What makes recession

The nature and causes of recessions are simultaneously evident and uncertain. Recessions are, in essence, a cluster of business failures being realized simultaneously. Firms are forced to reallocate resources, scale back production, limit losses, and, usually, lay off employees. Those are the clear and visible causes of recessions. There are several different ways to explain what causes a general cluster of business failures, why they are suddenly realized simultaneously, and how they can be avoided.

Economists disagree about the answers to these questions, and several different theories have been offered. The standard macroeconomic definition of a recession is two consecutive quarters of negative GDP growth.

When this occurs, private businesses often scale back production and tries to limit exposure to systematic risk. Measurable levels of spending and investment are likely to drop, and a natural downward pressure on prices may occur as aggregate demand slumps. GDP declines, and unemployment rates rise because companies lay off workers to reduce costs.

At the microeconomic level, firms experience declining margins during a recession. When revenue, whether from sales or investment, declines, firms look to cut their least-efficient activities. For example, a firm might stop producing low-margin products or reduce employee compensation. It might also renegotiate with creditors to obtain temporary interest relief.

Unfortunately, declining margins may force businesses to fire less productive employees. A range of financial, psychological, and real economic factors are at play in any given recession. The significant economic theories of recession focus on financial, psychological, and fundamental economic factors that can lead to the cascade of business failures that constitute a recession. Some theories look at long-term economic trends that lay the groundwork for a recession in the years leading up to it.

Some look only at the immediately visible factors that appear at the onset of a recession. Many or all of these various factors may be at play in any given recession. Financial factors can contribute to an economy's fall into a recession during the — U.

The overextension of credit and debt on risky loans and marginal borrowers can lead to an enormous build-up of risk in the financial sector. The expansion of the supply of money and credit in the economy by the Federal Reserve and the banking sector can drive this process to extremes, stimulating risky asset price bubbles.

Artificially suppressed interest rates during the boom times leading up to a recession can distort the structure of relationships among businesses and consumers. It happens by making business projects, investments, and consumption decisions that are interest rate-sensitive, such as the decision to buy a bigger house or launch a risky long-term business expansion, appear to be much more appealing than they ought to be. The failure of these decisions when rates rise to reflect reality constitutes a major component of the rash of business failures that make up a recession.

Psychological factors are frequently cited by economists for their contribution to recessions also. Share your feedback. Send feedback to the editorial team. Rate this Article. Thank You for your feedback!

Something went wrong. Please try again later. Best Ofs. More from. By Kat Tretina Contributor. Information provided on Forbes Advisor is for educational purposes only. Your financial situation is unique and the products and services we review may not be right for your circumstances. We do not offer financial advice, advisory or brokerage services, nor do we recommend or advise individuals or to buy or sell particular stocks or securities.

Performance information may have changed since the time of publication. Past performance is not indicative of future results. Forbes Advisor adheres to strict editorial integrity standards. To the best of our knowledge, all content is accurate as of the date posted, though offers contained herein may no longer be available. David Rodeck Contributor. Benjamin Curry Editor.

The Forbes Advisor editorial team is independent and objective. To help support our reporting work, and to continue our ability to provide this content for free to our readers, we receive compensation from the companies that advertise on the Forbes Advisor site. Consumer Financial Protection Bureau. The White House of Barack Obama. Bureau of Economic Analysis. Actively scan device characteristics for identification. Use precise geolocation data. Select personalised content. Create a personalised content profile.

Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products.

List of Partners vendors. Part of. Recession Defined Overview Recession Basics. Your Money During Recession. Recessions in U. By Kimberly Amadeo. Learn about our editorial policies.

Reviewed by Eric Estevez. Learn about our Financial Review Board. Article Sources. Part Of. Your Privacy Rights. When consumers worry about the state of the economy, they slow their spending and keep whatever money they can. High interest rates. High interest rates makes it expensive for consumers to buy houses, cars and other large purchases.

Companies reduce their spending and growth plans because the cost of financing is too high. The economy shrinks. The opposite of inflation, deflation means product and asset prices fall because of a large drop in demand.

As demand falls, so do prices as sellers try to attract buyers. People put off purchases, waiting for lower prices, causing an ongoing downward spiral or slow economic activity and greater unemployment.. Asset bubbles. In an asset bubble, the prices of things like tech stocks in the dot-com era or real estate before the Great Recession rise rapidly because buyers believe they will perpetually increase.

But then the bubble bursts, people lose what they had on paper and fear kicks in. As a result, people and companies pull back on spending, giving way to a recession. Same thing at the top: Things that are not predictable. The NBER follows a business cycle dating procedure that is retrospective, meaning it waits for sufficient data to proclaim when we reach its phase of the cycle. What we can do, however, is look at learnings from past recessions:.

At the time, the Great Recession was the worst and deepest economic downturn since the Great Depression. It was a result of bubbles in real estate and complex investments called derivatives. Even though it lasted just 18 months, the recession had a profound impact on the decade to follow, because recovery — the path back up from the bottom — can take years.

While the housing market recovered, there are currently millions of Americans who still haven't regained what they had lost, showing that a rising tide lifts all boats only if it can reach each of them.