of IMF, global recession does occur in a cyclical phase of 8 and 10 years. As per them, the past three global recessions of the past 20 years, the global output per capita growth was in negative or less than zero. The economists with IMF states the global growth rate of 3 % or less would slowdown the overall growth of the countries. The recessions of 1990-1993,1998, 2001-2002, and 2008-2009 had a massive decline of the growth rate below zero.

USA has faced many expansions and contractions since 1854 which has an average of seventeen months of contraction and thirty eight months of expansion. Meanwhile, since USA entered in 1980’s they have faced only 8 periods of negative or zero growth in the economy over a fiscal quarter or more, and four periods considered recessions:

  • January-July 1980 and July 1981-November 1982: 2 years total
  • July 1990-March 1991: 8 months
  • March 2001-November 2001: 8 months
  • December 2007-current: 15 months as of March 2009

From 1991 to 2000, the U.S. experienced 37 quarters of economic expansion, the longest period of expansion on record.

NBER in USA announces the arrival of the recessions in its economy and have succeeded in conforming correctly the economy in recession over a decline period of two quarters. But, there is a point of consideration of the recession of 2001 which involved the preceding of two quarters of alternative decline and weak growth in spite of the decline of the two consecutive quarters.

Stock market and recessions

Anticipations have been made by the economists about the recessions of the decline in the stock markets. However, the stock market crashes after the recession is in. In the recent period of time, there have been many sounds of crash from all over the world’s stock markets. According to Siegel, in the Long run, since 1948 there have been 10 recessions which were preceded by a fall in the stock market with an average time period of around six months, however, there have been some stock markets in the Dow Jones which crashed below ten percent but still they did not come into recessions.

The impact of recessions can be also seen on real estate market which however last much longer than the recessions and take a good number of quarters to gain the momentum again. It’s almost next to impossible to predict the business cycle. And Therefore, Siegel on this argues strongly and say it’s almost impossible to make timings investment decisions on based of these economic cycles. In fact, NBER also takes quite a bit of time to determine about the negative growth in all the sectors brining down the economy to a halt.

Whenever, there is a decline in the economy, the consumers tend to adopt the stuffs of daily requirement from the market in whole sale and keep them in their stocks. Tobacco, contraceptives and medicines industry grow even at the time of negative economic and tends to hold a better position than any other industry. The stock market gets better day by day as the economy progress at a span of time. Once the economy is at worst i.e. after the lowest decline, market tends to grow and the stocks moves really fast building its strong position once again. There have been issues and objection over the health care companies progress. This is so because, they are in a better position than any other industry at the time of recession and after the market recovers; it is quite interesting to watch their stocks progress. Some companies diversify their risks and invest into the international projects which may provide them safety and a better industry position however, the countries which are very closely trading with USA also gets affected by the US recession.

There has been a trend set of the recession by their historical figures and therefore, the investors begin discounting a recovery when the recession has crossed its halfway. The average length of a recession in US has been taken as thirteen months; nevertheless there are many recessions which have been shorter in period than thirteen months.

Therefore, the present recession discounting period had already been started in the November 2009 and the market is growing with a good speed and trying to gain the momentum once again and is expected to be in a good position by the Middle of 2010.

PoliTICS & RECESSION

The administration gets the blame or the credit for the economy of its country. The political controllers has to make sure the country’s economy is running into a good position, which has actually made disagreements about the arrival of the recession. Whenever, there is a downturn in an economy in can be considered a posi


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