What causes an economic recession

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For millennia, the people of Britain had been using bronze to make tools, jewelry, and as a currency for trade. However, around 800 BCE, things began to change as the value of bronze declined, causing social upheaval and an economic crisis—what we would call a recession today.

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What causes recessions? This question has long been the subject of heated debate among economists, and for good reason. A recession can range from a mild decline in economic activity in a single country that lasts a few months to a long-lasting global downturn with effects lasting years, or anything in between. Complicating the matter, there are countless variables that contribute to an economy’s health, making it difficult to pinpoint specific causes.

Looking at the big picture, recessions occur when there is a negative disruption in the balance between supply and demand. There’s a mismatch between how many goods people want to buy, how many products and services producers can offer, and the price of those goods and services, which prompts an economic decline.

An economy’s relationship between supply and demand is reflected in its inflation and interest rates. Inflation happens when goods and services become more expensive, meaning the value of money decreases. However, inflation isn’t always a bad thing; in fact, a low inflation rate can encourage economic activity. But when high inflation is not accompanied by high demand, it can cause economic problems and eventually lead to a recession.

Interest rates, on the other hand, reflect the cost of taking on debt for individuals and companies. Interest rates are typically an annual percentage of a loan that borrowers pay to their creditors until the loan is fully repaid. Low interest rates allow companies to borrow more money, which they can use to invest in more projects. High interest rates, however, increase costs for both producers and consumers, slowing economic activity.

Fluctuations in inflation and interest rates provide insight into the health of the economy, but what causes these fluctuations? The most obvious causes are shocks like natural disasters, wars, and geopolitical factors. For instance, an earthquake can destroy infrastructure needed to produce essential commodities such as oil, forcing the supply side to charge more for products that use oil. This discourages demand and can trigger a recession.

Interestingly, some recessions occur in times of economic prosperity—possibly even because of that prosperity. Some economists believe that excessive business activity during a market expansion can reach unsustainable levels. For example, corporations and consumers may borrow more, assuming that economic growth will allow them to handle the added burden. But if growth doesn’t happen as expected, they may end up with more debt than they can manage. To repay it, they must cut spending on other activities, leading to reduced business activity.

Psychology also plays a role in recessions. Fear of a recession can become a self-fulfilling prophecy if people pull back on investing and spending. In response, producers might cut operating costs, expecting a decline in demand. This can trigger a vicious cycle where cost-cutting lowers wages, further reducing demand.

Even policies aimed at preventing recessions can sometimes contribute to them. In tough times, governments and central banks may print money, increase spending, and lower interest rates to stimulate the economy. Smaller lenders follow by lowering their interest rates, making debt cheaper to encourage spending. But these policies are not sustainable and eventually need to be reversed to prevent excessive inflation. When this happens, a recession can occur if people have become too reliant on cheap debt and government stimulus.

The Bronze recession in Britain eventually ended when the adoption of iron revolutionized farming and food production. While modern markets are far more complex, making today’s recessions harder to navigate, each recession provides new data that helps us better anticipate and respond to future downturns.