How Does an Economic Recession Start?

What is a Recession?

Economic recession is the opposite of economic growth. The National Bureau of Economic Research (NBER), which is usually the official body that certifies recessions in the U.S., defines it as "a significant decline in economic activity spread across the economy." This leaves some room for interpretation, but recessions are commonly recognized by decline in gross domestic product (GDP) for two or more fiscal quarters, increased joblessness, decreased industrial output and declining retail sales.

Recession and Interest Rates

Recessions are never triggered by the same exact causes, but typically, they occur in periods of relatively high interest rates and a general lack of access to capital. In fact, one leading indicator of an impending recession is an inverted yield curve, where short-term interest rates rise above long-term rates. This widely followed predictor of recession indicates a relative scarcity of capital in the near term relative to demand.

The Business Cycle

Lack of access to capital creates a chain of events that lead toward recession. In periods of cheap and available money and credit, businesses are able to expand more easily, creating jobs and industrial production. This virtuous cycle yields to the vicious cycle of recession, however, when lack of capital forces businesses to limit their inventories and defer expansion. If lack of capital is combined with increased joblessness, consumers spending will be adversely affected, further tightening business investment and leading to further job loss. Typically, recessions are ended when short-term interest rates are lowered enough to provide easy access to capital, which jumpstarts a recovery period.

Other Causes

With the exception of war, which can cause recession by depleting or destroying the financial and natural resources of a nation, other occasionally cited causes of recessions are all linked to interest rates. Speculation, inflation and currency crisis are all products of excessively "loose" monetary policy, which equates to low interest rates. The relation between interest rates and the business cycle has led many to conclude that the Federal Reserve, which sets short-term interbank lending rates in the U.S., artificially creates economic expansion and recession, often for political reasons.

Resources

• Wikipedia on Recession
• National Bureau of Economic Research
• Recession.org