Reasons for Recessions

See also:

Some economic factors that could cause a recession. Note this list is not exhaustive.

  1. Tighter Monetary Policy. This involves increasing interest rates this can reduce AD.
    • If there is high inflation the Monetary authorities may increase interest rates and this may cause a recession. e.g. recession of 1991
  1. Tighter Fiscal Policy. This involves higher taxes and lower govt spending and again will reduce AD. e.g. recession of 1981
  1. Global recession, leading to less trade and demand for UK exports.

For example if the US economy entered into a recession

      • US consumers would by UK exports
      • A fall in economic confidence leading to more cautious spending
      • A devaluation of the dollar against sterling, reducing AD
      • US stock market would fall causing a fall in UK stock markets leading to lower wealth and spending.
  1. Loss of Confidence.
    • If people believe there is going to be a recession, then they will spend less.
    • They will not borrow money or spend on credit cards. This is because they fear they could be made unemployed. This causes AD to fall. There is also likely to be a negative multiplier effect, causing AD to fall even further.
    • This shows that confidence is very important, people could talk themselves into a recession

    5. Fall in House Prices and/or Share Prices.

  • Falling house prices causes a negative wealth effect, reducing consumer confidence and consumer spending.

6. Credit Crunch

Collapse in normal banking lending. See: Essays on credit crunch

Classical View of Recessions

Classical economists argue that a recession will only be temporary, and the economy will be below the natural rate of output for a short time.

Keynesian View of Recessions

However Keynesians argue that the economy could be below full potential for a long time, this is because

  1. A fall in AD can cause a negative multiplier effect. Rising unemployment means less people will be spending therefore there will be less output causing even more people to be made unemployment.
  1. If there is unemployment Classical economists argue wages should fall to regain equilibrium in the labour markets.
    • However Keynes argued that if wages fall there will be a further fall in AD leading to even lower consumer spending.
  1. During a global recession, countries often take an insular approach of raising tariff barriers to protect their local industries. However this leads to other countries retaliating and higher tariffs lead to lower trade and output.