Economic recessions can be caused by many different factors, including loss of consumer confidence, high interest rates, stock market crashes, and asset bubble bursts. Most events that cause an economic slowdown can also lead to a recession if not addressed.
Does GDP indicate a recession?
A decline in gross domestic product (GDP) growth is often recorded as a cause of a recession, but it serves as a warning sign that a recession may have already begun. GDP is reported after the end of a quarter, so the recession may have started several months prior by the time GDP turns negative.
Loss of consumer confidence
Loss of confidence in the economy leads consumers to stop buying, which can create a vicious cycle. If demand for goods and services is sufficiently reduced, it will ultimately decrease business profits and the necessity or financial ability to hire more employees.
High interest rates
High interest rates make borrowing money more expensive, which deters consumers and businesses from borrowing money for purchases or investments. Reduced spending leads to decreased demand for goods and services in the economy.
Stock market crash
If the stock market crashes, it can lead to a recession. With falling stock prices, investors often have less capital to invest in companies. If companies cannot raise funds for growth and operating costs, it may lead to layoffs or hiring freezes.
Economic deregulation
Lawmakers can lead to a recession when they remove essential safeguards. The seeds of the savings and loan crisis and subsequent recession were sown in 1982 when the Garn-St. Germain Depository Institutions Act was approved. These laws, along with the Monetary Control Act of 1980, removed loan-to-value ratios and interest rate ceilings for savings and loan associations.
Post-war recessions
Post-war recessions have occurred frequently throughout U.S. history. Recessions occurred after World War II, the Korean War, the Vietnam War, and the Gulf War. Average growth decreased by 4.5% after the Korean War, the Vietnam War, and the Gulf War, while the average unemployment rate rose by 1%.
Credit contraction
Credit contraction occurs when there is a sudden shortage of available funds for lending, meaning there are fewer loans. For example, during the credit crisis of 2008, banks incurred significant losses due to defaults on many mortgages, and because they had bought bad mortgage debt. These losses meant they were very reluctant to lend money.
Asset bubble bursts
Asset bubbles occur when the prices of investments, including gold, stocks, and real estate, become inflated compared to their sustainable values. The bubble itself sets the stage for a recession when it bursts. The “dot-com” stock bubble and the real estate bubble preceded the recessions of 2001 and 2008.
Inflation
Inflation reduces the value of goods and services offered in the market, which encourages people to wait to make purchases until prices drop. Inflation is often associated with high interest rates, which can also cause people to wait to make purchases as they cannot afford debt with very high-interest rates.
Recession of 2008
There was a housing bubble and poor regulation in the early millennium. Banks and lenders allowed consumers to take out loans they could not repay. As a result, many buyers purchased homes they could not afford. Many of these borrowers were victims of predatory lending practices.
Recession of 2020
The U.S. economy contracted due to COVID-19 lockdowns in March 2020. Real GDP fell by 5.1% in the first quarter of 2020. The cause of the recession in 2020 was an “unexpected event” as the global COVID-19 pandemic forced most businesses to close to avoid the spread of the virus.
Questions
Frequently Asked Questions (FAQs)
What causes interest rates to decline during a recession?
In some cases, interest rates decline during a recession because central banks use monetary policy to encourage growth. Lower interest income is an incentive for investment rather than hoarding cash in a bank account. In other cases, interest rates decline during a recession because investors seek the safety of relative bonds. This can put downward pressure on interest rates.
How do governments try to stimulate growth during a recession?
Monetary policy – such as lowering interest rates – is one of the ways governments try to stimulate growth during a recession. Fiscal policy is another tool, such as lowering taxes to encourage consumer spending. Governments also directly spend taxpayer money in the economy, such as hiring workers for government projects or supporting wages and benefits for low-income workers.
Source: https://www.thebalancemoney.com/causes-of-economic-recession-3306010
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