A recession is a decrease in economic activity over a period of time. Officially, a recession is considered to exist when the GDP variation rate is negative for two consecutive quarters. It is also known as a period of economic contraction.
The economic recession is the phase of the economic cycle in which economic activity decreases, consumption and investment decrease and unemployment increases.
In the following chart we can see an example of recession, with two quarters of negative growth. If the negative growth continued, it would be a longer economic recession. However, if the negative growth were to occur for only one quarter, we could not officially consider that decrease as an economic recession.
Characteristics of economic recessions
Recessions are characterized by a worsening of the economy for at least two consecutive quarters. They usually lead to a decrease in consumption, investment and the production of goods and services. This, in turn, causes workers to be fired and, therefore, increases unemployment.
It is also very common for inflation to drop in recessions due to falling consumption. On many occasions deflation can occur, which can be dangerous if the economy goes into a deflationary spiral. On the contrary, if high inflation occurs during a recession, it is known as stagflation. Stagflation produces impoverishment of the population and makes it difficult to get out of the recession. In other words, it makes it more difficult for governments and central banks to take effective measures to correct the situation.
The years before a recession are usually years of economic boom. As reflected in the theory of economic cycles, the economy is made up of phases, in which the economy first grows and then declines. Recession is the phase in which the economy declines.
Causes of the economic recession
One of the main causes of recessions is usually the overproduction that occurred in previous years when there is economic growth and rising prices. The price increase occurs mainly in commodities, stock indices and homes. This price increase leads many people to get into debt taking advantage of that economic boom, thus causing, later, the slowdown in the economy to be stronger and the economy to fall into recession.
When an economic recession is very intense and prolonged in time it is called an economic depression. Recessions are clearly reflected in the financial markets through falling stock indices.
Keynes said that an economic recession occurs when families and entrepreneurs lose confidence and stop investing, wanting to accumulate liquidity. When a person decides to do this, nothing happens, but if everyone wants to accumulate cash, expenses and income decrease. This in the economy as a whole translates into bankruptcy of companies, empty stores and decreased credit provided by banks.
Different definitions of economic recession
There is no exclusive consensus among economists globally. However, based on different sources, we can consult the definitions of institutions such as the Organisation for Economic Co–operation and Development. (OECD) or the United States Bureau of Labor Statistics.
The National Bureau of Economic Research (NBER) does not limit itself to defining the recession as an issue related solely to GDP. They indicate that there are other variables to take into account such as employment, industry or global trade.
For its part, the OECD indicates that the recession can begin when the expansive phase of the economic cycle ends and not after it marks negative records exclusively.
The problem with these alternative definitions is that they are not completely objective and it will be up to the economist to determine whether it is indeed a recession. At Forex Dominion we opted for the criterion of Julius Shiskin, who in 1974, while he was a commissioner in the United States Bureau of Labor Statistics, published in the New York Times newspaper the criterion of decrease for two consecutive quarters. It is a simple and objective goal.