Why is US in Recession?

Readers Question: Why is US in Recession?

Firstly, it may come as a surprise to most people, but, the US is not officially in a recession.

According to the latest statistics provided by the Economist April 24th 2008

• US economic growth is 2.4% year on year.
• In the last quarter, growth is 0.6%. This is still a long way off the technical definition of a recession – negative economic growth for two consecutive quarters.

Nevertheless people have been predicting that the US will soon enter into recession. This is because

1. Credit Crunch. Banks have lost money in lending subprime mortgages, which involved high levels of defaults. It is not just mortgage companies who have been affected, but, banks who lent to the mortgage companies. The result is that there is a shortage of funds for borrowing and bank lending has become more difficult.

2. Housing Crash. This is probably the biggest factor dragging the US towards a recession. House prices are falling because

1. Shortgage of mortgage funding
2. decline in confidence
3. Prices became overvalued.
4. Increase in supply now accompanies falling demand

Falling house prices creates:

• Negative wealth effect – much less chance to remortgage and gain increased equity
• Falling confidence – both these cause lower aggregate demand and lower growth.

Rising Debt levels The past few years have seen a rise in debt and decline in savings ratio, reflected by the growing current account deficit. This means there is little scope for increasing consumer spending. As confidence in the housing market and wider economy falls, consumers are looking to increase savings and deal with their debt, rather than further increase it.

Rising Cost Push Factors. Rising prices of oil and food are increasing the costs of production (for A level students it causes the AS curve to shift to the left leading to higher prices and lower output)

There are more factors, but, I feel that it is the housing market and decline in consumer spending which is the major factor in threatening a recession.

I wrote this in 2007, but the factors are still pretty relevant today – Is US heading towards a recession?

• Iraq War and US Recession