Economics for everyone: Recession and its reasons

Recession And its Reasons

The US is slowing down and possibly heading for recession but India is growing at 8 per cent. Inflation fear has gripped the world. Turn the pages of any financial paper or Web site and the news and talk is only about how the general price level is rising much faster than at any time in more than the last decade.

It could not have come at a worse time. Growth is ebbing and the US is in recession thanks to its housing and mortgage crises. If central banks cut interest rates to stimulate growth, they risk inflation. And raising rates seems hardly the thing to do in the midst of an economic slowdown.

According to the RBI Governor Dr Reddy said, "The global financial uncertainties were not entirely unanticipated but the intensity was not predicted nor was the duration expected. The outlook seems to be far more uncertain now forthe global situation than before… There will be considerable attention paid to this in the monetary policy".

Alan Greenspan -- one of the most influential economists of our times -- described the sub-prime crisis in his book -- The Age of Turbulence. According to him the American economy was 'facing not a bubble but a froth -- lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy.'

Understanding Recession

The standard definition of a recession is a decline in the GDP for two or more consecutive quarters. However, this is still debated among the economists. Economists determine the amount of business activity in the economy by looking at things like employment, industrial production, real income and wholesale-retail sales. They define recession as the time when business activity has reached its peak and starts to fall until the time when business activity bottoms out. When the business activity starts to rise again it's called an expansionary period.

To understand the above concept further, it is important to understand the concept of business cycles.

Business Cycle

Business cycle refers to the periodic movements in the national income and output. The term cycle comes from the behaviour of these periodic movements. There is a period of rising output followed by a period of falling output, which is again followed by a rise in output. Many developed economies see such cyclical movements in their activity levels.

Business conditions never remain steady. Prosperity and boom are generally followed by panic and depression, which are in turn followed by revival leading to a new boom.

Fluctuations in total national output, income and employment, usually lasting for a specific period, marked by widespread and simultaneous expansion or contraction in many sectors of the economy. Recurring nature if the fluctuations and simultaneous and synchronized movements of several macro economic aggregates in the same direction are the major characteristics features of business cycles.

Phases of Business Cycle:

Business cycle can be broken up into four distinct phases: Peak, Recession, Trough and expansion.

Peak and tough represents the upper turning point and the lower turning point of the cycle respectively.

The peak is characterized by a high level of economic activity and is also referred to as the period of prosperity, while the trough is characterized by a very low level of economic activity and is also known as period of depression.Recession and expansion are the phases, which represents cumulative process, the former indicating a continuous movement on the downward direction while the expansion indicating a similar movement in the upward direction. During the phase of recession , production, employment, investment, profits prices are usually failing while in the phase of expansion all of them are usually rising.

The phase of recession comes to an end at trough where the reversal of the cumulative process takes place and the phase of expansion begins. The expansion phase comes to end at the peak where again the reversal takes place and the phase of reversal begins. Thus each phase of the cycle passes into the next trough the operation of certain economic forces trough the operation of certain economic forces, which may be either internal or external to the basic system.

Reasons

What are the factors, which cause income, employment, investment, etc., fluctuate in a regular cyclical pattern? To explain these factors, a large number of theories have been put forward by various economists. A variety of factors such as fluctuations in money supply and bank credit, underconsumption, overinvestment, clustering of innovations, interaction of the principles of the multiplier and accelerator, peoples expectation about the future etc., have been emphasized by different theories for explaining business cycles.

Various theories (factors) of business cycles can be broadly divided into two categories, external theories (factors) and internal theories (factors). In external factors, the basic cause of business cycles is found in events or factors outside the economic system like wars, revolutions, political events, growth and fluctuations in population, discoveries of new lands and resources, and finally scientific and technological innovations. The internal factors theorems emphasis on mechanisms or factors within the economic system such as money supply, over investment, under consumption, changes in consumption propensities and inducement to invest, etc.,