Before you can understand recession, you need to meet its similarly disturbing relative, inflation.
Inflation happens when there's a general increase in the price of goods and services over a specific period of time, and the value of a dollar decreases. In other words, the demand for product is higher than the supply that's available. Companies can boost prices, and people are willing to pay those higher prices. This process increases the money supply (puts more dollars in circulation), but your dollar doesn't buy as much stuff.
Inflation can lead to a recession.
The textbook definition of recession is when the Gross Domestic Product (GDP) declines for two or more quarters in a row (six months). Okay, go ahead and snore. Try this: When a country's economic activity (the buying and selling of goods and services) slows way down for a long time, it's said to be in recession.
The GDP is the market value of all final goods and services produced domestically — by a nation's own citizens and firms — in a specified period.
Final goods and services are goods and services that
- Have been purchased for final use
- Will not be resold or used in production within the year
For example, food and televisions are final goods; hair stylists and dentists provide final services. Consumers, however, aren't the only ones who contribute to the GDP. Factories, homebuilders, exported goods and services, and even the government all contribute to the GDP.
A vicious circle occurs when a country is in recession: People are afraid to spend money or buy non-essential goods and services. If consumers aren't buying, then companies aren't making money, and that leads to layoffs and price increases (to make up for falling sales). When people are out of work, they're afraid to spend money. See where this is going?
Here are some signs of a recession:
- Companies make less money; they curtail major purchases like new equipment.
- Businesses fail.
- Unemployment rises when companies downsize and new jobs are not being created.
- Wages and salaries are cut or stay unchanged. (No bonuses! No raises!)
- Retail sales fall because people are out of work and not spending. Or, if people still have their jobs, they're spending less — just in case.
- There's a drop in the number of new houses being built for private ownership. This number is a good economic indicator of how much money the general public has to spend.
One method that the government uses to curtail recession is to lower the interest rates. Lower rates make it easier for consumers and businesses to borrow money from banks and spend, thus stimulating the economy.