What Causes Recessions?

Numerous economic theories attempt to explain why and how the economy might fall off of its long-term growth trend and into a period of temporary recession..... 

These theories can be broadly categorized as based on real economic factors, financial factors, or psychological factors, with some theories that bridge the gaps between these.

Some economists believe that real changes and structural shifts in industries best explain when and how economic recessions occur. For example, a sudden, sustained spike in oil prices due to a geopolitical crisis might simultaneously raise costs across many industries or a revolutionary new technology might rapidly make entire industries obsolete, in either case triggering a widespread recession.

The spread of the COVID-19 epidemic and the resulting public health lock-downs in the economy in 2020 are an example of the type of economic shock that can precipitate a recession according to Real Business Cycle Theory. It may also be the case that other underling economic trends are at work leading toward a recession, and an economic shock just triggers the tipping point into a downturn.

Some theories explain recessions as dependent on financial factors. These usually focus on either the overexpansion of credit and financial risk during the good economic times preceding the recession, or the contraction of money and credit at the onset of recessions, or both. Monetarism, which blames recessions on insufficient growth in money supply, is a good example of this type of theory. Austrian Business Cycle Theory bridges the gap between real and monetary factors by exploring the links between credit, interest rates, the time horizon of market participants’ production and consumption plans, and the structure of relationships between specific kinds of productive capital goods. 

 

Psychology-based theories of recession tend to look at the excessive exuberance of the preceding boom time or the deep pessimism of the recessionary environment as explaining why recessions can occur and even persist. Keynesian economics falls squarely in this category, as it points out that once a recession begins, for whatever reason, the gloomy “animal spirits” of investors can become a self-fulfilling prophecy of curtailed investment spending based on market pessimism, which then leads to decreased incomes that decrease consumption spending. Minskyite theories look for the cause of recessions in the speculative euphoria of financial markets and the formation of financial bubbles based on debt which inevitably burst, combining psychological and financial factors.
 

Recessions and Depressions

Economists say there have been 33 recessions in the United States since 1854 through to now in total. Since 1980, there have been four such periods of negative economic growth that were considered recessions. Well known examples of recessions include the global recession in the wake of the 2008 financial crisis and the Great Depression of the 1930s.

A depression is a deep and long-lasting recession. While no specific criteria exist to declare a depression, unique features of the Great Depression included a GDP decline in excess of 10% and an unemployment rate that briefly touched 25%. Simply, a depression is a severe decline that lasts for many years.