Economic Contraction

7 Key excerpts on "Economic Contraction"

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  eBook - ePub

  Economics for Investment Decision Makers

  Micro, Macro, and International Economics

  • Christopher D. Piros, Jerald E. Pinto(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  depression when exceptionally severe—is a period in which aggregate economic activity is declining (although some individual sectors may be growing). Business cycles are usually viewed as fluctuations around the trend growth of an economy, so such points as peaks and troughs are relative to the individual cycle.

  Exhibit 6-1a shows a stylized representation of the business cycle, and Exhibit 6-1b provides a description of some important characteristics of each phase. The description distinguishes between early and late stages of the expansion phase, which are close to cycle turning points. Exhibit 6-1b also describes how several important economic variables evolve through the course of a business cycle.

  EXHIBIT 6-1a Schematic of Business Cycle Phases

  EXHIBIT 6-1b Characteristics

  The behavior of businesses and households frequently incorporates leads and lags, relative to what are established as turning points in a business cycle. For example, unemployment may not start decreasing immediately after the expansion phase starts because companies may want to fully use their existing workforces and wait to hire new employees until they are sure that the economy is indeed getting better. However, gradually all economic variables are going to revert toward their normal range of values (e.g., GDP growth will be a positive number). If any countercyclical economic policies were adopted during the recession, they would be gradually phased out; for example, if the central bank reduced interest rates to fight the recession, it should start increasing rates toward their historical norms. Central banks are the monetary authority in most modern economies.

  During a recession, investors place relatively high values on such safer assets as government securities and shares of companies with steady (or growing) positive cash flows, such as utilities and producers of staple goods. Such preferences reflect the fact that the marginal value of a safe income stream increases in periods when employment is insecure or declining. When asset markets expect the end of a recession and the beginning of an expansion phase, they will reprice risky assets upward. When an expansion is in sight, the markets will start incorporating higher profit expectations into the prices of corporate bonds and stocks, particularly those of such cyclical companies as producers of discretionary goods, for example automobiles. Typically, equity markets will hit the trough about three to six months before the economy and well before the economic indicators turn up. Indeed, the equity stock market is classified as a leading indicator of the economy.

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  eBook - ePub

  Macroeconomics

  (With Study Guide CD-ROM)

  • Jagdish Handa(Author)
  • 2010(Publication Date)
  • WSPC

    (Publisher)

  In a typical business cycle, the upturn eventually leads to the boom and the downturn leads into the recession. Note that, under these definitions, the terms ‘boom’ and ‘upturn’ are not synonymous; neither are ‘recession’ and ‘downturn’. In fact, given the definition of a recession as occurring when output is below its trend level, the recession will usually include the later part of the downturn, the trough and the early part of the upturn. Correspondingly, the boom will include the later part of the upturn, the peak, and the early part of the downturn. The dividing line between the recession and the boom will be set by when the economy crosses the trend line for output.

  In order to empirically specify the periods during which the boom and the recession occur, we need to know the trend level of real GDP. The procedure for deriving it is explained later. 16.1.1 The popular statistical designation of a recession

  As explained above, a recession can be defined as a decrease in output below its full-employment level. If this level has a trend, one measure of the economy being in a recession is that output is below its trend line. A more commonly used measure requires a fall in output from its preceding level. Since output fluctuates due to random factors, which could cause a temporary decrease in output when there is no fundamental cause for the fall, a popular practical definition of the start of a recession is when real GDP falls for two quarters.

  However, if we look beyond just GDP data, a recession is really a self-reinforcing decline in overall economic activity, with falling output, consumer expenditures, factory orders, industrial production, employment, and other major indices of the performance of the economy, though without a decline in them being due to purely random causes that are likely to be reversed sooner or later. Often, the various indices begin to signal a decline in the performance of the economy at different times: for example, output may have declined for two quarters while employment is still expanding, and some other indices indicate a static (rather than declining or improving) economy.3

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  eBook - PDF

  The Student's Guide to Financial Literacy

  • Robert E. Lawless(Author)
  • 2010(Publication Date)
  • Greenwood

    (Publisher)

  When high inflation persists, interest rates on credit cards, automobile, home and business loans, and other borrowing sources rise. Higher interest rates make it more expensive for consumers and businesses to borrow money, which leads to lower spending. Lower spending leads to greater unemployment, lower GDP, and lower economic growth. If the economy grows too slowly, stagnates, or experiences negative growth, a country runs the risk of moving into a recession or even a depression. The term economic recession can be measured in different ways. A common defini- tion of a recession is two or more quarters of negative growth in GDP. This means that instead of growing for a six-month or longer period, the economy y GUESS WHAT? Most U.S. economists agree that GDP growth of 3 to 5 percent per year is favorable for the overall economy. y GUESS WHAT? The U.S. economy is the largest in the world. For the year 2007, its gross domestic product was estimated to be $13.8 trillion. Economics 171 contracts. During periods of recession, people spend less and businesses make lower profits. This causes companies to reduce their workforces, and unemployment rises. As unemployment increases, people tend to spend even less, which places further strain on households and businesses. A depression is much more severe than a recession. There is no formal defi nition for an economic depression, but a depression includes a longer period of declining economic performance. During a depression, unem- ployment reaches very high levels, and many companies are forced to fi le bankruptcy. The last depression in the United States began in 1929 and lasted through the early 1930s. Other U.S. depressions occurred in the 1870s and 1890s. y GUESS WHAT? During the economic depression of the 1930s, one out of every four persons wanting to work could not find a job. In addition, the stock market declined by almost 90 percent from peak to bottom.

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  A History of Big Recessions in the Long Twentieth Century

  • Andrés Solimano(Author)
  • 2020(Publication Date)
  • Cambridge University Press

    (Publisher)

  11 2.2 Business Cycles, Recessions, Depressions, and Recoveries and protracted contractions in economic activity. Some may apply the term “depression” to permanent decelerations in output growth relative to some historical averages. The term “depression” is often attributed to US president Herbert Hoover who used it to describe the slump affecting the US economy in the period between 1929 and 1933, characterized by mas- sive bank failures, output contraction, high unemployment, plummeting investment, and pessimistic expectations (see Chapter 4). In the nineteenth century, when the system of national accounts as we know it today was in its infancy (or simply it did not exist), the term “depression” was used to describe episodes of financial instability, bank failures, and market panic. For example, the panics of 1819, 1873, and 1907 were defined as “depressions.” Nowadays, a Great Depression encompasses an economy in serious dis- tress, a situation that combines severe features of market destabilization, panic, and stress along with company bankruptcies, output contraction, investment collapses, rising unemployment and poverty. 7 8 9 10 11 12 13 2 3 4 5 6 7 8 9 10 Output Level Quarters (a) Inial trend line Temporary output loss Output 7 8 9 10 11 12 13 2 3 4 5 6 7 8 9 10 Output Level Quarters (b) Permanent output loss Inial trend line Output Figure 2.2. Transitory and permanent deviations from trend. Level of Real Output Time Figure 2.1. The phases of a business cycle. 12 Recession and Depression Economists have developed alternative empirical definitions for clas- sifying an event of Economic Contraction as a depression. To quote at least three of them: Definition I: a drop of total GDP above 10 percent combined with an unemployment rate over 20 percent of the labor force. In chapter 1 we define depression as a decline in GDP per capita above 15 percent. Definition II: a decline in GDP that lasts at least three years.

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  eBook - PDF

  Recessions and Depressions

  Understanding Business Cycles

  • Todd A. Knoop(Author)
  • 2009(Publication Date)
  • Praeger

    (Publisher)

  Second, major contractions/depressions tend to involve the collapse of financial markets in general, the banking industry in par- ticular. Third, major contractions/depressions almost always begin with some sort of macroeconomic policy mistake, in the form of runaway mon- etary and fiscal policy, misaligned exchange rates, deregulation of finan- cial markets, or all of the above. The Great Depression, the East Asian crisis, the Great Recession in Japan, and the 2007 Global Financial Crisis each follow this general pattern. Current business cycle research has not yet been able to provide a complete model that adequately incorporates each of these factors. Much of our current macroeconomic theory better explains recessions than it does major contractions and depressions. However, these recent international crises have served as a wake-up call to many economists and have spurred much needed research in open- economy models of business cycles that incorporate the macroeconomic effects of market failure, particularly within banking systems. 8 Recessions and Depressions: Understanding Business Cycles The final chapter, Chapter 16, is a brief conclusion in which the history of economic theory on business cycles is reviewed and the principal insights that have been gained from the study of business cycles are dis- cussed. This is followed by a list of questions which economists are still struggling to provide answers to, questions that serve as signposts to guide future economic research on business cycles. Why Study Business Cycles? 9 2 Describing Business Cycles INTRODUCTION In order to understand why economies are subject to business cycles, it is important to have a good grasp on the empirical regularities (and irregu- larities) of key macroeconomic variables that fluctuate as the economy contracts and expands.

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  Money for Minors

  A Student's Guide to Economics

  • Marie A. Bussing(Author)
  • 2008(Publication Date)
  • Greenwood

    (Publisher)

  BUSINESS CYCLE The regular fluctuations in economic activity, namely Gross Domestic Product (GDP). Prolonged contractions in economic activity are referred to as recessions. Recurrence of periods of recovery, or strong levels of activity, are referred to as expansions. Although the typical cycle can vary greatly, the average U.S. recession runs about 1 year, while the typical expansion period is 5 years long. Business cycles are influenced by a multitude of factors in the economy, including seasonal spending, consumer confidence, inflation, employment, war or the threat of war, monetary policy, or fiscal policy. BUYER A person or business that purchases goods and services from a seller in the marketplace for a price. CALL OPTION A contract that gives the holder the right to buy a stock at a particular price, called a strike price, within a fixed period of time. CAPITAL Goods used in the production of other goods and services. These goods make up a nation’s productive capacity because they are needed to turn out all the things and services a nation supplies. Capital goods are produced goods used as factor inputs for production of additional goods and services. These might include machinery, equipment, office buildings, computers, airplanes, and trucks. Check 17 In finance, the term often refers to money, specifically funds used by businesses for capital spending activities. CAPITALISM An economic system in which private businesses and individuals produce all goods and services. Decisions about what to produce, how to produce, and for whom to produce are made largely by businesses and individuals in the economy. The market forces of supply and demand, or fluctuations in prices, coordinate with individuals’ wants. Capitalism is sometimes referred to as free enterprise, the free market, a market economy, or private enterprise. For capitalism to exist, private property rights must be defended by the government.

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  eBook - PDF

  Demystifying Global Macroeconomics

  • John E. Marthinsen(Author)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  The duration of an expansion is from the cycle ’ s trough to its peak. The entire business cycle can be measured from one peak to the next peak, or it can be measured from one trough to the next. In Figure 14.1, the business cycle is measured from peak to peak. https://doi.org/10.1515/9781547401437-014 To identify the phases of a business cycle, a nation needs to measure its real economic activity , but how is this done? Often, real GDP is used as a proxy. An increase in real GDP means that production is rising, which usually in-creases employment and improves economic conditions. Declining real GDP im-plies that the opposite is happening. The association between real GDP and the business cycle is so strong that the media and many analysts commonly define a recession as a decline in real GDP for at least two consecutive quarters. Even though this definition appeals to common sense, it is only a practical guideline (i.e., unofficial shortcut) and not the way recessions and expansions are officially measured or dated. 1 Business Cycle: Peak to Peak Economic Activity Peak Peak Trend line Trough Expansion Recovery Recession Contraction Time (Months) Figure 14.1: Recessions and Expansions During the Business Cycle. 1 To prove that the two-consecutive-quarters rule is a shortcut or approximation (and not an offi-cial rule) for defining recessions, we only need to look at historical records. From 1947 to 2019, the United States suffered 12 recessions. In 10 of them, real GDP fell for at least two consecutive quar-ters, but two official recessions (i.e., from April 1960 to February 1961 and from March 2001 to November 2001) occurred without real GDP falling for two consecutive quarters. There was one downturn in economic activity (from January to July 1947) during which real GDP fell for two con-secutive quarters without triggering an official recession. To understand who officially dates U.S. recessions, see “ Who Measures U.S.

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