Recessions are caused by a drop in GDP for at least two consecutive quarters, with a decline of around 10% having a significant impact on the economy. Inflated prices can lead to reduced spending, causing companies to lose money and lay off workers. However, a more reasonable explanation is that a shock to the economy, such as a physical attack or market collapse, can drastically affect spending on multiple levels. Recovery from a recession can take months or years, and sometimes the elements used for recovery do not fix the problem completely.
There are many causes of recession, which are defined as a drop in Gross Domestic Product (GDP) for at least two consecutive quarters. This decline is less than 10%; therefore, small recessions that occur occasionally have only a minor effect on the economy. When a longer-lasting recession occurs, where GDP – which is the sum total of all public and private spending – is reduced by around 10%, it can have a huge impact on the economy, making recovery more challenging. Perhaps it is simpler to say that what causes a recession is this decrease in spending on goods, services and investments, but what causes the public and private sectors to change their consumption habits is not always constant.
Some financial experts suggest that the causes of recession are always inflated prices. As prices rise, people can’t afford to spend as much and start budgeting and spending less than they normally would. This scenario means that nobody really profits from the inflated prices and soon companies are losing money. This leads them to take actions such as spending less and laying off workers. With fewer people making money, spending continues to decline. This cycle doesn’t reverse until job growth, or government and corporate spending starts to pick up again.
This account of the causes of recession does not explain the initial drop in spending or inflation and why prices suddenly rise, especially if spending is lower. A more reasonable explanation of one of the causes of the recession is that the economy suffers some kind of shock that radically changes the way the market is perceived. That shock can include things like a physical attack on the country, as occurred during 9/11 in the US, the rapid deterioration of an industry, as what happened during the dot.com meltdown in the 1990s, or the collapse of financial markets, such as the real estate market and the stock market in the mid-2000s.
When these “shocks” occur, they drastically affect spending on multiple levels. People facing foreclosure on their homes during the US housing crisis could not afford to spend as much, and the lack of securities and investment firms felt in investing in real estate and the stock market further reduced GDP. Other factors, such as most people’s inability to obtain home equity loans or mortgage loans, hampered the ability to spend on credit. As is common, a drop in spending led to a rise in prices or inflation as merchants and service providers tried to recoup their losses created by reduced consumer and investor spending, meaning people bought even less, further reducing GDP.
Regardless of the individual causes of the recession, it is clear that the more sectors it affects, the harder it is to recover. If the recession continues beyond a few quarters and GDP declines further, it could become a depression. In this scenario, it may take months or years to fully recover, and sometimes the elements used for recovery do not fix the problem completely. The term jobless recovery is often used to discuss a recession or depression that ends without restoring people to their jobs.
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