Causes of Economic Recession

What is a Recession?

Officially, a recession is defined as a period when the Gross Domestic Product (GDP) growth is negative for at least two quarters or more. This can cause troublesome economic changes such as rising unemployment, falling stock prices, and stagnating business activity.

While the official definition of a recession is rather limited, public fears of a recession usually begin when people start to notice increases in necessary items such as gas and groceries. When overall inflation is met with the slow yet still positive growth in the GDP, it becomes common for people to start to wonder if a recession is on the horizon.

Understanding the Causes of Economic Recession

It can be difficult to predict the causes of economic recession. However, many economists believe the Index of Leading Indicators may be a useful tool for determining when a recession is coming. Factors in this measurement of the country’s financial health include:

• Weekly hours worked by manufacturing workers on average
• Average number of initial applications for unemployment insurance claims
• S&P 500-stock index
• Inflation-adjusted monetary supply
• Spread between long and short interest rates
• Pessimistic consumer sentiment
• Amount of manufacturer orders for consumer goods and materials
• Speed of delivery of new merchandise to vendors from suppliers
• New orders for capital goods unrelated to defense
• Number of new building permits for residential buildings

The Index of Leading Indicators is not foolproof, however. Although it predicted each of the seven recessions between 1959 and 2001, it also forecasted five recessions that failed to materialize.

Many people believe that recessions are a natural part of the capitalist economic system. In fact, there are those who think recessions help “clean the fat” from businesses that are failing to operate within their means. By this logic, recessions help pave the way for periods of economic expansion.

Recession vs. Depression

Although the general public often uses the terms interchangeably, a recession is not the same thing as an economic depression. A depression is a severe recession, often defined by economists as a period in the real GDP declines by more than 10 percent. Using this definition, the last depression in the United States was during the period from May 1937 to June 1938.

Preparing Yourself for a Recession

Instead of worrying over news reports about the state of the U.S. economy, consider taking steps to prepare yourself for a recession. For example:

• Plan for the worst case scenario. It may be a frightening thought to consider losing your job or having a loved one come down with a serious illness, but you need to have a plan that will allow your family to make it through this difficult time.
• Cut unnecessary expenses. Part of preparing for the worst involves having an emergency fund to help your family though hard times. If you don’t have money saved, consider cutting restaurant meals, expensive entertainment, or other luxury items from your household budget and putting the extra money into your rainy day savings account.
• Monitor your investments. During a recession, stock prices can change dramatically. If you have invested in stocks as part of your retirement savings, try to diversify to reduce the risk to your portfolio.
• Avoid taking on new debts. If you’re concerned about a possible recession, try to put off the purchase of new items as long as you can. If you already have a car that’s paid for and provides reliable transportation, for example, think twice before taking out a loan for a new one.

Additional Information

If you are interested in learning more about the causes of economic recession and its impact on the U.S., LoveToKnow Save suggests visiting the following helpful resources:

• Recession.org
• Recession History
• Recession-Proof Yourself
• Recession 2008?