What Are the Causes And Effects of Recession?

source: stanford

Recession is generally negative growth of the economy in two successive quarters. This adverse economic condition, however, can continue for more than two quarters or six months. As an impact of the recession, the demand for sales decreases significantly, creating an adverse situation and financial hardships for small to large businesses.

To get a complete overview of causes and effects of recession on an economy, go through the sections mentioned below.

Here are the impacts of a recession on economy:

• Restricted Purschasing: During the recession, people within an economy limit their spending primarily to essential items, which are necessary for them to meet their basic standards of living. As a result, demand for sales decreases by a massive rate, leading to the worry of small to large businesses.
• Increased Unemployment:  Some businesses and corporations start laying off their employees due to shortage in the demand of their products. It helps them reduce their outgoing money, so they can maintain their workflow during that critical time. Additionally, it becomes difficult for people to get new jobs.

Here are some major reasons that lead to a recession within an economy:

• Stock Market Crash: If the bearish market continues for a prolonged period, the prices of the stocks decline day by day. It impacts both the business and investors. First, investors, in such circumstances, lose their patience after a certain time and liquidate their holdings. It leads to a shortage of capital flow for the businesses whose stock price got the impact of the bearish market.In such a circumstance, businesses start cutting their overall costs and even go to the extent of layoffs and freezing new recruitment processes. If such a situation lasts for a long time, it can cause a recession.
• High-Interest Rate of Banks: If the lending rates within an economy become high, people avoid borrowing. As a result, the supply of capital falls which again leads to a decrease in investment. The consequent economic slowdown can lead to recession.
• Fraudulent Activities or Scandals: Large corporations, banks and government authorities are some of the pillars of the economy. If they take resort to unlawful means to enhance the profitability of some groups or themselves, the economy can suffer significantly, leading to the downfall of investment, cutting down employment and new recruitment.
• Impact of War: War leads to massive financial loss for a nation as the demand for items in the international market generally becomes low. In fact, the domestic market also becomes adverse for the corporates as well as the small companies. To get a detailed picture of the causes and effects of recession led by war, you can go through the case studies of the American economy after the Korean, Vietnam and Gulf wars.
• Reduction in Wages: If the salaries and wages within an economy fail to align with the constantly increasing prices of products and services, the purchasing power of people reduces. They face difficulties to buy their necessary items or avail their required services. Such an economic condition can also lead to an economic slowdown and subsequently recession.
• Deflation: During deflation, the prices of products and services keep falling. However, people, instead of buying, wait for further decline. Often, deflation occurs along with the increase in lending rates. As a result, people avoid borrowing to make their purchases. Another thing that makes the economic condition worse during deflation is the layoffs. This happens as companies take cost-cutting measures to maintain profit even after a reduction in the prices of their produced items.

Following are some of the significant adverse impacts that small to medium businesses witness during a recession:

• Delayed Payment from Customers: One of the first visible negative effects of recession is customers' unwillingness to pay bills on time. They hold payments owing to less availability of cash during this difficult economic situation. Due to this factor, businesses have less money to keep afloat.
• Reduction in Cash Flow: Businesses mainly operate and thrive on the available cash flow. If it is a small business, this cash flow remains tight as it does not run with a large capital to maintain its operation. They get money from customers to meet their working capital requirements. Since customers do not pay on time, this cycle of monetary transaction breaks, resulting in hampered cash flow.
• Loss of Employment: Job losses in different sectors also come as one of the most significant impacts of a recession. This happens as the demand, sales, and revenue decrease during this critical economic condition. It helps employers reduce their outgoing capital and use that to maintain their commercial operations. 
• Less Demand: Recession takes a significant toll on the overall demand in business as people stop or downsize their purchase of items, especially the non-essential or luxury ones. As a result, the income or revenue generation of those businesses declines on a large scale. Besides this, the decline in demand also leaves a domino effect in other aspects like inventory management and financial loss. 
• Exit from the Business: Small businesses run on a tight budget and limited working capital. As the worst effect of the recession, some companies, especially the small ones, also have no choice but to leave the field. This results from a prolonged halt in sales and revenue generation. Here are the positive effects of a recession on businesses:
• Reduced Borrowing Rates: As mentioned earlier, a recession induces a negative market sentiment, and people stop spending their money or spend more judiciously. The government takes necessary measures to reduce the lending rate and break the economy's standstill condition. It motivates business owners to take loans and start their commercial activities with a new zeal.
• Negotiations on Leased Commercial Property: Businesses can save much on their real estate lease during a recession when there is less demand. They may also find their landlords agreeing to negotiate with the lease terms. 
• Time to Cut Down Costs: As there is no pressure from the customers' side, small businesses can deviate their focus from the production of items to internal processes for management and operations. They also get opportunities to find non-essential expenses that do not contribute to their productivity and eliminate them if possible. This way, they will be able to save much of their cost during the time of crisis.

Corporations stay relatively more stable than small businesses due to a large amount of capital they possess. Still, a recession impacts them both positively and negatively.

The negative impacts of the recession on corporations are as mentioned below:

• Decrease in Profit: During a recession, consumers' confidence in their financial prospects drops and as a result, they try to reduce their purchases as much as possible. This decrease in sales hit corporations with their chances of earning revenues and making a profit. This factor is equally true for small businesses and the corporate sector.
• Changes in Operations: A recession pushes corporations to achieve much more by investing less. Therefore, they try out different measures and reconsider their methods of operation. They intend to enhance their efficiency during an economic downturn by changing their workflow.
• War of Pricing: When recessionary sales begin, different corporations in the same field lower the prices of their manufactured or produced items to retain their market share. It can start a price war, thereby reducing profit margins substantially. Although it benefits customers significantly, companies face financial hardships as they need to meet their operating costs. 

In this regard, shrinkflation also appears as an overall effect of the recession in the economy. It is a short-term tactic to gain a high profit by reducing the weight or volume of items while keeping the price the same.

Here are the positive effects of the recession on corporations:

• Decline in the Quality of the Product: There can also be a significant reduction in the overall quality of the product after the recession. It occurs as large manufacturing companies try to maintain profitability despite the dip in sales.
• Reduced Cost of Operations: Recessions push businesses to condense, eliminate or consolidate different verticals and horizontals due to the less reserve of working capital. They can also be left with no choice but to reduce the number of their inventories and employees. So, after a recession, businesses operate with decreased resources, saving costs to a large extent.
• More Time to Focus on Improving: Corporations can leverage the critical hour of recession to focus on their future strategy for business. They can analyse their strength and areas of improvement and take steps accordingly. At this time of reduced activity, they can also be proactive and start developing new products or business verticals.
• Increase in Market Share: The effect of recession is worse on small businesses and startups than on large corporations due to the availability of cash. Big corporations get the edge during this time of crisis as they have a large number of assets. Since a recession hits small businesses harder, corporations get a competitive edge to increase their market share.

The following are some adverse effects of the recession on the stock market:

• Reduction in Stock Prices: In times of recession, stock prices usually plunge due to reduced sales, income and restricted business operations. All these further lead to negative market sentiment, and as a result, you can see a bearish trend in the stock market. Individuals who have invested a large amount of money in stocks can face a substantial loss in times of recession. 
• Increased Volatility: The recession also causes market volatility, but this impact comes after the stock prices drop. Low stock prices attract investors as they want to book shares of companies at a reduced value. When this number of investors increases, stock prices also go upward for the time being, leading to stock market volatility.Here are the positive impacts of the recession on the stock market:
• Stocks at Lower Prices: Since the prices of stocks of companies plunge during the recession, it becomes easier to invest in them. With a low investment, you can increase opportunities for earnings when the economy revives and demand returns to normal. 
• Stock Price Balancing: Some companies become overvalued during normal economic conditions. As a result, it becomes risky to invest in those stocks. However, when a recession hits the market, the imbalance of those stocks becomes rectified.

Not all business sectors experience the impact of recession similarly. Some businesses stay more or less stable, while others become vulnerable. Following are some industries on which recession has a detrimental effect:

• Restaurants
• Travel and Tourism
• Retail
• Real Estate
• Manufacturing and Warehousing

The main reason behind this impact is people's tendency to eliminate unnecessary purchases from their budget to survive this difficult time.

From the detailed discussion on causes and effects of recession, we can conclude that during a recession, the economy faces a significant reduction in demand for products and services. As a result of this decline in demand and sales, organisations lay off their employees and make changes in the management and operations to reduce the outflow of money. Nevertheless, a recession also has positive effects, such as reduction of the interest rate, balancing of stock prices, etc.