Finance explained: what is a recession?
Many of you may be following the news about the G20 in Brisbane. Some of the reports centred on Japan and its economy. Its bad news for people in Japan, as their economy is now in recession. The word “recession” has been on people’s minds since about 2007, when the Global Financial Crisis hit. Many people were worried Australia might go into recession. Depending who you ask, there are many people to thank for Australia avoiding recession. But what is a recession? The team at Smallloans.com.au are here to explain.
A simple explanation
A country’s economy goes into recession when the growth in Gross Domestic Product goes backwards for two quarters in a row or more.
A GDP is a sum of all of a country’s contribution to the domestic economy. This can be worked out by how much business or the public sector produces and what’s bought and sold in the marketplace.
Sometimes the GDP per capita or “per person” is calculated too. This is usually an indicator of a country’s overall wealth. Countries with higher GDP per capita are “richer” than those with lower GDP per capita. Higher living standards are usually found in countries with high GDP.
What generally happens?
When a recession occurs, a lot of different things might already be happening in the economy. Economists call this an “inequality in aggregate demand” which put plainly means there’s more goods being produced than people buying them. These might be houses, cars, consumer goods or business services.
When this happens, there are many flow-on effects. Businesses may not be able to sell their products and services. This means they cannot hire staff, or let go some staff they already have. That means more people will become unemployed or stay unemployed. This definitely happened in the United States during the “Great Recession” of 2007, as the unemployment rate almost hit 10%.
What does that mean for me?
If you work in a business that will have trouble selling its goods or services during a recession, you may lose your job or miss out on pay rises. Of course this isn’t a rule. It is something that happens in a recession more often than it does during boom times or periods of normal economic activity. You may have heard some jobs being “recession proof,” since there will always be goods or services that people really need, like groceries, healthcare or utilities.
When recessions hit, prices generally have to fall to attract demand. This might mean your house will become worth less than you originally paid for it.
This was widespread during the Great Recession in the United States. People who bought say, $200,000 houses with $200,000 loans were suddenly paying back the same amount on a house now only worth $100,000.
Not only that, but the stock market may also take a dive. The shares you may have bought at a higher price are suddenly worth much less. On paper, you are certainly in a worse off position.
Cuts in interest rates
Sometimes a recession will prompt the Central Bank to cut interest rates. Read our blog post on interest rates for more information. The cuts in interest rates are designed for banks to get more money into the economy so businesses can grow, hire more people and get people spending.
Sometimes this doesn’t work because businesses are focussed on saving their money instead of spending it. This causes a “paradox of thrift” that the saving doesn’t actually save the business in the long term; it only harms the economy further.
The economy is always in a cycle, caught between good and bad periods. Recessions aren’t totally avoidable, but we all have to deal with them when they happen.