What causes an economic recession? - Richard Coffin
For millennia,
the people of Britain had been using
bronze to make tools and jewelry,
and as a currency for trade.
But around 800 BCE, that began to change:
the value of bronze declined, causing
social upheaval and an economic crisis—
what we would call a recession today.
What causes recessions?
This question has long been the subject
of heated debate among economists,
and for good reason.
A recession can be a mild decline in
economic activity
in a single country that lasts months,
a long-lasting downturn with global
ramifications that last years,
or anything in between.
Complicating matters further,
there are countless variables that
contribute to an economy’s health,
making it difficult to pinpoint
specific causes.
So it helps to start with the big picture:
recessions occur when there is a negative
disruption
to the balance between supply and demand.
There’s a mismatch between how many
goods people want to buy,
how many products and services producers
can offer,
and the price of the goods and services
sold, which prompts an economic decline.
An economy’s relationship between supply
and demand
is reflected in its inflation rates
and interest rates.
Inflation happens when goods and services
get more expensive.
Put another way, the value
of money decreases.
Still, inflation isn’t necessarily
a bad thing.
In fact, a low inflation rate is thought
to encourage economic activity.
But high inflation that isn’t accompanied
with high demand
can both cause problems for an economy
and eventually lead to a recession.
Interest rates, meanwhile,
reflect the cost of taking on debt for
individuals and companies.
The rate is typically an annual percentage
of a loan
that borrowers pay to their creditors
until the loan is repaid.
Low interest rates mean that companies
can afford to borrow more money,
which they can use to invest
in more projects.
High interest rates, meanwhile, increase
costs for producers and consumers,
slowing economic activity.
Fluctuations in inflation and interest
rates
can give us insight into the health
of the economy,
but what causes these fluctuations
in the first place?
The most obvious causes are shocks
like natural disaster, war,
and geopolitical factors.
An earthquake, for example,
can destroy the infrastructure needed to
produce important commodities such as oil.
That forces the supply side of the economy
to charge more for products that use oil,
discouraging demand and potentially
prompting a recession.
But some recessions occur in times of
economic prosperity—
possibly even because
of economic prosperity.
Some economists believe that business
activity from a market’s expansion
can occasionally reach
an unsustainable level.
For example, corporations and consumers
may borrow more money
with the assumption that economic growth
will help them handle the added burden.
But if the economy doesn’t grow as
quickly as expected,
they may end up with more debt
than they can manage.
To pay it off, they’ll have to redirect
funds from other activities,
reducing business activity.
Psychology can also contribute
to a recession.
Fear of a recession can become a
self-fulfilling prophecy
if it causes people to pull back investing
and spending.
In response, producers might
cut operating costs
to help weather the expected
decline in demand.
That can lead to a vicious cycle as cost
cuts eventually lower wages,
leading to even lower demand.
Even policy designed to help prevent
recessions can contribute.
When times are tough, governments and
central banks may print money,
increase spending, and lower central bank
interest rates.
Smaller lenders can in turn lower their
interest rates,
effectively making debt “cheaper”
to boost spending.
But these policies are not sustainable
and eventually need to be reversed
to prevent excessive inflation.
That can cause a recession if people have
become too reliant on cheap debt
and government stimulus.
The Bronze recession in Britain eventually
ended when the adoption of iron
helped revolutionize farming
and food production.
Modern markets are more complex,
making today’s recessions far
more difficult to navigate.
But each recession provides new data to
help anticipate and respond
to future recessions more effectively.
