Problems of Recessions

Readers Question: Identify and explain economic variables that may be affected negatively by the economic slowdown.

Some of the Problems of a recession

• Falling Output. Less will be produced leading to lower real GDP and lower average incomes. Wages tend to rise much more slowly or not at all.
• Unemployment. The biggest problem of a recession is a rise in cyclical unemployment. Because firms produce less, they demand fewer workers leading to a rise in unemployment.

• Higher Government Borrowing. In a recession, government finances tend to deteriorate. People pay less taxes because of higher unemployment and they need to spend more on unemployment benefits. This deterioration in government finances can cause markets to be worried about levels of government borrowing leading to higher interest rate costs. This rise in bond yields may put pressure on governments to reduce budget deficits through spending cuts and tax rises. This can make recession worse and more difficult to get out of. This was particularly a problem for many Euro zone economies in aftermath of 2009 recession. See: Euro fiscal crisis
• Devaluation in exchange rate.  Currencies tend to devalue in a recession because, in a recession, people expect lower interest rates and so there is less demand for the currency. However, if there is a global recession and all countries are affected this may not occur.
• Hysteresis. This is the argument that a rise in temporary (cyclical) unemployment can translate into higher structural (long-term) unemployment. If someone has been unemployed for a year during a recession, they may become less employable (e.g. lose on the job training, e.t.c)
• Falling asset prices. In a recession, there is less demand for buying fixed assets such as housing. Falling house prices can aggravate the fall in consumer spending and also increase bank losses. This fall in asset prices is particularly a feature of a balance sheet recession (e.g. 2009-10) recession. See: Balance sheet recession.
• Falling share prices. Lower profits lead to lower levels of share prices.
• Social problems related to rising unemployment, e.g. higher rates of social exclusion.
• Increased inequality. A recession tends to aggravate income inequality and relative poverty. In particular, unemployment (relying on unemployment benefits) is one of the largest causes of relative poverty.
• Rise in Protectionism. In response to a global downturn, countries are often encouraged to respond with protectionist measures (e.g. raising import duties). This leads to retaliation and a general decline in trade which has adverse effects.

Related

• Problems in preventing a recession
• Double Dip recession
• What Happens in a recession?