What causes an economic recession?

Economic Recession

For millennia, the people of England have been using bronze to make equipment and jewelry, and to be used as a currency for trade. But around 800 BCE, that began to change. The value of bronze declined, causing social upheaval and an economic disaster, what we would call a recession today.

What causes recessions? This question has long been the subject of heated debate among economists, and for good reason. A recession can be a mild decline in economic activity in a single country that lasts months, a lasting downturn with global ramifications that lasts years, or something somewhere in between.

Economic Variables

Complicating matters further, there are endless variables that contribute to an economy's health, making it very difficult to pinpoint specific causes. So, it helps to start with looking at the big picture.

Recessions occur when there is a negative disruption to the balance between supply and demand. There's a mismatch between how many goods people want to buy, how many services and products manufacturers can offer, and particularly the price of the goods and services bought, which then prompts a financial downslide in the form of an economic decline.

Supply & Demand

An economy's relationship between supply and demand is reflected in its inflation rates and interest rates. Inflation happens when goods and services get more expensive, meaning the value of currency decreases. Still, inflation isn't necessarily a bad thing. In fact, a low inflation rate is thought to encourage economic activity. However, high inflation that isn't accompanied with high demand can both cause problems for an economy and eventually lead to a recession.

Interest Rates & Inflation

Interest rates, meanwhile, reflect the cost of taking on debt for individuals and businesses. The rate is usually an annual percentage of a loan that borrowers pay to their lenders until the loan is repaid. Low interest rates mean that businesses can afford to borrow more money, which they can use to invest in more projects. High interest rates, on the other hand, increase costs for producers and consumers, slowing down a countries economic activity.

Fluctuations in inflation and interest rates can give us insight into the health of the economy. However, what causes these fluctuations in the first place? The most obvious causes are shocks like natural disaster, war, and geopolitical factors. An earthquake, for example, can damage the infrastructure needed to produce vital commodities such as oil or Hydro-electricity That forces the supply side of the economy to charge more for products that use electric power and oil, discouraging demand and potentially prompting a recession.

Recession

That said, some recessions occur in times of economic prosperity, perhaps even because of economic prosperity. Some economists believe that business activity from a market's expansion can sometimes reach an unsustainable level. For example, companies and consumers may borrow more money with the unhealthy assumption that economic growth will help them deal with the added burden. But if the economy doesn't grow as quickly as expected, they'll end up with more debt than they can handle. In order to pay it off, they'll need to redirect funds from other business activities, reducing business stability.

The Fear Factor

Psychology can also contribute to a recession. Fear of a recession can become a self-fulfilling prophecy if it causes people to pull back investing and spending in response. Producers might reduce operating costs to help weather the expected decline in demand, which can lead to a vicious cycle as cost cuts eventually lower wages, leading to even lower demand.

Even policy designed to prevent recessions can contribute. When times are tough, governments and central banks may print more and more money, increase spending, and lower central bank interest rates such as has recently been exposed in the weakening and decreased confidence in the US dollar and the American Banking system. Smaller lenders can, in turn, lower their interest rates, effectively making debt cheaper to boost spending. However, these policies aren't sustainable and eventually need to be reversed to prevent excessive inflation that can cause a recession.

If people have become too reliant on cheap debt and government stimulus, like history has taught us, the bronze recession in Britain ultimately ended when the wide spread use of iron helped to industrialise and revolutionise farming and food production. Ofcourse modern economic markets are more complex, making today's recessions far more difficult to untangle and navigate. But as long as the economic wizards learn that each recession provides new information to help anticipate and respond to future recessions more effectively. economic recovery is possible.
It's what happens if they don't… that we have to consider in the near future!