What is Recession? How is it different from Depression?

“Jobs are down due to recession”

 

“It is impossible to conduct business in this economy”

 

“I cannot hire you, this recession is killing me”

 

These were some of the phrases that were floating around during the 2008 Financial Crisis. With over 6 million people unemployed during that time in the United States alone, a recession is a pretty accurate term to peg the period as. But what exactly does the concept of a recession entail?

 

A recession is a macroeconomic concept that refers to a decrease or decline in economic activity in a specified country or sector. The most commonly accepted definition of recession is two quarters of consecutive economic decline. The most common measure of economic growth is Gross Domestic Product.

 

When the Gross Domestic Product of a country is in a decline for two consecutive financial quarters, the economy is said to be in recession. A common example of a country in recession would be the United States during the global recession of 2008 where from 2007 to 2009 there was a net contraction of 4.2%.

 

Recessions are often accompanied by increase in Unemployment, Income inequality, decrease in consumer expenses, contraction of credit and a general lowering of the standard of living for those affected by it the most. 

 

(Recommended blog - Income distribution)

 

Recessions are often the outcomes of either poor economic decisions, improper central planning or even the result of freak natural accidents like Hurricane Katrina or more notably the Coronavirus pandemic.

 

 

Characteristics of a recession

 

1. Contraction

 

Contraction of an economy is one of the foremost outcomes of a recession. During a period of recession, countries and economies undergo underproduction and are often accompanied by businesses limited their sales and expansions which all ultimately tie into a reduction in a Nation’s Gross Domestic Product or its National Income. 

 

(Related blog - Gross National Product)

 

Thus, it can be said that a recession is first and foremost a contraction of an economy.

 

 

2. Unemployment

 

Another characteristic of a recession is unemployment. In the 2008 recession, more than 8% of the American population were laid off with many companies shrinking their sizes by exponential proportions just to stay in business.

 

Interestingly enough, a recession propagates another recession through this way because when companies lay off employees, a household’s source of income is reduced causing them to have less money for expenditure. 

 

This then results in a lower demand for products as consumers now do not have the income required to generate high products. Low demand leads to low production as producers only produce those commodities that people want which results in a recession and the cycle continues! 

 

 

3. Income Inequality

 

The problem of income inequality is often subservient to those of growth and unemployment. The best example of income inequality during a recession would be the United States. 

 

(Related blog - Revenue Deficit)

 

During the Coronavirus pandemic where over 0.7 million people lost their lives, the wealthiest of the wealthy added over 1.2 trillion USD to their wallets. With the first recession showing a similar trend in the United States, It remains to be seen that Income Inequality is the buy one get one free for the product you never bought.

 

 

4. Business Cycles

 

One of the biggest flaws in a free economy is the nature of business cycles. Business cycles refer to the trends of an economy that are regular and/or periodic. 

 

The problem with business cycles is that along with the existence of periodic highs come periodic lows. These periodic lows are recessions. Fortunately, this feature also helps economists predict when, why and how a recession will affect an economy.

 

 

5. Long Term Growth

 

Recessions affect long term growth both positively and negatively. In economies where there is a need for technological upheaval, a recession will force companies to adopt newer and more efficient methods of production which requires investment into Research and Development. 

 

Thus, recessions have the potential to give long term gains at the short term cost. However, major recessions can affect nations in the long term. In nations where the economy is highly dependent on a concentrated range of products and not diversified, a recession can bring the country to its knees. 

 

When the economic situation of a nation is dire, the government often appeals to foreign nations for aid which can result in debt entrapment. 

 

Debt entrapment can result in foreign nations having a say in a nation’s economy which can violate the sovereignty of countries. This results in a modern form of neocolonialism that ultimately propagates imperialism.

 

Recession v/s Depression

 

1. In modern speech, the words recession and depression are used interchangeably. While they both indicate decline of economic activity, they are not the same. The fundamental problem is that depression is not a clearly defined term by any international economic body. 

 

2. The only instance of a Depression being used across the board to mean the same thing is the Great Depression of the 1930s. The Great Depression was 10 consecutive years of economic decline in the western world that originated in the United States(Pells 2021) and had its effects across the world.

 

During the peak of the recession, the United States economy had contracted over 30% in GDP with industrial growth reducing by over 40%. Mass unemployment, declines in consumer demand and other factors combined to create the biggest economic downturn in the modern western world.

 

Recommended blog - Elasticity of Demand

 

3. A recession and a Depression differ on two main criteria: Intensity and duration  Depressions are usually much longer and their severity is spread over several years. 

 

The only instance of a depression is the crash of 1929 followed by a 10 year long downward economic spiral. Even the recession of 2008 is considered only a recession and not a full fledged depression despite its effects. The short time period is the reason for the same. 

 

However, a prolonged recession can be referred to as a depression. When nations undergo recessions for many consecutive years with severe and wide ranging effects such that it requires active policy changes by both the government and major companies, it may be termed as a depression. 

 

Recession Indicators

 

Considering that recessions are a part of business cycles, they can be estimated to a certain degree. To predict the possibility of a recession occurring, governments and investors alike use many methods. 

 

1. The yield curve is a curve depicting interest rates on government bonds. It shows the interaction between the interest rate and the maturity time period of a government bond. When the curve slopes upwards, it shows that a longer time period demands a longer interest rate. This indicates that investors believe that a longer investment is safer than a shorter one. 

 

However, when the curve begins to slope downwards, it shows that investors are demanding higher interest rates for a lower time period. The implication behind this is that investors do not trust the stability of the current economy therefore making it riskier to hold their bond. 

 

The mass selling of government bonds and stock market crashes are a central symptom of a recession and a yield curve is simply the warning indicator.

 

2. Another indicator of an incoming economic recession are Confidence Indexes. Confidence Indexes are collected statistics that are an indicator of how confident either a consumer or a producer is of the future of an economy. 

 

During the pandemic, many nations experienced a fall in their Confidence Indexes as investors, business owners and consumers alike were all unsure regarding price fluctuations and government policy during and post the lockdown. 

 

Read more on the pandemic in India and its economic effects

 

3. In a rather paradoxical manner, unemployment can also be an indicator of a recession. When employment increases, firms expand business and production and consumption booms. 

 

People have more money to spend while firms have more customers to sell to and everybody’s happy. But what happens when a firm is uncertain in its future and restricts hiring?

 

The moment jobs are down, so is consumer demand which ultimately leads to a recession. It appears that economics has a sense of irony with both recession and unemployment causing the other.

In conclusion, a recession is a term used to describe a situation of economic decline. It is a normal part of any free market economy and requires active government intervention to reverse it and return a nation to the path of growth. In the post Pandemic world, it appears all the more relevant that a recession can and must be predicted and accounted for in the deliberations of policy makers. 

 

With the modern trend of globalization and interlinking of world economies, it becomes all the more vital to understand the implications of a recession and what it means when the government or the Reserve bank declares a recession.