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Why Do Recessions Happen?

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Dan Lehavi is a student, activist, economic enthusiast, and debater. He most frequently writes about economics.

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Understanding Economies and Recessions Part 1: GDP

Economies are very delicate, complex, and interesting. Economies are built off of many individual interactions. In these interactions there are usually two parties. The first is the consumer who is the person buying a product or service. The second is the seller who supplies the goods or services. When the consumer buys a product ( a good or service) that is known as consumer spending and that principle drives the economy. Economies rely on consumers to keep spending and circulating capital. When money keeps circulating, economies thrive which is really important because wages and jobs increase and prices increase. That last part may not seem like a good thing but in this context it is. Because people have more disposable income(money they can spend) they buy more products which means prices increase to accommodate. When prices increase businesses get more money which they put back into salaries increasing income and thus the cycle continues increasing quality of life and reducing poverty. It's very difficult to track every single exchange and interaction so in order to measure the strength of an economy, economists use GDP or Gross-Domestic-Product. GDP is measure of every product's value. In a healthy economy, not only are their more products but those products have a higher value, increasing GDP.

Gross domestic product (GDP) is the total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health.

— Jim Chappelow, Investopedia

Understanding Economies and Recessions Part 2: Recessions

In order for economies to stay healthy they must always grow. If GDP isn't increasing, the economy becomes unhealthy and quality of life worsens. A recession is precisely this, when economic growth is negative or 0, that is a recession. Additionally, if a recession gets really bad, it becomes a depression. This has only happened once in US history in the 1930s. Recessions in general are definitionally severe, you will never have a 3 day recession. In order to actually cause an economic downturn, the shock must be so severe that it creates a lasting problem. A majority of the time, recessions are necessary corrections in an economies value. Investors get over confident over time which overvalues the economy. This is known as a bubble. Eventually, the economy self corrects and the bubble pops. This is what happened in 2008 when investors overestimated the quality of certain bonds. When everyone defaulted on said bonds, the economy corrected, causing a recession.

why-do-recessions-happen

Understanding the COVID Recession Part 1: History

Before getting into specifics please note that current measurements of economics are all speculation. It is very difficult to know exactly how good an economy is doing at the moment. Instead economists look to the past and try to determine trends. For these reasons, exact economic measurements usually trail the actual economy by a couple months. With that disclaimer out of the way, it is important to understand why the COVID-19 recession is so dangerous. As was mentioned earlier, recessions are typically corrections in the market. For example, in 2007 the housing market was extremely over valued. Investors were pouring tons of money into housing bonds they thought were reliable when in reality they were full of faulty, unreliable loans. When a wave of defaults spread across the country, the housing market crashed. In other words, the bubble popped. This "popping of the bubble" is what caused the economic downturn. COVID-19 however, is vastly different.

Recent projections predict an economic downturn and job losses that are worse than the global financial crisis a dozen years ago

— Robert Azevedo, WTO Cheif

Understanding the COVID Recession Part 2: The Recession

The 2008 recession was the worst recession since the 1930s , putting almost a billion people in poverty worldwide. Many are saying the COVID recession will be worse and, frankly, I agree. The reason why the coronavirus recession is so bad is because there is no correction for a bubble. The recession came out of no where and cause a massive economic downturn. When the government instituted a lockdown and closed businesses, consumer spending tanked. Nobody was spending any money which means companies werent making money. When companies made less money they couldn't afford to pay all of their employees, leading to massive layoffs. These layoffs decreased consumer spending and so the cycle continued. This puts people in poverty in two ways.

  1. Inflation- In times of recession, inflation sky rockets which means the value of the dollar is lower and the poverty line raises, trapping millions of people in poor conditions
  2. Layoffs- When consumer spending decreases, companies have to shave down on their bills which means less employees and paying many employees less. This action can put millions into poverty

For these two reasons, the COVID-19 recession has put an estimated 1 billion people in poverty worldwide and that number is only growing.