What is RECESSION and why its Happen
Article / Finance and Investing
What is RECESSION and why its Happen
Mohammad Nazish Mallick , Business Consultant, India
Executive Summary of RECESSION
Economic Recession is a financial meltdown, which can last for a period of few months to couple of years and can affect regional or world economy, leading to financial crisis, market crash, unemployment and economic depression. A long lasting impact of economic recession can lead to economic depression. This section provides articles and news on sub prime mortgage crisis, credit crunch, current economic crisis, stock market crash, financial bailout, major causes of economic recession, signs of economic depression, US economic recession history, and recession cycle.
A country’s economy is said to be in a recession when the GDP, or Gross Domestic Product, falls below 5-10 percent, lasting for two or more quarters consecutively. The GDP can be defined as the total market value of services, goods, investment and labor within a country in a given period of time, which is usually one year.
The gross domestic product (GDP) in the United States is tracked by the Commerce Department's Bureau of Economic Analysis. A recession may involve declines at the same time in the measures of overall economic activity such as employment, investment, and corporate profits. Recessions may also be a combined with deflation, or, alternatively, sharply rising prices or inflation. An economic depression is a severe or long recession.
In simple words its is flying of money (huge to very huge) from market, when it begins? How it begins? Where is started? It started with a very small thing. At that time very few could have thought or this disaster. It is surprise to many but all begins with disbursement of loan (bad) to buy houses, to people who don’t have credit worthiness, then called it NINJA loans (No Income No Job Approval). The providers of loans were US Bankers supported by policies of US Government and Federal Reserve (Central Bank of USA). Loans were given to those people who don’t have job or any income source to repay the load. Though stringent conditions were attached with such disbursement e.g. in the initial period of loan no interest or very small interest rate has been charged and in later period of loan (after 2-3 yrs) higher interest charged for the rest of loan period. That was the point (when higher interest started), when many started defaulting on repayment of these loans.
but you must be thinking that how this small thing, a small sparkle can create this big fire? It was “Systematic Plan” US government created two mortgage companies (Fannie Me and Freddie Mac) to disburse the loans, they created bonds of these loans (loans were assets of those companies, they converted loans into bonds) and sold them to investors. Investors included bankers, financial institutions, investment companies (like Lehaman Brothers), foreign banks, foreign governments and small investors (like you and me). Bad loans disbursed where to the tune of some Trillion US dollars when default started in repayment of these loans the value of bonds stated shrinking. That has impacted liquidity as well as profitability of many banks. Many banks shows losses or lesser profits compare to previous periods. Some banks closed down, some sacks employee for cost cutting. Financial impact of this was so huge that it spread across the globe. Overall demand comes down heavily which results in more loss to many companies.
Right now nobody can predict how far this will go? It is true as of now India has not seen any major event of recession.
Whatever camp you’re in you can’t fail to notice the increasing talk of recession and ongoing coverage of rising fuel prices, the credit crunch and instability in the housing market.
Even if you haven’t noticed any effect on your business just yet, it is clear that all the talk is having an affect on consumer confidence and eventually the results will be felt by many businesses.
Now is the time to take stock of your business and implement changes to your processes that will lead to increased revenue and higher profitability. After all, the worst that can happen from taking action now will be better profits at the end of the year.
So, assuming that we are heading into rockier times, who will be the first businesses to feel the effects?
What Happens During a Recession?????????????
In an economic recession, Gross Domestic Product growth is negative for a period of two quarters or more. In the beginning, positive growth in achieved in spite of several quarters slowing considerably. The first quarter of negative growth will be followed by a few quarters of positive growth and then again negative growth will return.
• In a recession people tend to save money because there is a fall in confidence. If people expect to be made unemployed then you don’t want to spend and borrow, it is less risky to save.
• The paradox of thrift states those in a recession people are nervous so save more. This makes the recession worse because it causes a further fall in consumption. People think they are doing a good, responsible thing to save, but actually they are making the recession worse.
• In recessions, interest rates tend to fall. Because inflation is lower and Central Banks wish to try and stimulate the economy.
• The government will also try to use expansionary fiscal policy. This involves cutting taxes and increasing government spending. It will cause higher government borrowing (higher budget deficit) Expansionary fiscal policy may not work in the long run due to crowding out.
• In the US the authorities are trying both lower interest rates and lower taxes.
• The problem with lower interest rates is that it is causing a further devaluation of the dollar.
• Also lower interest rates may not actually help increase spending if confidence is low (e.g. because of falling house prices)
• There is a limit to how much the government can cut taxes because government borrowing is already quite high. US national debt is about 65% of GDP. In the recession this will definitely increase.
• Stock Markets fall because firms make less profit. There is also the danger firms may go out of business
Why recession happen??????????????????????
Recession happened because of supply side economics.
Lending creates money. You put money in the bank, the bank lends it out, for example by writing a mortgage, the borrower has the money but you still have the same amount of money in the bank. The bank sells the mortgage, the buyer exchanges money for a financial asset, therefore the buyer's wealth does not change. The bank can now lend the money again creating more wealth.
When the mortgage defaults the last owner of the mortgage loses wealth. The borrower also loses wealth because the house goes to the bank but the value of the house is now less than the mortgage (because mortgages are defaulting all around and house prices have dropped), so the borrower still owes money.
If many mortgages default the economy loses money. That is, money disappears. We still have the same resources, but we no longer have enough money to transfer all the resources from producer to user, so some resources stand unused. That includes workers, factories, raw materials and consumer goods in stores, all waiting for money that isn't there any more.
The long term question is why there were so many bad loans. The long term answer is that "trickle down" policies took money from consumers and handed it to investors. Investors will invest in production only when consumers have the money to buy the product. If consumers don't have enough money to encourage productive investment, investors turn to financial investments to extract money from other investors. Or else they spend the money on things like art works, with the result that art prices soar.
A thriving economy works on "trickle up," not "trickle down." Workers get paid, and then as consumers they buy stuff from retailers. The money they pay the retailers goes partly to the retailer's profit, partly to workers and partly to wholesalers. The money paid to wholesalers goes partly to the wholesaler's profit, partly to workers and partly to producers. The money paid to producers goes partly to the producer's profit, partly to workers and partly to suppliers of raw materials. At each step a part goes back to the workers to go around again, and another part goes to investors to be reinvested. The process is driven by consumers buying. If consumers can't buy, nobody invests and nobody works.
Why the recession? Because we moved from a productive economy to a "service economy," from an economy that made and sold goods and services to an economy that shuffled money around.
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