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What is an Economic Recession?

Recession is a word that triggers the emotion of fear. Usually, when people hear this term, it causes them to worry about their financial future.

Stock market investors are particularly sensitive to what a recession can do to equity portfolios.

Keeping in mind the big impact recessions have on our lives, let’s find out more about them and understand why they are so important.

What is recession?

Recession is a time of economic decline. During a recession, the economy of a country enters a state of contraction. This is measured by negative GDP growth. If it’s serious enough to engulf the whole world, a global recession will be the result.

A recession is usually identified by negative GDP growth for two successive quarters. However, this is not the definition of a recession. It’s a widely used means of identifying one.

There is no widely accepted definition of a recession. Despite this, it’s usually not difficult to determine if a country is going through a recession or not.

What happens in a recession?

  • Trade in goods and services declines as does industrial activity.
  • Investments lose value as financial markets fall.
  • Revenues of businesses fall and weak businesses shut down.
  • Inventories increase as goods remain unsold.
  • Unemployment rises as large numbers of people lose their jobs.
  • Commodity prices fall due to reduced demand.
  • Real estate prices tend to fall or stagnate.
  • Individuals and businesses default of debts due to loss of income.
  • Stress in the banking system rises due to debt defaults. This causes tight lending conditions.
  • Due to low demand and falling commodity prices, the rate of inflation declines. In some cases, it becomes negative (deflation). However, inflation can remain high during some recessions.
  • Central banks reduce interest rates and ease liquidity conditions to boost the economy. In some cases, money is pumped directly into the banking system as a stimulus.
  • Governments cut taxes and increase spending on infrastructure and social programs to boost growth and put money in the hands of the people.
  • Liquid cash in hand becomes a valuable asset.

How long does a recessions last?

The minimum period of economic decline considered to be a recession is six months. There is no limit in terms of how long a recession can go on.

The duration of any recession depends on many economic factors. Usually, there isn’t one cause that ends a recession. However, the extent of government and central bank intervention in the economy is a major factor.

Are there silver linings in a recession?

The good thing about recessions is that prices of almost everything tends to fall or at least stagnate.

Thus, people (and businesses) who don’t lose their income will benefit from an increase in purchasing power. This is especially true during a period of deflation.

However, if a recession is accompanied by persistently high inflation due to supply side problems (as in the case of covid) then purchasing power will fall across the board.

Stock markets fall during recessions. Thus, investors with cash ready to deploy will find ample opportunities to buy fundamentally strong stocks at reasonable prices.

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