What is a Recession?

What is a Recession?

Understanding What is a Recession and how it can affect housing prices

What is a Recession?

A recession occurs when a country goes into a major economic decline that lasts more than a few months. Usually, it had been identified as two consecutive quarters of economic decline, as expressed by Gross Domestic Product (GDP) in combination with other monthly measures such as an increase in unemployment.

The parameters have been modified to that quarterly GDP falls are not necessarily aligned with the decision to call a recession. Before quarterly GDP reports are out a recession will begin quietly. It is a temporary phase in which an economic decline is visible in real GDP, real income, employment, industrial production (manufacturing), and wholesale-retail sales, lasting more than a few months.

Thus, the economic output of the country as a whole stagnates throughout the recession time, companies and the government will suffer the recession’s impacts due to the struggling economy, people losing work, firms making fewer sales and the overall decline in the country’s economic output. If the economy’s growth is very low, there will be increased spare capacity and increased unemployment; people will feel a growth recession.

What causes a Recession

In the financial sector, overextension of credit and debt on risky loans and marginal lenders will result in huge risk build-ups. The expansion of the country’s Reserve and the banking sector’s supply of money and credit in the economy may force this cycle to extremes, causing risky price bubbles for assets. 

Artificially abolished interest rates during boom times leading to a recession can distort the relationship structure between businesses and consumers by making interest-sensitive business projects, investments, and consumer decisions, such as buying a larger house or launching a risky long-term expansion, It seems much more enticing than it should be. When prices rise to reflect the fact, the eventual failure of these decisions constitutes a major component of the rash of business failures that shape a recession.

Psychological factors are frequently cited by economists for their contribution to recessions too. The irrational exuberance of investors during the boom years that carry the economy to its height and the corresponding doom-and-gloom pessimism that sets in after a market crash at a minimum exacerbates the impact of real economic and financial factors as the market swings. In addition, as all economic actions and decisions are often to some degree forward-looking, the subjective aspirations of creditors, companies and customers are also involved in the initiation and spread of an economic downturn.

Concrete shifts in economic conditions also make vital contributions to a recession. Many analysts describe recessions primarily as a result of actual economic shocks, such as supply chains disturbances, and the harm that they can do to a wide variety of businesses. Shocks that affect key sectors such as energy or transportation may have such widespread consequences that they cause many companies across the economy to retrench and postpone investment and recruit plans simultaneously, with ripple effects on jobs, customers and the stock market. 

There are also some real economic conditions that can be linked back into financial markets. Because market interest rates not only represent businesses’ financial liquidity costs but also consumer, saver and investor time preferences for the present versus future consumption; in the boom years before a recession, artificial manipulation of interest rates by a central bank distorts not only financial markets but actual business and consumer decisions.

A financial crisis when banks have a liquidity deficit, loans are lowered and this limits investments.

  • Rise in interest rates increases borrowing costs and lowers demand. There isn’t much liquidity in the economy when the interest rate is very high. Therefore the investment rates would plummet, triggering a recession in the economy. They limit liquidity when interest rates rise which is money available for investment.
  • fall in asset prices where a negative effect on wealth leads to less expenditure. Asset bubbles occur when an item’s price, such as gold, stocks or housing, inflates beyond its sustainable value. The bubble itself is setting the stage for a recession when it breaks out.
  • Fall in real wages when inflation outstrips nominal wage increases. When the wages and salaries of workers do not increase with the same level as the inflation in the economy, the purchasing power of the public will reduce. The demand falls since families have lower incomes. Consumers will not be able to afford the same goods and services that they used to which can cause an economic slowdown. Companies are unable to reduce costs, so they lay off even more employees. 
  • Fall in consumer/business confidence is aggravated even by the negative multiplier effect when spending is at an all-time low.
  • Appreciation in the exchange rate as exports is less competitive.
  • Fiscal austerity when the government cuts spending.
  • Trade war in which there is a global economic downturn.
  • Supply-side shock e.g. rise in oil prices causing inflation and lower spending power.
  • Black swan events, when there is an unpredictable occurrence, very difficult to predict. For instance, a Covid-19 flu pandemic that disrupts travel, supply chains and normal business. A pandemic affecting supply and demand alike.
  • The stock market where investors in a bear market would be taking money out of the stock market. This will drain capital from businesses and cause an economic slowdown. Stock market crashes are rather prejudicial to the economy. The sudden lack of trust in investing may trigger a subsequent bear market that drains capital from enterprises.
  • A housing crisis, falling in house prices have a major impact on consumer wealth and spending and as home values decline, the owners begin to lose equity. As homeowners lose equity, they cannot pay their mortgages on their homes or take out second mortgages which could result in foreclosure. They are then forced to cut spending as they can’t take out second mortgages any more. Ultimately, banks lose money on complex assets that were in decline based on underlying home prices.
  • Economic scandals and frauds are done to boost profitability. Banks, large corporations and even government institutions employ questionable practices and illegal activities. When they expose these schemes and scandals, the entire economy suffers. Bad business practices often cause recessions due to a result of land flips, questionable loans, and illegal activities.
  • Effects of war, as wars cause stress on the economy, we generally see an economic slowdown after a war. 
  • Deflation causes a general fall in product and service prices, the market value drops. The customers can wait until the costs are reduced more. Prices that decline over time have a greater impact than inflation on the economy. Demand falls and triggers a recession.
  • Loss of confidence in investment and economy causes customers to stop purchasing and move to defensive mode. Fear sets in as a critical mass marches toward the exit symbol which results in slow retail sales. Companies are advertising fewer job ads and the economy is producing fewer workers. Manufacturers are cutting back in response to falling orders as the rate of unemployment is increasing.
  • Slow manufacturing orders as there is a decline in manufacturing orders.
  • Lawmakers can trigger a recession by removing important safeguards. Some may remove restrictions on loan-to-value ratios for banks.
  • Credit crunches occur when lenders are lenient in borrowing to businesses as they are scared of bankruptcy or defaults creating a massive credit crunch.

What could cause the next recession in South Africa?

  • Covid19 Pandemic which causes disruption to trade, manufacturing, travel and business confidence and a fall in house prices.
  • Very low-interest rates result in no room for a monetary boost.
  • Overextension of supply chains, overinvestment in marginal industry, razor-thin inventories and fundamental inequalities in company, expenditure, and consumer behaviour that may leave the economy with zero margins in resilience to protect against negative economic shocks. The lockdown in South Africa could shoot a blow to the economy, import and export investment disruptions have occurred and there could be possible downgrading from rating firm Moodys’. In addition to COVID-19, load shedding is a further consideration for South Africa as it affects the activity and investments of the country.

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