What does Recession really mean?
May 17, 2023
Recession in the economy is part of the negative phase of the business cycle, along with many terms such as economic crisis, depression and inflation.
In this article we will discover the differences between these terms, the mechanisms that lead to this condition, then how to prevent it and finally treat it, citing some examples.
Let’s then address the true meaning of recession in order to better understand the world we live in.
Recession: the meaning in economics
The meaning of recession in economics is inextricably linked to that of GDP. In fact, a recession is defined as when productive activity, as measured by GDP, is below the level that can be achieved by effectively exploiting the factors of production.
Based on GDP, different types of recessions are defined:
- Economic recession: the decrease in GDP compared to the previous year.
- Economic crisis: if the annual decrease in GDP is at least -1%.
- Technical recession: if real GDP falls for at least two consecutive quarters.
The one related to GDP is the most useful definition for calculating when we actually are in a recession, however there is not just one: some business cycle theorists consider the meaning of recession to be the entire negative phase of the cycle, others only the first half of the downturn.
What does it mean to be in recession?
In explaining the meaning of recession, we said that it is a drop in GDP. But what exactly does this mean?
GDP falls because this situation occurs: consumers reduce their spending, so the demand for goods and services drops, consequently production decreases and unemployment rises.
In fact, if consumers spend less, producers produce less because their products would not be bought, and so they look for fewer workers to produce them; thus unemployment increases and consumers become poorer, spending even less, in a continuous cycle.
Usually the first response of central banks to this situation is to lower interest rates to stimulate spending and inflation towards their target.
Being in a recession, in everyday life, means having difficulty finding work, struggling to increase one’s salary and tending to save. If not managed with the right tools, this condition risks slowing down technological progress and creating widespread discontent, thus aggravating into the ‘depression’ phase.
Before moving on to solutions, let us look at the causes that can lead to a recession.
The causes of a recession
The meaning of recession is also linked to the phenomena that trigger it, and an economy can be in a recessionary stage for several reasons. A mild and temporary recession is normal and physiological for a capitalist system: large expenditures during the economic growth phase always lead to a subsequent depletion of capital and a slowdown in spending by both consumers and companies.
If this spending has not been excessive, and is handled gently and patiently, the economy will soon recover on its own following its natural cycle. On average, recessions last 10 months and resolve themselves with a spontaneous rebound into the positive.
However, this is not always the case.
Situations in which recession lasts for years, or recurring at close quarters, are all too familiar. The reasons for a prolonged or abnormal recession can be internal or external to the economic system concerned.
If they are internal, they may be linked to flawed or missing economic policies. If the growth of the previous phase went on too long and uncontrolled, for example, it may have caused capital drain, or even consumers’ and producers’ debt. This is why prevention is better than cure: a sustainable recession is only possible if it follows a moderate and healthy expansion.
Measures that avoid the occurrence of severe recessions are social shock absorbers, fair distribution of wealth, expectation management and growth control.
If in fact recession is linked to a decrease in consumer spending and unemployment, services such as unemployment benefits and the equal distribution of resources prevent spending and demand from collapsing quickly, causing the rest of the economy to collapse.
With regard to managing expectations for the future and controlling growth, then, these aspects concern the behaviour of consumers and investors in response to economic policies. For example, if the government does not curb spending at the right time during a growth phase, companies and consumers may end up going into debt, driven by incentives or enthusiasm. If, on the other hand, the government sends an alarmist message during a prosperous phase, panic may spread and spending may stop, as consumer expectations for the future have become very negative.
Sometimes, however, external factors contribute to aggravate the economic conditions of one or more countries. Think of natural disasters such as earthquakes, epidemics or wars: unforeseen events for which we often pay the price for many economic cycles.
To determine the true meaning of recession and the correct treatment, it is essential to identify its causes: if all crises were the same, they would not be problematic.
Remedies for a recession
Once the meaning of the term has been clarified, we can get to the heart of the matter: how do we get out of a recession?
As with any disease, the remedy depends on the symptoms and causes, and prevention must also be considered.
Let’s begin again with the least serious scenario: the physiological recession. In this case it could be resolved without institutional intervention, or by applying the prevention rules mentioned above.
If, however, the recession lasts longer than it should and is already in progress, the solution is usually to stimulate demand for goods and services. How this is done depends, among other things, on economic theory: monetarists prefer to act on monetary policies in an expansionary direction, reducing interest rates and favouring loans. Keynesians then argue that it is more effective to compensate with increased public spending, which is however frowned upon by indebted states; others again recommend lowering taxes on companies to stimulate investment, however this may not be enough.
Choosing the right solution or the right mix is complex as it must once again take into account the psychological factor: what expectations will be created in citizens, what reactions will the participants in the economy have. In addition, the links of interdependence with other governments, which are increasingly intertwined in the context of the global economy, need to be addressed nowadays.
The consequences of a recession
What is recession if not a disease of the economic system? To better digest this pill, let us continue to talk about it in medical language. The consequences of a neglected recession, therefore, are generally depression or stagflation. Stagflation occurs when the recessionary phase is accompanied by an excessive increase in prices: inflation.
Depression, on the other hand, is when the recession becomes chronic: all engines of economic growth, such as innovation and capital accumulation, stop.
Depending on the course of the recession, we will have different types of curves on our economic growth graph:
- A V-shaped curve means a short recession, easy to treat
- A U-shaped curve represents the continuation of a more difficult but resolvable recession
- A W-curve shows the relapse into an obviously untreated recession
- An L-shaped curve means that the recession has turned into a depression
- A K-curve denotes a divergence in recovery paths, where one part of the economy recovers quickly, with a V-shaped pattern, and the other proceeds towards depression (L).
The latter is a representation born after the Covid-19 crisis in the US, where central banks used exceptional monetary instruments to generate speculative bubbles that protected the investments of the wealthiest segments of society from the financial effects of the pandemic. In the absence of measures to protect the less well-off, they never fully recovered and economic inequality reached levels not seen since the 1920s.
Returning to the other curves, the European debt crisis of the early 2010s is an example of a W-shaped recession. After the Great Recession of 2008-2009, a combination of several factors plunged many eurozone countries into a second recessionary phase from 2011 to 2013. Among the factors were austerity, falling business investment, rising interest rates, global economic weakness, high energy prices and weak consumer spending. The countries involved included Italy, Spain, Portugal, France, Ireland, Germany and Cyprus. Greece, although part of the eurozone, saw a continuous economic contraction from 2007 to 2015 and thus falls within the definition of an L-shaped recession.
What was the Great Recession?
To close the analysis of the meaning of recession, its possible causes, and its possible cures, it is worth taking a leap back in time and mentioning one of the most well-known recessions of recent years. The Great Recession was a global economic crisis that occurred between 2007 and 2013, originating in the US in 2006. It originated from a housing bubble that created a severe financial crisis in the US economy, which then gradually spread around the world through financial contagion mechanisms.
Among the main triggers were high commodity prices, especially oil, a global food crisis, the threat of a global recession, and a credit crisis followed by a drop in confidence in the stock markets. This crisis was regarded by many economists as one of the worst in history, second only to the Great Depression of the early decades of the 20th century.
We therefore found the meaning of recession in its causes and consequences, concluding that each case must be treated separately, but that preventing the continuation of this condition is always the most far-sighted solution.