Economic recessions are typically caused by one of five factors. These include loss of high interest rates, a stock market crash, asset bubbles bursting, and a loss in consumer confidence.
Infrequently, recessions are caused by natural disasters or wars. Most events that cause the economy to slow down can also lead to a recession if left unchecked.
High Interest Rates
High interest rates is one of the leading causes of recessions. When interest rates are high, borrowing money becomes more expensive. This discourages consumers and businesses from borrowing money . As they reduce spending, demand for goods and services also drops. This has the same effect as lower consumer confidence. Less purchasing means business higher fewer people. If it goes on long enough, layoffs result. By the time this happens, the central bank will lower interest rates. Since it takes six months or more for changes in interest rates to filter through the economy, it may not happen in time to prevent a recession.
Stock Market Crash
A stock market crash doesn't necessarily cause a recession. It depends on how severe the crash is, and how long stock prices stay depressed. In a stock market crash, both businesses and wealthy people have have less capital to invest or spend. If businesses can't raise money for growth and operating costs, that can lead to layoffs or hiring freezes.
At least three major U.S. stock market crashes kicked off a recession. These include the stock market crash of 1929, also known as "Black Tuesday", the 2008 financial crisis, and the short-term crash due to COVID-19.6
Asset Bubbles Burst
Asset bubbles occur when the prices of investments, such as gold, stocks, or housing, become inflated beyond their sustainable value. The bubble itself sets the stage for a recession to occur when it bursts. When they burst, it has the same impact as a stock market crash. Those that held their capital in the asset that burst lose their money. They have less to spend, leading to a recession. In addition, a bursting asset bubble can destroy consumer confidence. The "dot com" stock bubble and the housing bubble came right before the recessions of 2001 and 2008.
Deregulation
Lawmakers can trigger a recession when they remove important safeguards. The seeds of the savings and loan crisis and the subsequent recession were planted in 1982 when the Garn-St. Germain Depository Institutions Act was passed. This and the Depository Institutions Deregulation and Monetary Control Act of 1980 removed loan-to-value ratio and interest rate cap restrictions for savings and loan associations. The savings and loans crisis caused the 1990 recession. More than 1,000 banks, with total assets of $500 billion, failed as a result of land flips, questionable loans, and illegal activities.
Loss of Consumer Confidence
When people lose confidence that the economy will continue to grow, they cut spending. This can cause a recession because fewer sales means less revenue for businesses . If this goes on long enough, then companies will need to cut their costs so they don't go bankrupt. The largest cost area is usually employees. This means they will cut jobs and lay off workers. The newly unemployed will spend even less, leading to a vicious downward cycle. It's difficult to restore consumer confidence when people are losing jobs.
Natural Disaster
Pandemics have caused recessions twice in the modern history of the United States.
The first was the so-called Spanish flu pandemic in 1918-1919. It sickened 25% of the U.S. population (25 million), and killed between 675,000 people. The death rate was 3%, triggering a mild recession as the pandemic spread. In addition, the government enacted restrictions such as closing non-essential businesses. As a result, manufacturing declined 18%, with a corresponding 23% drop in employment. The impact was buffered by the government's ramp-up in production to fight World War I. according to the Federal Reserve Bank of St. Louis.
The Covid-19 pandemic created the 2020 recession. In March 2020, the federal government shut down all non-essential services to slow the spread of the disease. As a result, the economy contracted 5.3% in the first quarter of 2020 and a devastating 28% in the second quarter, according to the national income report from the Bureau of Economic Analysis.
