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 include

  • 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 fewer 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 the recession worse and more difficult to get out of. This was particularly a problem for many Eurozone economies in the aftermath of 2009 recession. See: Euro fiscal crisis
  • Devaluation of the 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) See – hysteresis
  • 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.

Evaluation – can recessions be beneficial?

  • Some economists may say an economic downturn is necessary to solve inflation. For example, recessions of 1980 and UK recession of 1991/92.
  • Recessions can force firms to be more efficient and the ‘creative destruction’ of a recession can allow new firms to emerge.

However, these factors don’t outweigh the high personal and social costs of recession.

Examples of recession US 2008/09

Economic growth

us-economic-growth

Recession 2008-2009. Fall in real GDP

Unemployment

us-unemployment

Unemployment started to rise just as the economy went into recession.

Government borrowing

us-federal-deficit
US Federal Deficit. A sharp rise in government borrowing in 2009. This was partly due to automatic stabilisers but also expansionary fiscal policy (tax cuts and higher spending)

 

US house prices

us-house-prices-99-17

House prices fell just before the recession started in 2006; falling house prices were a factor in causing the recession. But, as the recession started, house prices fell further.

Great Depression 1929-32

US-real-GDP-growth-recession-1930s

The Great Depression was a much more serious recession, with output falling over 26% in three years.

us-unemployment-1930s-great-depression

It led to a much higher rate of unemployment – with the rate rising from 0% to 25% in two years time.

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By on October 11th, 2017

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