A lot has happened in the last few years, from a global pandemic to Russia invading Ukraine. Both of these events have had a huge impact on economies around the world and may even be leading to recessions in many. But what if things get worse?
When does a recession become a depression, and should you be worried?
Let’s find out.
These are unprecedented times as modern-day economies have never had to contend with a global pandemic, war, and supply chain issues at the same time. The decisions made during this period in human history and the impact they will have on the future are unknown.
However, we do know that due to current events, economies have slowed, and inflation is on the rise. These factors, along with increasing unemployment rates, bankruptcies, and falling consumer spending, are key indicators that an economy could be heading towards a recession.
But what does this actually mean, and are recessions such a bad thing?
A recession is defined as a slowdown or shrinking of an economy over the course of several months.
Many experts classify a recession as two consecutive quarters of declines in real gross domestic
product or GDP.
Real GDP means that economic numbers have been adjusted to account for inflation so that they can be more accurately compared to other quarters of economic activity.
This creates a more precise picture of what the economy is actually doing and if we might
be headed for a financial disaster.
However, it’s important to keep in mind that recessions are a normal part of economic growth.If you’ve ever bought stocks or followed the stock market, you know that there are inevitable highs and lows over the course of several years.
Almost all economists agree that recessions are a part of the long cycle that economies go through in order to grow organically. Economies will continue to grow until something triggers them to slow down or shrink.
There are plenty of reasons this might happen, such as war, pandemics, or the bursting of a financial bubble like in the 2007 housing market in the United States. Another key factor that can indicate whether or not an economy is headed towards a recession is rising interest rates.
It may seem intuitive that if high-interest rates cause an economy to slow down, banks and governments should just keep interest rates as low as possible, but it’s not that simple.
Recently interest rates have been on the rise, and for good reason. Increasing interest rates are a good way to slow down or reverse inflation. Inflation is when prices increase and result in a currency losing value as consumers must spend more money than they used to in order to purchase the same products.
However you think about it, inflation is bad for the consumer and for the economy. This has been happening as we come out of the pandemic. People who kept their jobs or qualified for stimulus checks had money they could not spend at the time as they couldn’t go out and do things.
When COVID restrictions became more relaxed, people spent that saved up money, creating a high demand for products. Unfortunately, the amount of products being produced was disrupted by factories shutting down and supply chain issues caused by the pandemic.
This has led to prices for everyday goods such as groceries and electronics to skyrocket.
The supply for these goods cannot keep up with the demand, and prices are rising too fast for the consumer to keep up with. Inflation of prices has caused the Federal Reserve in the United States to increase interest rates so that people will be less likely to take out loans and rack up debt.
At the time that this video was made, increased interest rates seemed to have worked, and inflation levels appear to be stabilizing. However, only time will tell if the higher interest rates have actually stopped the United States from going into a recession. Many countries worldwide are battling this same problem and have taken precautionary measures to ensure their economies don’t go into a recession.
But what happens in a worst-case scenario?
What if the United States or other countries do go into a recession?
The main concern for most people during a recession is that unemployment rates go up. As an economy slows down, companies need to lay off employees to cut costs. This means more and more people have less income to spend, which will slow down the economy even more.
When people are laid off because of a recession, more pressure is put on the government to provide aid.Yet, the government is also hurting financially during these times, making it difficult to lend support to their citizens. Once an economy is in a recession, things start to spiral downward. However, raising interest rates, providing support to the unemployed, and giving businesses time to recover will eventually cause the economy to pick back up and grow again.
This will bring jobs back and allow businesses to become profitable as people begin spending their money again.
But what if this doesn’t happen?
What if the economy spirals out of control?
This is when a depression occurs.
Currently, there has only been one economic depression in the United States, the Great Depression, which lasted from 1929 to 1939. However, since these are unprecedented times, there is no knowing what the economic future will hold.
So, what exactly is a depression, and how does it differ from recessions?
Many economists agree that a depression is just a really long recession. There is no exact length of time that an economy needs to be in decline for a depression to be declared, but it typically needs to be several years.
Recessions tend to last two or more quarters of a fiscal year or about six months but can be longer if things get really bad. During the 1973 oil crisis, when oil prices quadrupled, and the stock market crashed, the U.S economy was in a recession for about a year and four months.
Similarly, the Great Recession of 2008 lasted around a year and a half. However, none of these periods of time are classified as depressions because they did not meet certain other criteria. A recession transitions into a depression when it lasts roughly two or more years.
The real GDP of an economy also needs to decline by at least ten percent in a single year for that time period to be considered an economic depression. Like with a recession, a key indicator that an economy is in a depression other than the dramatic lowering of GDP is high unemployment rates.
However, unlike a recession, these unemployment rates continue to grow for years until the economy finally bottoms out. A byproduct of a depression is that international trade tends to stall, and production is dialed back as consumers both at home and abroad lose faith in the economy. The easiest way to understand an economic depression is to examine the only one that has ever happened.
Like recessions of the past and present, the Great Depression occurred due to a number of different factors.
The first was that the U.S. economy grew tremendously and unsustainably during the roaring 20s.It seemed as if the profits would never stop, which led to the masses pouring huge amounts of money into the stock market. They would take out loans from banks just so that they could invest more money with the stipulation that they would pay interest on the loans using their gains when they sold their stocks. This worked great for most of the 1920s, but then everything fell apart. Banks lent out too much money that they did not have with the expectation that it would all come back with interest.
It’s important to remember that what goes up must come down, even the economy. People mortgaged their homes and used all of their disposable income to buy into the stock market. In October of 1929, the stock market reached its peak and began to cool off. This was always bound to happen as economic growth can not last forever. There is always an inevitable resetting of the stock market so that it can grow organically in the future.
Unfortunately, during the 1920s, people were not thinking about the consequences of pouring all of their money and assets into an economic system that would eventually need to reset. Stock prices began to decline, and everyone began to panic.
If the masses remained calm and didn’t try to desperately pull their money out of the stock market, the crash of 1929 might have just led to a recession. But that’s not what happened.
Banks and companies warned that if everyone withdrew their money all at once, they would default on their loans, and the entire economy would fall apart, but no one listened. This would be one of the main factors that led to the Great Depression.
At the same time that the stock market crashed, people lost faith in the banks themselves. They had seen the bad decisions made by bankers when they extended loans that were not sustainable. Now people were worried that the banks would lose all their savings as well, so they started withdrawing all of their money from financial institutions.
With less money in their vaults, banks defaulted on more loans, thus exacerbating the economic decline even further and extending the depression of the economy for several more years. During the Great Depression, the unemployment rate skyrocketed to almost 25%. A quarter of the country couldn’t feed their families, let alone buy products or invest in the economy.
This meant businesses couldn’t grow, and entire industries collapsed. It’s estimated that GDP fell by 30% as United States companies struggled to produce their products and sell them within the country and abroad. This led to another problem. As the United States economy went into freefall, it had consequences for the rest of the world.
U.S. citizens struggled to make ends meet, meaning they did not have surplus money to spend on foreign products. This hurt other economies around the world that depended heavily on the U.S. consumer buying their goods.
The exports coming out of the United States tended to be relatively cheap, while products from countries in Europe were more expensive. As foreign economies bought more and more U.S. goods, their gold stores flowed into the United States. This, in turn, devalued the currencies of other countries as their gold reserves were depleted.
Foreign banks raised interest rates to try and stop the trade imbalance, but it was too late. The Great Depression in the United States spread across the world and caused other economies to decline. In the end, the United States was not the only country to experience a depression during the 1930s.
Almost every economy in the world was impacted by a decline in output and trade. In order to fix the economy, United States President Franklin D. Roosevelt started the Federal Deposit Insurance Corporation or FDIC. This organization used several monetary and fiscal policies to stabilize the economy and increase GDP.
These policies, along with high-interest rates, eventually caused the economy to recover. It’s important to note that the Great Depression was a series of unfortunate events that all occurred at the same time. This is exactly how recessions occur as well. There is rarely a single event that economists can point to which causes a recession. This is why economists, bankers, and corporations don’t know if an economy is in a recession until it actually happens.
Predicting a recession with 100% accuracy is impossible.
There are definitely key factors that indicate a recession might be coming, such as an increase in inflation and the resulting increase in interest rates. And if unemployment rates are going up at the same time as interest rates, there is an even higher chance that an economy is about to go into a recession. However, until real GDP can be analyzed and economists have all of the data, no definitive conclusion can be made.
So, the difference between an economic recession and depression is mostly a matter of time and how bad things actually get. A severe recession that lasts for several years is definitely a depression. Also, if GDP declines by ten percent multiple years in a row, then an economy is also officially in a depression.
And since we now operate in a global economy, one country’s recession will impact the rest of the world’s economies. This is especially true of countries like the United States, China, and those in the European Union, who generate an enormous amount of GDP and are also large consumers.
Only time will tell how current events will affect the economy, but one thing is for sure:
if a major economy goes into a depression in today’s day and age, it will have severe consequences for economies around the world.
Post a Comment
0Comments