Take away the cause, and the effect ceases

Causes of Recession:

It’s been a lot of time; “Recession” is the hottest topic the world over. Everyone is talking about recession. People hang on to newspapers, television, news channels, and financial reports only to discover “what next” in recession. Reports of IMF, World Bank, WTO, OECD and stalwarts of finance discipline have assumed unfathomable importance overnight.

There are various causes of recession happening but ‘fall in Aggregate Demand’ is perhaps the cause of causes. Inflation is a condition of an economy when the prices of goods and services rise immensely over a period of time. On account of rising inflation, a person can now buy lesser goods and services than before even with the equal amount of money. This lower discretionary income in the hands of consumers occur on account of increased production costs, higher energy costs, cost of living including food consumption and national debt. When the prices of goods mount very high, people tend to cut on overall spending especially on luxury goods, restrict them towards basic necessities and thus save more and more. As a result, GDP declines and amidst diminishing sales, the companies are forced to cut their costs as well as retrench workers which bring unemployment.

Most mainstream economists believe that recessions are caused by inadequate aggregte demand in the economy, and favor the use of expansionary macroeconomic policy during recessions. Strategies favored for moving an economy out of a recession vary depending on which economic school the policymakers follow. Monetarists would favor the use of expansionary monetary policies, while Keynesian economists may advocate increased government spending to spark economic growth. Supply-side economists may suggest tax cuts to promote business capital investment. Laissez-Faire minded economists may simply recommend that the government not interfere with natural market forces. For Capitalists, it is phase of inevitable business cycle.

There are other causes which also role their reason and are obviously attributed to various recessions in past.

A currency crisis, which is also called a balance-of-payments crisis, occurs when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange or a store value. It is a type of financial crisis and is often associated with a real economic crisis.

An energy crisis is any great bottleneck(or price rise) in the supply of energy resources to an economy. It usually refers to the shortage of oil and additionally electricity or other natural resources. An energy crisis may be referred to as an oil crisis, petroleum crisis, energy shortage, electricity shortage or electricity crisis.

War not only causes death and disability among military personnel and civilians, but it also destroys the social, economic, and political infrastructure necessary for well-being and health. War violates basic human rights. As a violent method of settling conflicts, it promotes other forms of violence in the community and the home. War causes immediate and long-term damage to the environment. And war and preparation for war deplete human and economic resources that might be used for social good.

In Underconsumption theory, recessions and stagnation arise due to inadequate consumer demand relative to the amount produced.
In an expanding economy, production tends to grow more rapidly than consumption. The disparity results from the unequal distribution of income; the rich do not consume all their income, while the poor do not have sufficient income to meet their consumption needs. This imbalance between output and sales has led to theories that the business cycle is caused by overproduction or Underconsumption.

General over-production is meant a production of commodities in general beyond the needs of society. Careful thought will show at once the absurdity of such an idea. The purpose of production is always consumption. Imperatively, there has hardly been a time when more economic goods were produced than men really needed to satisfy their legitimate wants. On the contrary, there has never been enough produced for this purpose. When there is an almost universal difficulty in disposing of goods, the chief cause is not Over-production but Underconsumption. Men want the goods, but they cannot at the time dispose of their services, and consequently lack the purchasing power which restricts them to satisfy their wants. Mistakes in judgment result in over-production in particular industries and over-production in a few industries often leads to the spread of doubt and uncertainty throughout the business world. Then men in their fear restrict production and thus incidentally close the market for labor. Laborers seeking and failing to find regular employment lose their purchasing power, with the result that the Underconsumption spreads all along the line, and society passes through what is called an industrial crisis or panic.


Overproduction is the accumulation of unsaleable inventories in the hands of businesses. Generally believed, an abundance of production creates general prosperity. However in the capitalist economy, commodities are produced for profit. This so-called profit motive, leading to uncontrolled production, causes negative consequences. The overproduction of commodities forces businesses to reduce production in order to clear inventories and alleviate blockage of funds. Any reduction in production implies a reduction in employment. This creates a "feed-back loop" or "vicious cycle", whereby excess inventories force businesses to reduce production, thereby reducing employment, which in turn reduces the demand for the excess inventories. The general reduction in the level of prices (deflation) caused by the law of supply and demand also forces businesses to reduce production as profits decline. Reduced profits render certain fields of production unprofitable.

Failure of Financial system: Rampant lending by Banks is a new but vital reason which played a pivotal role for inflicting worst recession of 2008-09. During growth period, banks made an increasing number of loans regardless of ability to repay. Banks found ways to increase the number of mortgage loans such as interest only mortgages, 100% mortgages and lending to people with poor credit histories ( sub-prime mortgages). Over confidence and complacency seeped into the whole financial system brought banks at the doorstep of bankruptcy, paralyzing the entire global financial system.

To be continued......

Economists have forecasted nine out of the last five recessions

Recession brings hardship for common people of society and also for economists, but in superlative terms. For common people, it is a painful surprise and perplexion about series of unpredictable developments concerning collapse of house prices, banking system, financial policy, and insolvency of insurance companies, job losses, inflation, and car sales and so on. It's hard enough to understand what's happening. However, for academic economists who are entirely dedicated to the subject, situation is unreasonably awkward and they feel like eating their humble pie when they fail to forecast the distressful recession. Different schools of thoughts propounding different theories are finding a shelter in such times. When we look back to history, we find that periods of severe economic distress have shaken up economics and economists have run over haphazardly to find the ways of recovery and forecast future meltdowns. It is well said that the astrology was invented to make the economy a more accurate science. To an economist, real life is a special case. There is one good joke in this context. During morning walk, three friends – Surgeon, Architect and economist were boasting about their profession’s supremacy. Surgeon said that he is very important because God Himself was a surgeon and the first thing He did was to extract Eve from Adam’s rib. The architect said, ‘wait a minute, God was Architect as he made the world in seven days out Chaos. Economist simply laughed and asked “ And who made chaos !!!”

It is a natural instinct of human being to look for someone to blame after the occurrence of crisis. Also, hindsight is always better than foresight; anyone can become wise after the event. Ever since the gravest Great Depression, there has been much soul-searching of the economics profession. There are too many criticisms leveled against economic profession. There is a large number of mathematical models, ideologies, theories, assumptions. There are monetarists, Austrian school economists, Keynesians, Marxists who have their own reasoning. But it is difficult to measure how much plausible their comprehension is because the debate for self-defense never ends. It has been observed that an entire field of experts dedicated to studying the behavior of markets failed to anticipate what may prove to be the biggest economic collapse of lifetime that has taken place in 2009.

However, to be realistic, it should be remembered economists don't run the economy. They don't even necessarily make the decisions which influence the economy. The failure of economists is partly due to the difficulty of keeping updated with a very fast changing financial system. But, there is still huge room for improvement.

What is recession? - The decline in river flow after a tempest has passed

A period of recession is a significant decline in economic activity. A recession documents simultaneous decline in employment, profit and investment, and an upscale inflation. A period of recession witnesses a stock market drop at the onset. It can also be sensed via the unemployment rate and subsequent claims, a housing recession and the use of index indicators.

In economics, the term recession is generally used to describe a situation in which a country's GDP (Gross Domestic Product), sustains a negative growth factor for at least 2 consecutive quarters However, this is the explanation that presents recession only as a definition to remember. To understand what it actually means, we need to first understand the meaning of GDP. It is the value of all final goods and services produced in an economy in a given year. These final goods are those goods which are not transformed into other goods. These goods are evaluated as per their market value. It means when the value of all final goods and services produced in a given year declines for two consecutive quarters, the state is referred to as “recession”. It is visible in real GDP, real income, employment, industrial production, and wholesale-retail sales in an economy.

Recession can be defined differently by different economists. Some economists also suggest that a recession occurs when the natural growth rate in GDP is less than the average of 2%. Typically, a normal economic recession lasts for approximately 1 year. A recession may involve simultaneous declines in coincident measures of overall economic activity such as employment, investment, and corporate profits, falling prices (deflation), or, alternatively, sharply rising prices (inflation) in a process known as stagflation. So, economic recession can be spotted before it happens. While the growth in GDP will still be present, it will show signs of sputtering and one can see higher levels of unemployment, decline in housing prices, decline in the stock market, and business expansion plans being put on hold. A severe or long recession is referred to as an economic depression. A devastating breakdown of an economy is called economic collapse. One definition that distinguishes recession and depression was a favorite of U.S. Presidents Harry S. Truman and Ronald Reagan. “A recession is when your neighbor loses his job; a depression is when you lose yours.” Nowadays, one funny comment is added these days to sum up the definition -Recovery is when Obama loses his job.

To be continued…………