A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale retail trade. It is caused by a chain of events in the economy, such as disruptions to the supply chain, a financial crisis, or a world event.
Key Facts
- Supply shocks: These occur when something reduces the economy’s ability to produce output at a given price level.
- Demand shocks: These occur when there is a significant decline in activity spread across the economy, leading to decreased consumer and corporate spending.
- Financial factors: Overextension of credit and debt, risky loans, and asset price bubbles can contribute to a recession.
- Psychological factors: Excessive exuberance during boom years followed by pessimism after a market crash can amplify the effects of real economic and financial factors.
- Fundamental economic factors: Disruptions in supply chains and vital industries, such as energy or transportation, can cause businesses to retrench and cancel investment and hiring plans, leading to a recession.
Supply Shocks
Supply shocks are one of the main causes of recession. They occur when something reduces the economy’s ability to produce output at a given price level. Examples of supply shocks include natural disasters, such as earthquakes or floods, and disruptions to the supply of critical resources, such as oil or food. Supply shocks can lead to a recession by causing prices to rise and output to fall.
Demand Shocks
Demand shocks are another major cause of recession. They occur when there is a significant decline in activity spread across the economy, leading to decreased consumer and corporate spending. Demand shocks can be caused by a variety of factors, such as a decline in consumer confidence, a tightening of credit conditions, or a decrease in government spending.
Financial Factors
Financial factors can also contribute to a recession. Overextension of credit and debt, risky loans, and asset price bubbles can all lead to a recession. When these financial imbalances unwind, it can cause a sharp decline in economic activity.
Psychological Factors
Psychological factors can also play a role in recessions. Excessive exuberance during boom years followed by pessimism after a market crash can amplify the effects of real economic and financial factors.
Fundamental Economic Factors
Finally, fundamental economic factors can also cause recessions. Disruptions in supply chains and vital industries, such as energy or transportation, can cause businesses to retrench and cancel investment and hiring plans, leading to a recession.
Conclusion
Recessions are caused by a variety of factors, including supply shocks, demand shocks, financial factors, psychological factors, and fundamental economic factors. The relative importance of these factors can vary from one recession to the next.
Sources
FAQs
What is a recession?
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale retail trade.
What are the main causes of recession?
The main causes of recession are:
– Supply shocks: disruptions to the supply of critical resources or natural disasters
– Demand shocks: a decline in consumer and corporate spending
– Financial factors: overextension of credit and debt, risky loans, and asset price bubbles
– Psychological factors: excessive exuberance during boom years followed by pessimism after a market crash
– Fundamental economic factors: disruptions in supply chains and vital industries
What are some examples of supply shocks that can cause a recession?
Examples of supply shocks include natural disasters, such as earthquakes or floods, and disruptions to the supply of critical resources, such as oil or food.
What are some examples of demand shocks that can cause a recession?
Examples of demand shocks include a decline in consumer confidence, a tightening of credit conditions, or a decrease in government spending.