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......