A recessions refers to the moment when a country’s economy experiences decline as a result of different factors.
Recession commonly lasts for 6 months or more and affects the following pillars of an economy – GDP, employment, income, retail sales and manufacturing.
It is important to understand that recession is normal but unpleasant and as such, fiscal and monetary policies are used to ensure that recession does not prolong.
The federal government uses the above policies to increase or decrease spending especially on certain programs and projects that help to create employment. Furthermore, bank reserve requirements may be changed together with interest rates used by the Federal Reserve to lend funds to banks.
Real World Example Of Recession
In 2007 to 2009, the world suffered a global recession. During this time, a lot of attention was placed on risky investment strategies that were used by financial institutions.
The global recession was attributed to a drop in global output which coincided with the decline of macro-economic indicators like trade, capital flows and employment.
As a result, economies of both the developed and developing nations suffered greatly together with the global financial system which experienced lots of setbacks.
To improve the economy and fight recession, governments around the world implemented policies which helped to prevent any future crisis.
According to financial experts, the probability of a recession is determined by studying two main indicators. They include:
a. Lagging Indicators
This is an economic measure that changes only when a country’s economy begins to follow a specific trend. As a technical indicator, it is known to follow the price action of a security and as such, traders use it to determine the strength of a particular trend. When it comes to recession, lagging indicators are used by economic experts to know when the economy has experienced a major shift.
Examples of lagging indicators include balance of trade, corporate profits, GDP, interest rate, consumer price index, labor cost per unit of output and unemployment rate. Interest rate is one of the best examples of a lagging indicator. Why? It changes due to a shift in the market.
b. Leading indicator
This is another major indicator that is used by economic experts to determine the occurrence of recession in the near future. The indicator is known to change just before a country’s economy begins to follow a specific trend. Although leading indicators are used to determine the occurrence of recession, they are not always accurate.
They can be used by investors in determining the best strategy that will ensure they benefit from the market. Federal policy makers use leading indicators to consider changes when it comes to monetary policies while businesses use it to learn more about the condition of the economy.
A good example of leading indicators includes the durable goods report and purchasing manager index. The durable goods report is used to check the health of the durable goods industry while the purchase manager index is used to predict the growth of the GDP.
Although recession results in the economic decline for both developing and developed countries, economic experts have found out that it helps to cure inflation too.
That is why the Federal Reserve ensures balance prevails which helps to prevent inflation and recession altogether. This is achieved through the implementation of the fiscal policy.