What Is a Recession: Deflation, Boom, Inflation, & Prediction


There are signs that the global economy may be facing a recession. But what exactly is a recession, why does it occur and are there measures that can curb it?

So, what is a recession?

Some of the characteristics of a recession are that we are seeing deteriorations in the labor market, unemployment rising, employment declining, production growth slowing. Household consumption develops more weakly, you simply become more careful and save more of your income. There are no predetermined figures that if growth is X, then it is a recession.

Are there different kinds of recessions?

There are degrees in how deep and serious a recession is. A slump is a milder version of recession and a recession is deep and lasting.

If you go back to the financial crisis, 2008/2009, it was a very deep recession, where production fell drastically, unemployment rose rapidly, and employment fell.

Other recessions can be so mild that they are barely noticeable to the vast majority.

Financial crises in particular tend to cause more severe recessions, such as the banking crisis in Sweden in the early 1990s. Fortunately, they are also more unusual.

Deflation, recession and depression

During a recession, price increases tend to slow down and sometimes prices even fall. The price reductions due to a recession are called deflation.

If the country’s GDP falls for a long time due to the recession, this is called a recession, and if the decline is extremely sharp or prolonged, this is called depression.

At the end of a recession, companies usually start producing new again and then also need to hire staff. This may be due to the fact that demand never completely disappears and that companies’ stocks sooner or later run out.

With increased production at several companies, the curve for the business cycle can once again begin to point upwards.

What is a boom?

Just as the name reveals, a boom then means the opposite of a recession. During this period, the economy is strong and economic activity is high.

During periods of boom, unemployment tends to be low, as companies and industry need to hire many to meet market demand.

Households have more money to spend and business is going well for both small and large companies. It can also mean that more new companies are started and more investment capital can be available on the market.

As consumers are more active and demand for goods and services is high, prices tend to rise. Therefore, high inflation may be a sign that there is a boom.

If inflation becomes too high and prices rise too fast, the economy can turn around, as people find it harder to afford to spend their money.

The state can try to control inflation by raising or lowering the policy rate in the country. If the interest rate is raised, people will have an incentive to save and take out fewer loans, which tends to lead to reduced consumption and inflation can be kept down.

Lower interest rates instead lead to cheaper loans and greater incentives to spend instead of saving. Then inflation can be kept high or raised.

If we were to have a global recession now, what factors would be behind it?

In 2019, we saw indicators that could mean that we are heading for a recession. Growth is declining both globally and in Sweden. Above all, three factors are behind it.

  • The trade dispute between the United States and China, which has led to the introduction of tariffs and uncertainty about where the conflict will go, dampens expectations and investment.
  • China’s domestic economy is growing more slowly than before, largely due to a shift from being the world’s factory to becoming a more domestically driven service economy with lower growth. If China grows more slowly, the rest of the world will grow more slowly.
  • The fact that the US Federal Reserve in 2017 and 2018 raised interest rates. This was done because signals in the economy then looked good, but possibly they went too far with the interest rate increases. The Fed has also previously been accused of pushing for recessions with excessive interest rate hikes, which lead to a higher interest burden for American households and companies, which then reduces consumption and investment, respectively.

To this can be added specific problems in the car industry, which still make up a large part of the global economy, where major structural changes in the industry mean that car consumption is dampened.

Inflation affects the economy

Another important factor that affects the economy is inflation. Inflation means that money becomes less valuable, which makes all goods and services more expensive.

Uncontrolled inflation can arise when demand is greater than supply for a long time.

Then prices rise and goods become more expensive. This means that people need higher wages to be able to buy the goods and services they usually use, which in turn leads to companies having to raise prices to be able to pay higher wages and so on.

Inflation occurs either by itself within the country or in connection with events that take place abroad.

If prices rise abroad, it will be more expensive to import. Then domestic prices also rise, which makes the money relatively less valuable.

The government’s goal is for inflation to be at most around two per cent each year. Then the economy is stable. Too high inflation leads to a recession.

The period between the peaks in the business cycle is called the business cycle. Such a cycle is usually between 5-8 years.

How long is a recession?

In the past, economists used to joke that years ending in 0 and 5 are boom years, but in recent years the cycles have become less and less regular.

But there is still a logic in that a recession follows a boom followed by a recession.

Because in a downturn people become more pessimistic, and after a while you reach a bottom, and then people become more positive and forget that it can go bad, and then you reach an excessive optimism, which eventually leads to a fall.

That it took so long from the last financial crisis to a new recession may have to do with the fact that the recent crisis was so deep, and affected so many people’s belief in the future, that the recovery has been more cautious.

But then you still reach that situation when you forget, and then it tips over to a period of optimism.

Do there have to be recessions?

Yes, it is difficult to prevent fluctuations in the economy. In Sweden where I live, decision-makers have been ambitious in their attempts to mitigate fluctuations, but we have nevertheless experienced both highs and lows.

Is it just bad with the recession?

In essence, it is something bad as people become unemployed, young people find it difficult to enter the labor market, which can leave permanent traces.

But there are those who highlight positive factors, among the negative ones, including the fact that in difficult times we are forced to rethink, which can lead us to leave unprofitable projects behind us and accelerate structural changes.

There is also a criticism of the “light monetary policy” that is pursued today, with low interest rates, that it keeps unproductive companies under control.

At the same time, it is difficult to weigh this possible side effect against a number of people losing their jobs.

How to curb a recession?

The state can stimulate the economy in a recession, for example through increased transfers to households or municipalities.

But it is quite difficult to control, because it is easier to agree on stimuli than austerity, which has historically often led to weak government finances.

It is also a difficult timing issue, because often once politicians have made a decision on a measure, it risks being too late and the economy may already be on the rise again.

In this way, fiscal policy has not infrequently increased cyclical fluctuations.

Sweden has had great ambitions to dampen economic fluctuations, but has nevertheless had large fluctuations, largely due to the fact that the economy is so much larger than the public sector and, among other things, governed by global developments.

We should therefore expect fluctuations in the economy also in the future. Not sure about the American economy but I think the same principal applies.

The economy is cyclical

It is often said that the economy goes in cycles. No society has a static economy but it goes from being low, to high and then it goes down again.

There are many factors that can affect what the current economy looks like and where we are headed.

Sweden’s economy is very dependent on exports, as a large part of our GDP comes from products we export. Therefore, events that affect the global market, and for example the demand for industrial products, can affect Sweden’s economy.

It may happen that a recession becomes more or less global and that all world trade is affected and loses momentum. But a recession can also be more local and hit individual countries harder than others.

It is usually said that a business cycle lasts for up to 8 years before the business cycle reverses.

But it is not written in stone and it can be both longer and shorter between the economic fluctuations.

Conclusion

Are we facing a recession in 2022?

It is difficult to determine with certainty whether we are facing a recession. It’s a bit like the stock market that no one can be sure if we are going up, down or if we stand still for a while.

However, there are some signs of an economic downturn and many fear that a recession may be underway. In the end, we can only guess where the economy will go.

But no matter what, it may be wise to be prepared for bad times.

For example, by not being over-leveraged and making sure to have a buffer ready, to cope with a period of economic downturn and declining incomes.

Sources

https://www.nber.org/papers/w14221

https://academic.oup.com/restud/article-abstract/81/2/787/1520611

https://www.tandfonline.com/doi/abs/10.1080/00031305.1967.10479828?journalCode=utas20

https://www.nber.org/papers/w17044

https://www.sciencedirect.com/science/article/abs/pii/S0014292110001030

https://www.sciencedirect.com/science/article/abs/pii/S0165176506001182

https://www.aeaweb.org/articles?id=10.1257/aer.20101557

https://www.aeaweb.org/articles?id=10.1257/mac.20140104

https://books.google.se/books?hl=en&lr=&id=vacp4DtnTkYC&oi=fnd&pg=PR5&dq=Recession&ots=C25kV8Pbw7&sig=gfGDBH54_4nta0JWuJAgR5-ZMFY&redir_esc=y#v=onepage&q=Recession&f=false

Kevin

This article has been reviewed by our editorial board and has been approved for publication in accordance with our editorial policies.

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