A recession means a period of decline in economic activities which is shown by a reduction of real national output. When there is decline of output for two consecutive years, it is technically referred as a recession.
CHARACTERISTICS OF A RECESSION
- Declining demand for output leading to higher levels of spare productive capacity
- A sharp fall in business confidence & profits
- A decrease in fixed capital investment spending because there is insufficient demand to justify new capital projects
- De-stocking and heavy price discounting – this leads to lower inflation
- Reduced inflationary pressure in the labour market as unemployment rises
- Falling demand for imports
- Increased government borrowing
- Businesses will reduce production levels as they find it difficult to sell their goods and services.
- In order to sustain growth, businesses will cut cost and will lay off employees.
- Economy will see an increased rate of retrenchment and more money is spent by the government on unemployment benefit.
- Government will get less revenue from income tax and VAT.
- Stock exchanges will see reduced activity.
A recession can happen due to a reduction in aggregate demand which could be the result of the following factors:
1. Higher interest rates which reduce borrowing and investment
2. Falling real wages
3. Falling consumer confidence
4. Credit crunch which causes a decline in bank lending and therefore lower investment.
5. A period of deflation. Falling prices often encourage people to delay spending. Also deflation increases the real 6. value of debt causing debtors to be worse off.
7. Appreciation in exchange rate which makes exports expensive and reduces demand for exports.
Recession can also happen due to a reduction in the aggregate supply. It is referred as supply-side shocks.
A few examples of things which could cause a reduction in aggregate supply are:
1. Higher crude oil and gas prices – leading to increased input costs, driving inflation higher and causing a fall in real incomes for households (less consumption) and a fall in profits for businesses (less investment and possible employment cut-backs) – this is known as stagflation.
2. Higher prices for metals and other non-fuel inputs .
3. Surge in foodstuff prices which increase costs and lower profits for food manufacturers.
4. Other inflationary effects globally such as a sharp rise in inflation in the USA or China, leading to a burst of imported inflation .
5. If wages remain sticky there is a danger of a wage-price spiral emerging.