You always hear the connection between recessions and stock markets. I understand a recession would trigger the stock market to plunge. But I don’t understand why and I also don’t understand the timeline of events of a recession and what’s happening with the U.S. economy overall during a recession.
In: Economics
From wikipedia: “In economics, a recession is a business cycle contraction that occurs when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending.”
When consumers are spending less, businesses take in less revenue which in turn means lower profits or possibly a loss for that business. Stock markets are the trading of tiny pieces of company ownership, so when the company you own a piece of is doing poorly, you want to sell it and by one that is doing well. In order to sell, you need to set a price better (aka lower) than everyone else, which leads to a stock’s price going down when lots of people think that same way. When there’s a recession and a GENERAL decline though, lots of people will be selling their stocks and few stocks will be a good investment since all businesses are doing poorly. This leads people to pull their money out of the stock market, reducing the amount of economic activity going on, reducing business’s revenue, and the cycle continues to feed itself.
Average Joe who isn’t invested in the stock market beyond a 401k won’t see much direct impact on his day-to-day until businesses need to raise prices to counter the loss of revenue. Then he may try to spend less on his hobbies, avoid fast food, and try to save money by not going on expensive trips. That’s also a reduction of economic activity though! That also feeds a recession cycle.
There’s also the risk that the company Average Joe works for will have a bad enough time in the recession that they need to cut costs in labor, and Average Joe is laid off! Now he really won’t have much extra cash to contribute to the economy.
As for what starts a recession, it can be unclear and hard to explain. The 2008 financial crisis was sparked by a downturn in US housing costs that wasn’t anticipated after a long period of sustained growth which cascaded into the global financial sector. COVID had a similar impact in 2020 (hard to contribute to economic activity when stay-at-home orders were active) and it could be argued we are still in the middle of the recovery from/reaction to that sudden spike in unemployment and drop in oil prices.
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