Recession

We hear the word “Recession” Since January 2008 almost daily. In the daily conversation we many time uses the word recession. But very few people know that What is Recession and how it works? So I have made this separate post for those who want to understand the basics of Recession in Layman’s Language. After reading this post, you will understand the basics of Recession and how it works?

What is Recession & How it Works?

Before understanding Recession, you need to understand the Market Economy.

A] Two Stages of Market Economy

- Growing Market Economy
- Declining Market Economy

B] Two Factors of Market

- Demand
- Supply

$ –> Growing Market Economy -

Starting Point = Willingness to Buy. –> Consumers feel confident in the future of the economy, so they buy more stuff –> In response to increased demand, producers hire more people and consume more raw materials –> Increased employment means even more consumers can buy stuff –> Investors believe trend will continue, so value of stock increases –> With more money, Investors buy more stocks and consume more goods and services –> Stock market rises over all –> The Upward Spiral

$ –> Declining Market Economy -

Starting Point = Unwillingness to Buy –> Consumers do not feel confident about the economy, so they buy less stuff –> In response to decreased demand; producers lay off people and decrease consumption of raw materials –> Unemployed workers have less money to spend so demand decreases further –> Employed workers fear they will lose their jobs so they spend less money –> Investors fear the value of stocks will decrease, so they are less willing to invest in new companies –> Stock Market falls over all –> The Downward Spiral

What is Recession?

Recession is Economy is shrinking for two consecutive quarters (= 6 months) with a decrease in GDP (Gross Domestic Product). If GDP is negative for two consecutive quarters, It is Recession. In India, The Current GDP is around 5-8% per Quarter. But in USA, since last so many quarters, GDP is below Zero so it means that USA is in Recession.

GDP = Value of all reported Goods & Services produced by the people operating in the country.
GDP is a good indicator of economy; Other

indicators could be;
-Unemployment Rate
-Consumption Rate
-Actual Personal Income
-Etc..

If GDP is growing, then market is growing due to increased demand.

What is Depression?

If Recession continues for more than two consecutive quarters ( > 6 Months), it means that the Economy is in Depression.

There is a joke that economists quote to explain the
Difference between “Recession & Depression”
Recession = When your Neighbor loses Job
Depression = When you lose your Job

Why Recession Happens?

01) Over Production -

When Companies make false projections, there occurs Pseudo Demand –> Companies Produce More –> Over Production –> A Situation in which the supply exceeds the Nation’s ability to consume what has been produced –> Supply > Demand

02) Low Confidence Level -

Low Confidence Level of Millions of consumers and producers after they hear many job cuts, Demand coming down, Companies’ bankruptcy, etc –>
Consumers are fearing that they may lose their jobs; So, they have less confidence to spend money and buy goods; This will result in reduction in demand in the market; Consumers start saving money instead of spending money; This is a downward spiral in the economy.

How to Know Recession? – Indicators to say a Nation is in Recession

- People buying less stuff
- Decrease in factory production
- Growing unemployment
- Slump in personal income
- An unhealthy stock market
- GDP below Zero for two consecutive quarters

How to Come out of Recession?

Any Government has 2 Plans to take economy out of Recession.

01) Fiscal Policies (By Government) - Government influences the economy by changing how it (Government) spends and collects money.

02) Monetary Policies (By Central Banks such as RBI, Federal Reserve Bank…etc…) - RBI manipulates the available supply of money in the country

$ –> Fiscal Policies -

- Tax cuts for Businesses or for Individuals
- More spending by Government to Create Jobs
- Unemployment Insurance

$ –> Monetary Policies -

- Reduce Reserve Ratio –> More Money available for Banks to give loans –> Demand picks up & Market can recover.

What is Reserve ratio?

Each bank has to keep a high % of their assets in Central Bank. These assets do not earn any interest to banks. This money kept in RBI is called “Reserves”; RBI sets certain ratio of this reserves and it is called “Reserve Ratio”

- Lower The Interest Rates –> Individuals & Businesses can take more Loans –> Demand picks up, Market can recover

- Use its own reserved Money to buy Govt. Bonds –> It becomes an Income to government to inject money into the market. Recently in March 2009, The Federal Government of USA has bought Treasury Bonds issued by Federal Reserve Bank worth of US $ 1.45 Trillion. In this way, the US Government has printed money in the true sense. It means that for future generations, there will be more Taxations. because they will have to pay this US $ 1.45 Trillion with interest.