Causes Of An Economic Recession (1)

While nobody wants to experience a stock market crash or an economic recession at worst, they are occurrences that will ultimately happen at some point in time.

Much like the stock market exists in phases, the economy of any nation too experiences a number of phases and lifecycles. While nobody wants to experience a stock market crash or an economic recession at worst, they are occurrences that will ultimately happen at some point in time.

For clarity, while a stock market crash affects only the stock market of a specific country, an economic recession (or simply known as a recession) is a phenomenon when there is a general decline in economic activity.

The usual way to determine if an economic recession is that the Gross Domestic Product (GDP) of any nation is negative for two or more successive quarters.

As a result of the broadness and complexity of things, it might be tough to prevent an economic recession; however, an understanding of what causes it will help us in making good investment decisions and nudge us to put systems in place to ensure that we come out of the period unscathed.

With the ongoing panic in many economies across the world for the possibility of an economic recession, here is a list of various causes of one:

High Interest Rates

One of the common causes of an economic recession is high interest rates for borrowing. When interest rates are high, people cannot borrow money as much as they should and essentially end up spending less on anything.

With this restriction in liquidity, the economy is not stimulated and investments can barely be made. This is said to be the primary cause of the 1980 recession.

An Asset Bubble Burst

In our last post, we spoke about what an asset bubble is and the various things that cause asset bubbles. As a recap, an asset bubble is stimply a situation where assets like housing, gold etc or investment securities like stocks, experience a dramatic rise in price over a short period of time.

More so, these rises occur and assets become much higher than their sustainable value. Since this rise is not supported by an increase in the value of the asset, it is only a matter of time before a burst occurs and all prices crash.

When an asset bubble has been on for a period of time, at the point where it crashes, a recession could be underway.

A Stock Market Crash

Another thing that could crash so bad that it leads to an economic recession, is the stock market itself!

A stock market crash is also a sudden decline of in the prices of many stocks across a vast section of any stock market, leading to the loss of actual wealth.

The causes of a stock market crash (also explained in a previous article) are also tied to speculation and a myriad of other economic factors. A crash ultimately drains the capital out of many businesses and can also spur an overall economic recession.

Reduction In Real Wages

There could also be situations where people have less money as a result of a reduction in wages. Quite simply, where people don’t have money to spend, there is no economy to grow.

However, this does not need to be as a result of companies actually paying their workers less (even though this too happens). Where inflation increases without a directly proportional increase wages, it means there is a reduction in real wages as your money can purchase less than it could before.

In essence, falling real wages reveals a situation where one’s salary is not keeping up with inflation. This overall reduction in purchasing power, if sustained, is also enough to cause a full economic recession.

More causes of an economic recession will be reviewed in our next post.

Written by Lawretta Egba.