A Guide to Economic Recession

A country or the world might face an economic slowdown at any point in time. This downturn or recession significantly impacts the country’s economy, which is generally visible in the employment rate, industrial production, real GDP, the decline in retail sales, and national income. Before we understand what causes recession and how to recover from it, it is important to know what it is.

What is an economic recession?

A significant, extensive, and prolonged decline in economic activity is referred to as a recession.

The National Bureau of Economic Research (NBER), an American private non-profit research organization, defines a recession as a prolonged, considerable fall in economic activity that affects all sectors of the economy negatively and is typically reflected in production, employment, real income, and other indicators.

What are the indicators of the recession?

Keep your eyes open for the below indicators to predict a recession.

1. Consistent fall in GDP value for two or three quarters
2. Increase in bankruptcies, defaults, and failures to repay loans
3. Overall drop in exports and imports in the manufacturing and service sectors
4. Rise in unemployment and companies laying off workers to reduce cost
5. Credit given to the public starts to tighten, and short-term interest rates tend to fall
6. Decline in consumers’ spending on goods and services

What are the factors that lead to economic recession?

A few of the factors that led to the economic recession are mentioned below.

1. 
   

   Mismatch in demand and supply

The excessive supply of goods and services that aren’t consumed when demand peaks, creates a situation of excess supply in the market. This leads to recession, and prices tend to fall. During this period, businesses will diminish production and lay off workers as consumers’ purchasing power declines and consumption declines further.

2. 
   

   Economic uncertainty

In case of unforeseen circumstances like wars and pandemics, consumers’ behavioral patterns can be unpredictable. These unexpected changes in the short, medium, and long-term create economic instability.

3. 
   

   Bubble burst

A bubble burst happens when the cost of an investment, such as gold, stocks, or real estate, rises unreasonably. When a bubble pops, it creates the conditions for a recession.

4. 
   

   Financial factor

For both consumers and businesses, higher interest rates from central banks make debt more expensive and borrowing more difficult. It leads to a lack of credit availability and money supply.

How does the recession impact the stock market and investors? 

The Indian economy and the stock market go hand-in-hand. Thus, any economic changes can also be seen in the stock market. The recession has a significant impact on the economy, thereby affecting the stock market. You can witness this effect in the below-mentioned ways.

a. Fall in the stock market

The economy starts falling during the recession, which leads to limited disposable income in households, negative market sentiments, and reduced demands. This causes the stock market to fall. Moreover, a recession in one country affects the domestic market and has international repercussions too. 

b. Increased volatility

As soon as the market falls, you can witness a significant increase in stock market volatility. This is because traders and investors start looking out for quality stocks at reduced prices to diversify their portfolios. In case there are too many buyers of a stock, its demand may temporarily drive up the stock price. This abrupt change in stock price adds to its volatility, thus making it an unfavorable choice for investors. 

c. Recession as investment opportunity

With a long-term investment in mind, the stock market decline also presents investors with a chance to purchase stocks at less rates.

How does the economy recover from the recession?

Recessions are followed by market economic adjustment before economies bounce back. Programs for fiscal stimulation also aid in the recovery of economies. Additionally, the government and the central bank affect the economy through monetary and fiscal policy, including modifying government expenditure, taxation, and interest rates.

Difference between recession and depression

Compared to a depression, a recession is less severe. Unemployment, a downward tendency in business cycle trends, and a decline in production and trading activity are all signs of recession. It affects households by causing them to make fewer purchases and investments. On the other hand, depression is a far more grave condition. It involves drastically reduced industrial and manufacturing activities, high unemployment rates, a sharp decline in global trade, and diminished capital movements.

Conclusion

Economic downturns, or recessions, are a common feature of the business cycle. But although being inevitable, they are temporary. Adopting preventive measures to protect finances can make a world of difference, such as savings, long-term investments, diversifying investment holdings, having multiple sources of income, and remaining realistic about your risk tolerance.

Traders can invest in defensive stocks and growth stocks. Defensive stocks such as consumer staples and healthcare typically have less impact from economic downturns than cyclical sectors like energy and industrial. On the other hand, value stocks frequently beat growth companies. This is so because investors looking for a good deal tend to prefer value stocks because they are typically less expensive.

Disclaimer

1. This blog is exclusively for educational purposes
2. Investments in the securities market are subject to market risks, read all the related documents carefully before investing