Recession

In economics, a recession is a period of significant decline in economic activity. It is a contraction within the business cycle. This means the economy is shrinking instead of growing. Recessions usually happen when there is a widespread drop in spending. This is often called an adverse demand shock. Many different events can trigger this drop. A financial crisis or a problem with international trade can cause it. An adverse supply shock or the bursting of an economic bubble can also be causes. Even large-scale natural disasters or pandemics can lead to a recession.

There is no single official definition for a recession used by everyone. The International Monetary Fund states there is no official definition. However, different regions use different rules to identify them. In the United States, the National Bureau of Economic Research (NBER) is the main authority. The NBER defines a recession as a significant decline in activity spread across the economy. This decline must last more than a few months. It is usually visible in real Gross Domestic Product (GDP), real income, and employment. The NBER says a recession begins at a peak of activity and ends at a trough. A trough is the lowest point of the economic decline.

Other countries and organizations use different measurements. In the United Kingdom and Canada, a recession is often defined by negative economic growth for two consecutive quarters. A quarter is a three-month period. The European Union uses a similar method to the NBER. They look at GDP alongside many other macroeconomic indicators. This helps them see the depth and breadth of the downturn. The Organisation for Economic Co-operation and Development (OECD) uses a more complex rule. They define a recession as a period of at least two years where the cumulative output gap reaches at least 2% of GDP. The output gap must be at least 1% for at least one year.

Economists also look at the "front end" of a recession to find early warning signs. This is the initial phase where negative trends emerge before a full recession is declared. During this time, indicators like GDP growth and consumer spending start to fall. Falling consumer confidence and reduced business investment are common signs. The labor market may also become sluggish. This means layoffs become more common and wage growth might stop. Some economists use the Sahm Rule to spot this. This rule looks at a rising three-month average unemployment rate. Other signals include rising inflation or an inverted yield curve. An inverted yield curve happens when market expectations suggest much lower growth ahead.

Recessions can take many different shapes. Economists use letters to describe these patterns. A V-shaped recession is short and sharp, followed by a rapid recovery. This happened in the United States in 1954 and 1990–1991. A U-shaped recession is a more prolonged slump. This occurred in the United States during 1974–1975. A W-shaped recession is sometimes called a double-dip recession. This happened in the United States in 1949 and 1980–1982. Some recessions are L-shaped, meaning the economy stays low for a long time. Thailand experienced eight consecutive quarters of decline, which is an L-shaped pattern. If a recession is extremely severe or lasts three to four years, it is called an economic depression.

Psychology plays a major role in how these cycles work. An economist named John Maynard Keynes used the term "animal spirits." This refers to the emotional mindsets and psychological factors that affect economic activity. It also describes the sense of trust people have in each other. If companies expect the economy to slow down, they might stop investing. They might also reduce their number of employees to save money. This can create a self-reinforcing cycle that makes the recession worse. When consumer confidence is low, people do not want to spend money. This lack of spending can lead to even less economic activity.

Governments often try to fix recessions using expansionary macroeconomic policies. These are actions taken to boost economic activity. One common method is to increase the money supply. Governments may also decrease interest rates. Lower interest rates make it cheaper for companies and people to borrow money.

Another method is to increase government spending. Governments can also choose to decrease taxation. These steps are intended to encourage spending and investment. By acting early during the front end of a recession, policymakers hope to mitigate the impact before the downturn deepens.