Recession definition

economic-cycle-real-gdp copy

Definition of recession In the UK and EU a recession is a period of negative economic growth for two consecutive quarters. This means there is a fall in National Output and National Income for six months. Inevitably a recession will involve higher unemployment and an increase in government borrowing. This diagram shows that there was …

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The great recession 2008-13


The great recession refers to the economic downturn between 2008 and 2013. The recession began after the 2007/08 global credit crunch and led to a prolonged period of low/negative growth, rising unemployment and a period of fiscal austerity. In particular, the great recession highlighted problems within the Eurozone which experienced a double-dip recession and high unemployment.

This shows the sharp fall in real GDP in the UK economy in 2008 and 2009. It was also the slowest recovery on record.


great recession

Recession in US and EU. Source: Eurostat

Output gap


Graph showing how much real GDP fell behind the trend growth in the UK. Unlike previous recessions, the economy did not catch up the lost output.

Causes of the great recession 2007-08

The primary cause of the great recession was the credit crunch (2007-08) where the global banking system became short of funds, leading to a decline in confidence and decline in bank lending. The causes of the credit crunch were quite complicated but in summary.

  1. In 2000-2007, US banks made a big increase in sub-prime mortgage loans. These mortgages were very risky, but there was a good deal of ‘irrational exuberance‘ and belief house prices would keep rising.
  2. US mortgage companies sold these ‘risky mortgage bundles’ on to banks around the world. (Credit rating agencies gave them AAA ratings – despite the fact they were very risky.)
  3. Starting around 2005, US interest rates rose, and homeowners in the US began to default on these risky mortgages.
  4. US banks lost money, but also banks around the world later realised the ‘safe’ mortgage bundles they bought were actually useless. So many banks around the world saw a big fall in liquidity and value of their assets.

See more at: Credit crunch for a more detailed account

The recession was also caused by

  1. Credit crunch led to a fall in bank lending, due to a shortage of liquidity.
  2. Fall in consumer and business confidence resulting from the financial instability.
  3. Fall in exports from the global recession.
  4. Fall in house prices leading to negative wealth effects.
  5. Fiscal austerity compounded the initial fall in GDP.
  6. In Europe, the single currency created additional problems because of over-valued exchange rates, and high bond yields.

More details on causes of great recession

  1. Great Moderation. The period 2000-2007 was a time of strong economic growth, low inflation and falling unemployment. Central Banks appeared to be successful in targeting low inflation and ensuring economic stability. However, underneath the macro-economic stability, there was growing instability regarding credit and financial markets.
  2. Housing bubble. Many countries experienced a rapid growth in house prices. House price rose faster than inflation and faster than incomes. This boom in housing was encouraged by a growth in bank lending and high confidence. Several countries, such as Ireland and Spain also experienced a boom in house building.
    uk-irish-house-pricesIrish and UK housing price fall in 2008.
  3. Bad loans. In the period leading up to the credit crunch, banks became more aggressive and willing to take risks in lending. Especially in America, banks and mortgage companies loosened their criteria for giving mortgages. Many homeowners were given large mortgages, with limited checks on their ability to repay. However, in the economic downturn, people were left with mortgages they couldn’t afford.
  4. Bad loans repacked and resold. These ‘bad’ mortgage loans were sold onto other financial institutions around the world. For example, many UK and European banks bought these mortgage bundles from the US (CDOs) and so were exposed to any potential losses in the US housing market.
  5. Housing Bubble Burst. In 2006, the US housing market bubble burst. House prices started to fall, and there was a rise in mortgage defaults. Banks began to realise they had lost significant sums of money through the US mortgage defaults.
  6. Banks short of liquidity. The scale of bank losses started to increase and it became harder for banks to borrow money on money markets. This caused banks to reduce loans and mortgages. Because banks were losing money, it became challenging to get credit and liquidity. Some banks lost so much they were running out of money. In several countries, such as UK, Ireland and US, major banks had to be bailed out by the government. But, the realisation banks were short of liquidity harmed consumer and investor confidence. The fall in confidence led to lower spending and investment.
  7. Rise in oil prices. In 2008, there was also a peak in oil prices. This complicated matters because it caused cost-push inflation. This cost-push inflation made Central Banks more reluctant to cut interest rates. Also, higher oil prices reduced discretionary income and led to lower spending. Usually, in a recession, oil prices fall. However, because of rising demand in China and India, we saw rising oil prices – even as Europe and the US went into recession. High oil and commodity prices was another factor reducing demand.

The impact of the credit crunch and recession

  • In 2008, all major economies experienced a very sharp drop in real GDP. The banking crisis severely curtailed normal bank lending. The result was a fall in investment and consumer spending leading to a sharp drop in real GDP.
  • The fall in house prices was another factor leading to recession. In the boom years, rising house prices (and wealth) underpinned higher consumer spending. When house prices dropped, many homeowners faced negative equity. Therefore, they cut back on spending and could no longer rely on re-mortgaging to gain equity withdrawal.
  • The global nature of the crisis meant that there was also a drop in world trade. Countries saw a drop in exports as the global downturn led to lower demand.
  • Unemployment. Unemployment rose in US and Eurozone.
  • Government debt. Government debt rose sharply due to the recession. This ushered in a period of ‘austerity’ with many governments in Europe seeking to cut spending.
  • Euro crisis. The Eurozone saw a rise in bond yields in 2010-12 – partly due to recession, and also due to lack of Central Bank willing to intervene.

Response to the great recession

  • Bank rescues. Firstly, governments felt obliged to intervene in the banking sector to avoid banks and financial institutions going bust. However, there was some reluctance to bailout those who were blamed for causing the crisis. In 2008, the US decided to allow Lehman Brothers to go bust. This caused a major loss of confidence. After the panic this created, governments realised they couldn’t allow a repeat of this experience. In the UK, the government intervened to bailout out major banks, such as Northern Rock, and Lloyds TSB.


  • Cuts in interest rates. Towards the latter half of 2008 and early 2009, Central Banks cut interest rates to record low levels. The UK cut base rates from 5% to 0.5%. Usually, a major cut in interest rates would make borrowing cheaper and encourage consumption and investment. (e.g. in 1992, when the UK cut interest rates, the economy recovered fairly quickly.) However, cuts in interest rates were less effective in this period.
  • Expansionary fiscal policy. The deep recession saw a sharp rise in budget deficits because government tax revenues evaporated. This was particularly noticeable for countries who relied on stamp duty and tax from the finance sector. However, in the UK and US, there was a moderate degree of fiscal expansion. The UK introduced a temporary cut in VAT. In the US, there was also a moderate fiscal stimulus.
  • It is worth noting that in comparison to the great depression of the 1930s, two things were avoided in the great recession.
  1. Large number of banks going bankrupt was avoided (In the 1930s, in the US over 500 commercial banks went bankrupt)
  2. There was no major trade war. In the 1930s, a tariff war developed as countries tried to protect domestic industries.

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What happens to value of currency during recession?

Readers Question: What will happen to the value of a currency during times of deep recession and high inflation?

There is no hard and fast rule about what will happen to the value of a currency during a deep recession – though, a currency is likely to fall because country becomes a less attractive place to invest. For example, when the great recession started in 2008, the UK experienced a significant depreciation.

The Pound Sterling fell over 25% from 2007 (before the start of the great recession) to July 2009

But the Euro and Dollar were less affected by the great recession.

U.S._Dollar_Index The US dollar index (which shows the value of the US dollar against a trade-weighted basket of other currencies, e.g. Euro and Yen) has fluctuated but overall has remained at similar value to the start of the recession.

Note in early 1980, the US went into recession, but during this period the value of the Dollar rose.

It was a similar experience in the UK, in the 1980s, In 1980,  there was a rapid appreciation in Sterling (which was one factor contributing to the recession of 1980/81.)

Economic theory behind the value of a currency in recession

Suppose one country, e.g. the UK, enters a deeper recession than all its other competitors. How might we expect the currency to behave?

Recession and interest rates. If the UK enters a recession, then we would expect UK interest rates to fall compared to other countries. This would make the UK less attractive for investors to save money. Hot money flows are likely to leave the UK and move to countries with higher interest rates. If people move money out of the UK, they will sell Pounds and buy other currencies, causing a fall in the value of Sterling. Therefore, in theory, we might expect a recession to cause a fall in the value of the currency.


1. In a recession, inflation is likely to fall. Lower inflation will help the country become more competitive, and this may increase demand for the currency causing it to rise.

2. Many factors affect the value of a currency. For example, if the UK had a large current account deficit, then we might expect this trade deficit to put downward pressure on the currency. The fall in the value of Sterling in 2008 was partly related to the UK’s trade deficit and lack of competitiveness. However, if a country like Germany entered a recession, they may be less downward pressure on their currency (the Euro) because Germany has a large current account surplus.

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How Long Do Recessions Last?

Readers Question: How Long do Recessions last?

There is no exact answer. Recessions can last for varying time lengths depending on the causes and also the response of governments and consumers.

  • If recessions are caused by a tightening of monetary policy (higher interest rates to reduce inflation), then it tends to be easier to get out of a recession, as the interest rate rise can be reversed and this will boost demand.
  • If the recession is more of a balance sheet recession (bad debts, falling asset prices, bank losses), then the recession will tend to last much longer. For example, in 2009, interest rate cuts were insufficient to boost demand.

Examples of Recessions


Comparing different recessions

The Great Depression


The Great Depression started in 1929 – by 1933 there was an economic recovery – though GDP did not recover its pre-crisis peak until 1936.

The Great Depression which started after the wall street crash in 1929, lasted for several years in the US. The length of the recession was due to several factors including:

  • Before the depression, there had been growth in private consumption and debt, which left individuals and firms exposed.
  • Global nature of depression. Many countries increased tariffs to try and protect domestic industries, but this caused lower global trade.
  • In response to depression, Government’s tried to balance the budget by increasing taxes, but this caused lower spending..
  • Negative Multiplier effect.
  • Allowing banks to fail, which led to a sharp fall in the money supply and lower aggregate demand.
  • Lack of economic stimulus
  • In 1937, there was a recovery in the US, but a tightening of fiscal policy pushed the economy back into recession

See also: The Great Depression

In recent years, recessions in the UK and US have lasted for shorter time periods.


UK recession 1981 was severe for the manufacturing sector but lasted less than a year. However, unemployment persisted at close to 3 million for another five years.

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The recession is over but not the depression

Some thought provoking analysis from NIESR. Firstly, they define recession and depression in an interesting way.

  • Recession – a period of time where output is falling.
  • Depression – The period of time where output is below it’s peak.

The UK economy is now growing, at a decent pace (0.8% in Q3). However, output is still significantly below the old 2008 peak. This means that the recession is over. But, with output still below the 2008 peak, the prolonged period of depression is still not over, according to this definition.

Also, if we compare this ongoing economic downturn (2008-2013) with other periods of serious economic stagnation, the UK economy is performing worse now than even the 1920s or 1930s.

NIERS - UK output
Source: NIERS

The NIERS don’t expect the 2008 GDP peak to be regained until 2015. Meaning, we will have a 7 year period of stagnating real GDP. An unprecedented length of economic stagnation. See also: more on comparison of different recessions

But, it doesn’t feel like a depression?

There are no commonly agreed definitions of what constitutes a depression. Most definitions tend to emphasise a significant fall in real GDP or a prolonged fall in GDP for a period of over 3 years. For example, if real GDP falls by over 10%, that would be classed as a depression. A depression also implies a very high rate of unemployment (perhaps greater than 15%).

The UK unemployment rate is relatively low by the standards of other recessions (helped by falling productivity and flexible labour markets) Therefore, with economic growth, and ‘reasonably’ low unemployment, it feels a different climate to the great depression of the 1930s.

On the other hand, although unemployment could be much higher, there has been a widespread fall in living standards, which is unprecedented in the post war period. Figures show UK living standards have dropped to their lowest in a decade after average real incomes fell a further 3 per cent last year.

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The depth of the European recession

Interesting graph which shows the depth of the EU recession compared to the great depression of the 1930s.

depth-euro-recession Source stats | via Krugman

UK recession compared

This graph is from the start of 2013. Since, then the UK economy is showing signs of  picking up. But, it is still worth bearing in mind the length of the decline in GDP since the start of the recession.


Comparing different recessions

For the first 15 months, the decline in real GDP is comparable to the great depression of the 1930s. The great depression shows a bigger fall in GDP (-8.0%) from peak. But, during the 2008- recession, GDP stagnated the longest. 

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Triple Dip Recession in UK Likely

Unfortunately, despite the post-Olympic bounce in GDP, other aspects of the UK economy look pretty grim. In manufacturing and industrial output, there has been no real recovery. In manufacturing it is not so much a triple dip recession – more a prolonged double dip. Manufacturing output is  2.1 per cent lower in October 2012 compared with October 2011;


Source: ONS

Looking at data since 2007, we see a similar pattern to GDP.


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Triple-dip Recession Could Lead to Lower Credit Rating

Recently, a report suggested austerity can increase debt levels. Now, there is an indication that austerity could cause a decline in credit ratings. This has certainly been the experience of many European countries – who since they introduced austerity measures – have seen a reduction in their credit rating. Austerity hawks have often sold immediate …

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