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A recession refers to the weaker conditions of economies due to various reasons. The economies depend on markets to run well. When the condition of the markets becomes unhealthy, there are chances for economies to collapse. This is what actually happens during a recession. This can happen worldwide as witnessed during the great recession in 2008.
What is a Global Recession?
A global recession refers to the economic downturn that affects all the nations of the world. It is usually observed that when the economy of a country becomes too fragile, the effect is transmitted to other countries. This happens when the economies of various nations are intertwined with each other, and economic shocks are transmitted from one to another quickly.
The IMF has set some distinct standards to identify global recessions. These standards include a decrease in per capita Gross Domestic Product (GDP) around the world.
Moreover, it suggests that in order to be a global recession, the nosedive in GDP must be accompanied by a weakening of some macroeconomic indicators, including but not limited to employment, trade, and capital flows.
The global financial crisis that originated in the US in 2007 is a good example of a global recession. It happened due to the burst of the housing bubble in the US. There was the availability of loans at lower rates in the US since 2001 which let the banks offer loans to even non-qualifying individuals at a sub-prime rate.
However, when the rates of loans started to increase in 2005, most homeowners found it tough to repay their loan installments.
As the demand for new houses no longer existed, the prices for homes started to fall. So, the homeowners could not save themselves by selling their houses for a profit. When the subprime mortgage market collapsed many banks found themselves in deep trouble. Banks started to doubt each other’s solvency which deepened the trouble even further. As foreclosures climbed up, banks stopped offering loans to subprime customers which further decreased the demands.
As many European banks had large investments in the US banks and corporates, the value of their investments fell abruptly, causing a ripple effect. This effect soon spread to most countries and the great recession grabbed the world within its grasp.
What Causes Global Recession?
The various causes of a global recession are the following:
Loss of confidence in the economy
Lack of confidence in the business and economy leads to less demand for products in the market. This means the production of goods is reduced by producers. So, manpower needs to come down. Organizations run fewer employment notices and fewer jobs are added to the economy. Growth becomes stagnant and may fall down. Governments must intervene to hike confidence in order to avoid a recession.
Interest rates are hiked to protect the value of the currency. But this limits the liquidity available in the hands of the individual which leads to limited consumption and less demand. This leads to a recession.
Crash of stock market
The crash of the stock market leads to a bearish outlook. When the outlook sustains for a long time, it drains capital from businesses leading to a recession.
Fall in housing prices and sales
As noticed in the great recession of 2008 in the US, falling housing rates lead to a vacuum in the market. When interest rates go up in such situations, the homeowners can no longer pay interest. The banks get miffed and this causes a loss of confidence in the interdependent banking industry. Ultimately recession sets in for lower availability of money in the market.
A slowdown in manufacturing may indicate an imminent recession. For example, manufacturing demand had slowed down in 2006 in the US before the recession in 2008.
Deregulation of financial systems and entities may lead to recession too. For example, when loan-to-value restrictions were lifted in the US, it led to the S&L crisis.
Lack of efficient management
Inefficient management practices by businesses may also create a recession. The savings and loans crisis had resulted in the recession of the 1990s.
Wage and price controls
Wage and price controls may also lead to recession. For example, in the 1973 recession, wages were fixed to curtail the recession. Employers cut back the jobs as wage demand could not be fulfilled. Demand fell due to a loss of income and companies could not increase prices. So, more workers were laid-off. This led to a recession.
Slowdowns due to war may lead to recession too. As war costs enough, economic factors may indicate a slowdown in manufacturing and consumption leading to a recession worldwide.
A credit crunch, such as that witnessed in the 2008 recession occurs when a company announces the collapse of big funds (hedge funds of Bear Sterns) collapse. Funds may be heavily invested in collateralized obligations. Banks who have invested in similar projects when the ratings of funds are downgraded, leading to panic and lack of confidence among one another. This may create a recession.
Bursting Asset Bubbles
When the value of investments in assets such as gold and property are inflated beyond their sustainable value, asset bubbles are created. When they burst, a recession may set in.
Deflation reduces consumption and reduction in manufacturing. Assets get devalued and a lack of demand in the market leads to recession.
Consequences of a Global Recession
There are many hard consequences of a global recession.
Some of these are as follows:
Monetary and fiscal effects: Credit crunch and short-term fall in interest rates may be noticed.
Rise in unemployment: Businesses often want to reduce costs due to recession which may mean loss of employment opportunities.
Inflation may go down: As consumption decreases, a recession may lead to a reduction in inflation.
Loss of profitability: Lower prices due to recession mean lowered profitability and more job cuts.
Bail out by governments: Recessions are followed by bailout measures by the governments in order to hike consumption and increase demand.
Opportunity for organizations: As employers agree to work at lower wages, highly educated employees may be retained by organizations.
Global recessions are a sign of impending danger for economies. As economic conditions worsen during recessions, it means a lack of social welfare. Recessions lead to illiquidity which means citizens have less money for expenditure.
Therefore, lifestyles may be impacted by the recession. As jobs are cut down, there is a loss of income which may instill less demand for products. This creates a vicious cycle of unholy effects getting rid of whom is difficult and resource-draining. Government should, therefore, be able to identify recession early and take necessary steps to avoid it.
1. Which is the longest global recession in history?
Ans. The Great recession that started in 2008 is the longest and most effective recession in history.
2. Why is it tough to avoid global recessions?
Ans. Global recessions are a result of continued practice which is not possible to be tracked by the government.
For example, until it burst, the housing bubble was invisible. Such limitations make global recessions tough to identify before they occur. However, economists learn from past conditions and can identify a global recession early if it resembles the ones that have already occurred.
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