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There are many causes of recession, which is defined as a fall in the Gross Domestic Product (GDP) for at least two back-to-back quarters. This decline is less than 10%, so small recessions that occur occasionally only have a minor effect on the economy. When a longer-lasting recession occurs where the GDP — which is the sum total of all public and private spending — is reduced by closer to 10%, this can have huge impact on the economy, making a recovery more challenging. It is perhaps simpler to say that what causes a recession is this decrease in spending on goods, services and investment, but what causes the private and public sectors to change their spending habits isn’t always constant.
Some financial experts suggest the causes of recession are always inflated prices. As prices rise, people can’t spend as much and they begin to budget and spend less than they ordinarily would. Such a scenario means that no one really profits by the inflated prices and soon companies are losing money. This causes them to take actions like spending less and firing workers. With fewer people making money, spending continues to decrease. This cycle doesn’t reverse until job growth occurs, or government and corporate spending begins to increase again.
This account of the causes of recession doesn’t explain initial drop in spending or inflation, and why prices suddenly go up, especially if spending is lower. A more reasonable account of one of the causes of recession is that the economy undergoes some form of shock that radically changes how the market is perceived. Such a shock could include things like a physical attack on the country, as occurred during 9/11 in the US, the rapid decay of an industry, as what happened during the dot.com bust of the 1990s, or collapse of financial markets, like the housing market and stock market in the mid 2000s.
When these “shocks” occur, they dramatically affect spending on a number of levels. People facing foreclosure on their homes during the US housing crisis couldn’t spend as much, and the lack of security people and investment firms felt in investing in real estate and the stock market reduced the GDP further. Other factors like the inability for most people to get loans on their home equity or mortgage equity loans hampered their ability to spend with credit. As is common, a drop in spending led to an increase in prices or inflation, as merchants and services providers attempted to recoup their losses created by reduced consumer and investor spending, meaning people bought even less, reducing the GDP further.
No matter what the causes of recession are individually, it’s clear that the more sectors it affects, the harder it is to recover. If recession continues beyond a few quarters and GDP decreases more, it can become a depression. In this scenario it can take months or years to fully recover, and sometimes the elements used for recovery don’t fix the problem completely. The term jobless recovery is often used to discuss a recession or depression that ends without restoring people to their jobs.
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