what causes recession

8/8/2019 What Causes Recession

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What Causes Recession ?

An economy which grows over a period of time tends to slow down the growth as a partof the normal economic cycle.An economy typically expands for 6-10 yearsand tends to go into a recession for about sixmonths to 2 years.

A recession normally takes place whenconsumers lose confidence in the growth of the economy and spend less.


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This leads to a decreased demand for goodsand services, which in turn leads to a decreasein production, lay-offs and a sharp rise inunemployment.Investors spend less as they fear stocks valueswill fall and thus stock markets fall on negativesentiment.


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Causes Of US Recession

The general consensus is that a recession isprimarily caused by the actions taken tocontrol the money supply in the economyThe Federal Reserve is responsible formaintaining an ideal balance between moneysupply, interest rates, and inflation.

When the Fed loses balance in this equation,the economy can spiral out of control, forcingit to correct itself.


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Relaxed policies in lending practices making iteasy to borrow money

The economic activity became unsustainableresulting in the economy coming to a nearhalt.Recession can be caused by factors that stuntshort term growth in the economy, such asspiking oil prices or war.


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Crisis In The US

T he United States entered 2008 during a housingmarket correction , a subprime mortgage crisis and adeclining dollar value

In February, 63,000 jobs were lost, a 5-year record.In September, 159,000 jobs were lost, bringing themonthly average to 84,000 per month from January toSeptember of 2008.

On September 5, 2008, the United States Departmentof Labor issued a report that its unemployment raterose to 6.1%, the highest in five years


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The defaults on sub-prime mortgages(homeloan defaults) have led to a major crisisin the US.Sub-prime is a high risk debt offered to peoplewith poor credit worthiness or unstableincomes. Major banks have landed in troubleafter people could not pay back loans.


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Liquidity Crisis

In early July, depositors at the Los Angelesoffices of IndyMac Bank frantically lined up inthe street to withdraw their money.On July 11, IndyMac - the largest mortgagelender in the US - was seized by federalregulators.

The mortgage lender succumbed to thepressures of tighter credit, tumbling homeprices and rising foreclosures.


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During the weekend of September 13 14,Lehman Brothers declared bankruptcy afterfailing to find a buyerBank of America agreed to purchase MerrillLynch, the insurance company AIGsought abridge loan from the Federal Reserve

and a consortium of 10 banks created anemergency fund of at least $70 billion to dealwith the effects of Lehman's closure


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The biggest bank failure in history occurred onSeptember 25 when JP Morgan Chase agreedto purchase the banking assets of WashingtonMutualThe year 2008 as of September 17 has seen 81public corporations file for bankruptcy in theUnited States, already higher than the 78 in2007


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Lehman Brothers being the largest bankruptcyin U.S. history also makes 2008 a record yearin terms of assets with Lehman's $691 billionin assets all past annual totals.The year also saw the ninth biggestbankruptcy with the failure of IndyMac Bank


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On September 29, Citigroup beat out WellsFargo to acquire the ailing Wachovia 's assetswill pay $1 a share, or about $2.2 billion.In addition, the FDICsaid that the agencywould absorb the company's losses above $42billion; in exchange they would receive $12billion in preferred stock and warrants fromCitigroup in return for assuming that risk


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H ow T he Government Tackles Recession

Tax cuts are the first step that a governmentfighting recessionary trends or a full-fledgedrecession proposes to do.T he government also hikes its spending to createmore jobs and boost the manufacturing andservices sectors and to prop up the economy.T he government also takes steps to help theprivate sector come out of the crisis.In the current case, the Bush government hasproposed a bailout package.


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Initial estimates of the cost of the Treasurybailout proposed by the Bush Administration'sdraft legislation (as of September 19, 2008) werein the range of $700 billion to $1 trillion U.S.dollars .President George W. Bush asked Congress on

September 20 , 2008 for the authority to spend asmuch as $700 billion to purchase troubledmortgage assets and contain the financial crisis.


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The crisis continued when the United StatesH ouse of Representatives rejected the bill.T

he bill was eventually passed by the Senateand the H ouse but the stock market continuedto fall nevertheless


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Impact On India

A slowdown in the US economy is bad newsfor India.

Indian companies have major outsourcingdeals from the US.India's exports to the US have also grownsubstantially over the years.Indian companies with big tickets deals in theUS are seeing their profit margins shrinking.


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More people have sold the shares in the indianshare market than they bought in the recentweeks. T his has added to the fall of sensex tolower points.One danger meanwhile is of a dip in theemployment market. T here is already anecdotal

evidence of this in the I T and financial sectors,and reports of quiet downsizing in many otherfields as companies cut costs.


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More than the downsizing itself, which may notinvolve large numbers, what this implies is a

significant drop in new hiring -- and that willchange the complexion of the job market.Many companies has laid off their staffs, thenumber of tourists inflow to india has comedown, companies have cut down compensationsand perks etc, government and other privatecompanies are reluctant in starting new venturesand starting new projects etc.


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Projects that are halfway to completion, orcompanies that are stuck with cash flow issueson businesses that are yet to reach breakeven, will run out of cash.one of the casualties this time could be realestate, where building projects are half-doneall over the country and in this tight liquiditysituation developers find it difficult to raisefinances.


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T he only way out of the mess is for builders to dropprices, which had reached unrealistic levels andassumed the characteristics of a property bubble, so asto bring buyers back into the market, but there is notenough evidence of that happening.Consumers are also frozen in this sudden glare of theheadlights.More expensive money means that floatingrate loans begin to bite even more; even those notcaught in such a pincer will decide that purchases of durables and cars are not desperately urgent.


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At the heart of the problem lie questions of liquidity and confidence.What the RBI needs to do, as events unfold, is toneutralise the outflow of FII money by unwindingthe market stabilisation securities that it hadused to sterilise the inflows when they happened.

This will mean drawing down the dollar reserves,but that is the logical thing to do at such a time.


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If done sensibly, it would prevent a suddentightening of liquidity, and also not allow thecredit market to overshoot by taking interestrates up too high.Meanwhile, there is an upside to be consideredas well.The falling rupee (against the dollar, more thanagainst other currencies) will mean that exporterswho felt squeezed by the earlier rise of thecurrency can breathe easy again, though buyersoverseas may now become more scarce.


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what causes recession

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