Difference between Credit Crunch and Recession

Economic expansion is affected by several factors, including capital creation, technology development, the interplay of social and political forces, and the accessibility of human and natural resources. An increase in national income and employment rates, and therefore in people's standard of life, is the end outcome of an economy that grows steadily through time. Even though this is the norm, recessions and credit crunches can result from causes such as a drop in consumer confidence in the economy, a rise in asset values, a drop in salaries, a depreciation in the value of the currency rate, and reduced interest rates.

What is Credit Crunch?

The term "credit crisis," which also includes the terms "credit crunch" and "dead money," describes a situation in which financial institutions reduce the amount of money they lend to individuals and businesses due to an unanticipated shortage of cash. Because of this, lenders lose faith, leading to higher interest rates and greater difficulty obtaining firms' finances.

The effects of a credit crisis may be felt all across the economy since they usually follow a recession. When a business can't receive the money it needs to keep running or expand, it has to make a tough decision − shut down entirely or drastically scale back its current operations.

The following circumstances might lead to a credit crisis −

• Rising interest rates

• Shortage of funds in the financial system

• State control over the monetary system

The primary reasons for credit shortages are a high loan default rate and a subsequent rise in bad debt among borrowers. That makes it, so banks and other lenders either have to stop making loans altogether or charge exorbitant interest rates to compensate for their losses.

Since credit availability has been cut back, the economy has not been able to bounce back as quickly as it once did, resulting in a prolonged recession marked by rising unemployment and falling productivity.

What is Recession?

This indicates a significant slowdown in economic activity in a certain area during two quarters. The real gross domestic product (GDP), employment, real income, wholesale and retail sales, and industrial production, all fall during a recession. Economic downturns can endure anywhere from a few months to many years.

Although nobody likes them, recessions are an inevitable part of the business cycle.

Some of the telltale signs of an economic downturn include −

• Failures in business

• Extremely high rates of unemployment

• Financial institutions imploding

• Deceleration in the rate of increase in output

Investors are advised to put their money into firms that have strong balance sheets, low debt levels, and a steady stream of cash flow in the case of an economic slump. Companies with high debt levels, cyclicality, or speculation should be avoided.

While it is impossible to predict when a recession will develop, economists may use a number of signals to evaluate its likelihood. A two-quarter GDP decline is the most reliable indication, followed by drops in the ISM Purchasing Managers Index, the Treasury yield curve, and the OECD Composite Leading Indicator. A rising unemployment rate is one lagging statistic that may be used to detect a recession.

Possible causes of economic downturns include the following −

• Modifications to business structures and evolutions

• Supply disruption

• Dreadful events, whether triggered by human hands or mother nature

• Collapse of market speculation

Differences − Credit Crunch and Recession

Both "credit crunch" and "recession" affect the economy negatively. The following table highlights how they are different −

Characteristics	Credit crunch	Recession
Definition	A "credit crunch" occurs when banks and other lending institutions cut back on loaning money because they suddenly find themselves with a lower cash reserve than expected.	A recession is defined as a significant decline in economic activity that lasts for two consecutive fiscal quarters in the same region.
Causes	The primary reasons for a credit crunch are an increase in the quantity of bad debt held by borrowers and a rise in the frequency with which loans default. That makes it, so banks and other lenders either stop making loans altogether or charge exorbitant interest rates to compensate for their losses.	Recessions may be brought on by anything from structural shifts and changes in industries to supply chain shocks, catastrophes both natural and manmade, and the popping of an economic bubble.
Measure	It is impossible to know with 100% confidence if a country's economy is experiencing a financial crisis.	Indicators of a recession include both leading and trailing metrics, such as a decline in GDP for two consecutive quarters, a flattening yield curve for Treasuries, and a rise in the OECD Composite Leading Indicator. When the economy contracts for two or more consecutive quarters, it is considered a recession.

Conclusion

For financial organizations, an unanticipated shortage of funds can lead to a "credit crunch," or a reduction in lending. Bad debt held by borrowers has increased due to a rising percentage of loans going unpaid. That makes it, so banks and other lenders either have to stop making loans altogether or charge exorbitant interest rates to compensate for their losses.

However, a recession is characterized as a significant decline in economic activities in a region over two consecutive quarters. Causes include a breakdown in the supply chain, a shift in industry structure, catastrophic events (both natural and man-made), and the popping of an economic bubble.