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Another field to be discussed in the report is what a good investment in a recession and
what are the new rules and policies introduced by world government to survive from the
recession.
Finally the report will discuss some examples of lessons learned from the recession.
Recession Definition
The Business Cycle Dating Committee at the National Bureau of Economic Research
(NBER) provides a better way to find out if there is a recession is taking place. This
committee determines the amount of business activity in the economy by looking at
things like employment, industrial production, real income and wholesale-retail sales.
They define a recession as the time when business activity has reached its peak and starts
to fall until the time when business activity bottoms out. When the business activity starts
to rise again it is called an expansionary period. By this definition, the average recession
lasts about a year.
Recession Vs Depression
In order to compare recession and depression, we must understand what does depression
means.
Depression Definition
Before the Great Depression of the 1930s any downturn in economic activity was
referred to as a depression. The term recession was developed in this period to
differentiate periods like the 1930s from smaller economic declines that occurred in 1910
and 1913. This leads to the simple definition of a depression as a recession that lasts
longer and has a larger decline in business activity.
The difference between the two terms is not very well understood for one simple reason:
There is not a universally agreed upon definition. If you ask 100 different economists to
define the terms recession and depression, you would get at least 100 different answers. I
will try to summarize both terms and explain the differences between them in a way that
almost all economists could agree with.
The Difference
So how can we tell the difference between a recession and a depression? A good rule of
thumb for determining the difference between a recession and a depression is to look at
the changes in GNP. A depression is any economic downturn where real GDP declines by
more than 10 percent. A recession is an economic downturn that is less severe.
By this yardstick, the last depression in the United States was from May 1937 to June
1938, where real GDP declined by 18.2 percent. If we use this method then the Great
Depression of the 1930s can be seen as two separate events: an incredibly severe
depression lasting from August 1929 to March 1933 where real GDP declined by almost
33 percent, a period of recovery, then another less severe depression of 1937-38. The
United States hasn’t had anything even close to a depression in the post-war period. The
worst recession in the last 60 years was from November 1973 to March 1975, where real
GDP fell by 4.9 percent. Countries such as Finland and Indonesia have suffered
depressions in recent memory using this definition.
Now you should be able to determine the difference between a recession and a depression
without resorting to the poor humor of the dismal scientists.
Often unemployment is a delayed factor) i.e. it takes time for unemployment to rise,
but, even when the economy is recovering, it takes time for unemployment to fall.
1. A recession will make it difficult for new firms who have just entered the
market. Most new firms have high set up costs; therefore, a downturn in the
economy could make them close down. However, this does not mean that they are
inefficient. It just means they are new and struggling to get established..
2. Increased Monopoly Power. If a recession causes the smaller and newer firms to
go out of business then the larger dominant firms will gain more monopoly power.
In the long run this will lead to less choice and higher prices. This is a definite
disadvantage of a recession. When the Chairman of Ryanair argued recessions
would be a good thing, maybe he meant - a good thing for Ryanair, as it may
involve new firms going out of business leaving him more market power.
3. Hysteresis. This is the argument that the past is a predictor for the future.
Basically, if you have high unemployment, then it is more likely to have high
unemployment in the future. If people are made unemployed in a recession, it
may take a long time for them to find work again. When they are unemployed
they lose skills, become demotivated and become less attractive to employers.
Note after the recession of 1981, Unemployment remained stubbornly high in the
UK, even into the boom years of the late 1980s
4. Fall in Productive Capacity. A recession can damage the productive capacity of
an economy. Firms can go out of business and therefore shut down their
resources. Furthermore in a recession, there will be a significant fall in
investment; this can harm the long term development of an economy.
5. You don't need a recession to weed out inefficient firms. If markets are
reasonably competitive, inefficient firms will be forced out of the market anyway.
An economic decline in the United States is pretty much guaranteed to reduce the income
of the business sector. The recent falls in the US stock markets are largely due
to expectations of a future downturn in the economy. Lower growth leads to lower
profits, therefore dividends decline and shares become less attractive. If the US enters
into recession, firms will experience a decline in profitability. This is because:
1. Tendency for price wars to develop in a recession. Low sales encourage firms to
cut prices
2. Falling sales will lead to lower revenues.
Some firms will be affected more by the downturn. Firms producing luxury goods
(Income elasticity of demand >1) will experience the biggest % fall in demand. This is
likely to include manufacturers of luxury cars, 5 star hotels. Firms producing basic
necessities will be more insulated from the effects of a recession.
Negative news makes the most interesting headlines; the media won't start reporting -
"Big supermarkets doing OK - no job losses this year" I don't blame them for this,
however, it is worth bearing in mind that for most people a recession might not actually
change things very much. Most people will keep their jobs, most companies won't go
bankrupt. For example, in the last recession, unemployment in the UK doubled from
1.5million (5%) to 3 million (10% of workforce). But, the majority of people still kept
their jobs.
People are more likely to be directly affected by rising costs of living. The rise in food
and energy prices is hard to ignore; it is estimated that many consumers could be worse
off this year because prices are rising faster than wages. This is what people will notice.
Interestingly, many non-economists may confuse the concepts of recession and inflation.
However, it is worth pointing out that although rising oil prices may help to cause a
recession. A recession means real output or at least real output per capita falls.
Of course, for those who are made unemployed in a recession, the effects are severe.
Being made unemployed is one of the most stressful events in life, both economically and
on an individual level. Surviving on unemployment benefits is no joke and the impact far
greater than rising petrol prices
How Long does Recession Last? An important factor is how long and how deep the
recession is. One of the notable features of the Great Depression was how long the mass
unemployment existed. More recent recessions have been shorter in duration.
Some sectors hit more than others. The impact of a recession is not equally distributed
throughout the economy. A recession will usually affect some sectors much more than
others. For example, in the present downturn, it is the construction sector which is
particularly badly hit. This is for two reasons:
• The collapse in house prices
• Construction investment tends to be more volatile than economic growth.
Some firms will be hit more than others. Early casualties of the current downturn are
companies like Starbucks and Marks & Spencer. Both have businesses focused on luxury
items. E.g. Starbucks coffee could be considered an expensive luxury; it is the kind of
spending you can easily cut out. Other companies producing basic food items are barely
touched by a recession. People do not stop buying grocery items in a recession; they just
buy less luxury items like a takeaway Starbucks or Marks & Spencer organic salad.
The important thing is that some firms will be hit much harder than others. If you're not
in construction, real estate or producing luxury SUV cars, the impact of the forthcoming
recession may feel more muted.
More difficult To Borrow. In a recession banks are less willing to lend. This is
particularly a problem at the moment, because of the concurrent credit crises which is
reducing the availability of loans.
• Solution: Avoid taking on any unnecessary debts. The debts you have try to
reduce and consolidate into a lower interest rates bearing account.
• On the positive side, in a recession interest rates are likely to be lower, meaning
lower interest payments for mortgage holders.
Unemployment. This is the main concern over a recession. If output does fall, there is
likely to be a fall in demand for labour. This problem is often concentrated in those
sectors most affected by the recession. For example, in the current climate, jobs related to
finance and the housing market are more at risk than say the manufacturing sector.
Falling profitability of Business. If you are a small business owner the effects of a
recession can be keenly felt. Lower profits could even threaten the survival of the
business.
• Solution: Look for ways to minimize costs without compromising the business.
There are always ways to cut costs and increase inefficiency. Some economists
even go so far as to say that recessions are a good thing because they force the
economy to become more efficient.
• If your business is particularly affected by the downturn, look to see whether you
can diversify to reflect the changing economic environment. For example, if you
specialise in selling luxury goods with a high margin try including some new
product lines which appeal to people's desire for frugality.
• A fall in profits is likely to be cyclical. therefore try to plan a financial plan to
borrow at a low cost for the difficult years.
Consumer Confidence
Often the worst aspect of a recession is the affect on consumer confidence and people's
fear about the future. Bear in mind, the media often exaggerate the extent of a downturn
in the economy. The media like to highlight sensationalist stories. However, it is often not
as bad as it is made out to be. Keep a calm and detached attitude and just make the best of
the current situation.
I don’t know whether a penniless economist is the best person to advise about investing,
however, these are some of the basic principles behind the different options for
investment at the present moment.
Housing Market
The housing market has outperformed most other types of investment in recent years. I
still remain a believe in the long term prospects of the housing market. However, for the
next 1-2 years, I expect house prices to fall slightly. If you are thinking of investing for
the next 10-20 years in the future, the shortage of supply relative to demand is likely to
keep pushing prices higher. However, there is no harm in waiting for 12-18 months to see
how much house prices fall. It may also become cheaper to borrow when the credit
crunch ends
Share Prices
In a recession, firms make less profits, pay lower dividends and so share prices fall. The
stock market may seem like a good place to avoid, especially given recent turbulence.
However, it is my belief that the impact of a recession is already built into share prices.
Sometimes share prices can actually rise in the period of a recession, because analysts are
already looking forward to the recovery. Investing in the stock market has given pretty
poor returns in the past few years, but, I think many shares now offer good value.
Mineral Prices
In a recession, people often resort to investing in solid products like silver and gold. It is
seen as a safe alternative to market based share prices. The price of metals and other
commodities are also being pushed higher by:
Government Bonds
Government bonds offer the chance to make a secure investment and stable interest
rate. However, on long term bonds, the market price is inversely related to the market
interest rate. If interest rates fall by more than market expectations then the price of
bonds will rise. In the UK, this is a possibility, but there is a little prospect of dramatic
changes in prices, it is most likely that bonds will just offer secure but steady
investment
1. Cutting Interest Rates. Recently, the Fed cut interest rates by 0.75% a big
stimulus for consumer spending. Amongst other things, lower interest rates reduce
mortgage interest payments, giving consumers more disposable income. - Fed Cut
Interest rates by 0.75%
2. Freeze on Sub prime Mortgage Rates. There is a 5 year scheme to freeze sub
prime rates, preventing house repossession. Effects of Freezing sub prime rates.
3. Tax Cuts. Cutting taxes increases consumer disposable income. But, will people
spend if they are nervous about the future? Can tax cuts avoid a recession?
Classical economists argue that a recession will only be temporary, because labor and
product markets are flexible. However, Keynesians argue that wage and price rigidity can
keep the economy below full capacity for a long time.
For example, to regain equilibrium it may be necessary to reduce prices and therefore
reduce nominal wages by an equivalent amount. However, this may be difficult because
trades unions will resist cuts in nominal wages, also firms would be unwilling to cut
wages because it may lead to lower productivity amongst workers.
Firstly there will be time lags. It takes time for the government to change its spending
plans and once implemented it will take time for this spending plan to actually increase
AD
Also increasing AD may cause crowding out. This means that if the government increases
its spending then it will lead to a corresponding fall in private sector spending. This is
because the government borrows from the private sector to finance its spending.
However, Keynesians reject this argument, they argue that the government will only be
using previously unemployed resources therefore there will be no crowding out.
4. Deflation.
If there is deflation this makes it difficult to increase demand. This is because
people will not spend if they feel that prices will be cheaper in the future. Also
monetary policy will become ineffective because interest rates cannot fall below
0%, therefore, with deflation real interest rates may remain high. E.g. Japan has
experienced deflation during the 1990s and this made it very difficult to increase
AD and economic growth.
5. Hysteresis.
This states that what has happened in the past will affect the future. For example
if unemployment is high then it is likely to continue being high. If people are
unemployed for a long time they become de-motivated and less employable,
because they are now less skilled (less on the job training). Also, if productive
capacity is not used for a long time then firms will shut factories down
completely, causing a fall in a supply (AS). Therefore, in a prolonged recession
there will be not just a fall in AD, there will also be a fall in AS, causing a
permanent fall in the potential output of an economy. This occurred during the
Great depression of the 1930s.
• Realize we can't spend what we don't have; credit and credit cards are not the same as
cash.
• Spend more time at home, we eat as a family, we are learning to spend time again with
each other and talk to each other more.
• Dessert out is as much fun and more affordable than dinner out.
• We do more family events using what we have; we look at photos, remember events and
reconnect to our kids, parents, cousins and grandparents, and what to what they
remember, share and think.
• We use now more limited weekly food money on real food and have eliminated many of
the snacks that are not good for us; we are starting to eat healthier.
• We reconnected to our neighbors and learned to share our extra when they did not have
enough; we are building our social networks face-to-face.
• We hang up our clothes instead of leaving them on the floor or on the chair; we do less
laundry, and we make things last.
• We waste less food, create less garbage and leave less of a footprint on the planet; we
are more aware that supplies of things are limited - and once gone, they may be gone
for good.
• We are less fixated on whether we have the newest, shiniest, best or most expensive, in
favor having the right things that keep people healthy and safe.
• We drive our cars less, consume less gas and learn about the great things in our
neighborhood; in the process we make our cars last a little longer.
• We slow down on the road knowing that it conserves fuel and offers a view of some
great things we generally didn't notice in our rush to get places.
• We spend more time with each other; we rekindle friendships that evaporated when life
became too busy to stay in touch.
• We recycle more; go to garage sales, flea markets and thrift stores. Bohemian and
trendy salvage styles are making a comeback.
• We buy local produce that saves on fuel and gives us healthier things to eat.
• We have learned to extend any meal by adding cans of things we had in the pantry; we
invent new family recipes; we use what we have.
• We borrow books and movies from the library instead of buying new ones.
• We spend more time with crayons, glue, paper and a box to make great things and have
a great time.
• We are beginning to realize that a gift is truly based on the thought instead of the cash
value - and that a flower picked or a handmade card delivered at the right moment
creates the right memory.
• We now turn lights off when we are not in a room, reduce the amount of heat or air
conditioning and are still fine.
• We live by the rule that for every bag that comes into the house, two must go - one to
trash/recycle, one to the needy.
• We now treat things with more respect - a person, book, toy, car or other important
thing.
• We give all of the clothes that don't fit or we can't use to organizations that ensure it gets
distributed to those who use them.
• An afternoon out is now a walk around the neighborhood, time at a park or appreciating
nature, architecture, a view or the weather; there doesn't have to be a purchase to make
the afternoon valuable.
Conclusion
This report is discussed the recession and the current economy down turn. The report
covered the definition of recession and how a recession defers from a depression.
Moreover; the report talked about the impact of the recession and it affecting the business
world. Furthermore, the report discussed how to survive in recession.
Another discussion covered in the report is what a good investment in a recession and
what are the new rules and policies introduced by world government to survive from the
recession.
Finally the report will discuss some examples of lessons learned from the recession.