Recession

Characteristics of a Recession

A recession is characterized by a decrease in consumer confidence and consumption. It affects investor confidence, which contributes to a reduction in investment. In other words, recession crowds out businesses because they feel pessimistic about the future. Thus, demand for investment decreases.

During a recession, both employment level and output growth decline. Nevertheless, the price level does not shrink rapidly. The price level will probably drop only if the recession is severe and lengthened, as in a depression. The cost of unemployment is the loss of production, the intensification of inequality, a bigger gap between the rich and the poor, and an escalation of human misery, according to economists.

Any recession or depression will disrupt economic activity and weaken economic strength for a long period. However, it does not mean that all recessions always entail acute and extended unemployment. Also, a cyclical peak does not always entail full employment and a high economic growth rate.

The Role of Government

During a recession, the government faces the challenge of a budget deficit because of lower tax revenue and social welfare commitments. Fewer jobs mean lower income tax revenue (assuming that the tax rate has remained the same). Higher unemployment means more people need financial assistance. Hence, government intervention through fiscal and monetary policies is needed to boost the demand for goods and services, which sequentially can help increase the levels of employment and output.

Fiscal policy refers to the adjustment of taxation and public spending. When a recession occurs, an easy/expansionary fiscal policy should be applied. This policy aims to reduce taxes and increase government spending, or a combination of these two tools, in order to reduce adverse effects of a recession. Lower income [Page 902]taxes will lead to higher disposable income, and thus households have more to spend, which increases the demand for goods and services. Lower corporate taxes can increase profit expectation and therefore can attract more investment.

When a recession occurs, one method that is used to alleviate the adverse effects is to increase the money supply in the market.

Monetary policy refers to the adjustment of the money supply in the market. When a recession occurs, an easy/expansionary monetary policy should be applied. This type of policy aims to increase the money supply in the market in order to lower the interest rate. Lower interest rates will lead to higher consumption and financial investment.

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