What happens in a recession
In: Economics
generally it means the economy slows down; people stop spending money which has cascading effects……if people dont spend money, businesses cant make money, if businesses cant make money they cant employ people, if businesses cant employ people; they fire people, if people get fired they cant afford stuff/spend money
“The economy” means “money moving around”.
“A recession” means “money isn’t moving around as much”.
We measure the economy in GDP (gross domestic product). This is basically an estimate of all the transactions in the economy. How much money people and companies are spending in a three month period (a quarter).
Ideally, this figure will always increase, which means the economy is growing. If it shrinks for two quarters in a row, the economy is in a recession (aka shrinking).
When an economy goes into a recession, everyone tightens their belt. People save more and spend less, companies start to worry about their profits and make redundancies. This of course only makes the situation worse.
It’s honestly a miracle that we ever escape the feedback loop. But eventually, things bounce back. People get sick of holding onto their money and start spending, events such as the holidays trigger consumer spending increases, companies see opportunities and invest money. It only takes one quarter of growth to break the chain.
Although occasionally an economy can slip back into negative growth, called a double-dip recession.
It means that the velocity of money has slowed significantly.
What is the velocity of money? Let’s say I spend 10 units of currency purchasing a widget from someone. they then buy something themselves using that 10 units of currency from someone else. That initial 10 units of currency was responsible for 20 units of economic activity. If you extend the chain that same unit of currency can generate significantly more economic activity than it’s actually worth. This is the velocity of money.
Ideally you want each unit of currency to travel as far as possible because every time it does it’s stimulating the economy. If someone in the chain decided to hold on to it for some reason this temporarily halts the chain and the associated economic activity that it would have created. The velocity of money is constantly changing but sometimes there’s a larger than average decrease and this is when you start to hear talk about recessions. It basically means that people are generally speaking holding onto money instead of spending it and as a result economic activity suffers.
When the economy is growing, there is a cycle of things that take place;
People feel more financially secure -> people buy things -> businesses do well -> business expand -> businesses hire more workers -> demand for workers rise -> wages go up -> people feel more financially secure -> repeat.
In a recession, that cycle slows or reverses.
People feel less financially secure -> people buy less things -> businesses do poorly -> businesses contract -> layoffs -> demand for workers goes down -> wages slow -> people feel less financially secure -> repeat.
A slowing or reversal can happen for a lot of reasons. A shock like a natural disaster, or war. A few big companies makes a bad bet, lose a lot of money, and have to lay off workers. A problem in the banking sector puts a lid on companies’ ability to expand, and so on. It can happen suddenly or gradually. And they can simply occur naturally.
Think of the economy as a body and different parts of the body are different groups of people. Money is the blood of this economy body. Blood has to flow (money being spent) through each part of the body for the economy to be healthy.
A recession is when the blood flow slows down or has stopped, so people stop spending, which means other people aren’ t payed so they stop spending too. This triggers a chain reaction to other parts of the economy body, so blood starved parts of the body start dying (businesses shut down, people layed off)
Think of it like not getting a pay cut at work but for the economy as a whole. The real problem remains inflation which just means you don’t have the same buying power as before using the same amount of money.
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