What Causes Recessions?

Economics shock

An economic shock is an unanticipated incident that significantly harms a nation’s economy. For instance, in the 1970s, when the Organization of the Petroleum Exporting Countries (OPEC) unexpectedly stopped supplying oil to the United States, there was a recession and long lines at the gas pumps. A more recent example of an unanticipated economic shock is the appearance of the coronavirus, which led to the collapse of economies throughout the world.

Excessive debt

People or businesses who take on excessive debt may find themselves unable to make their payments when the cost of debt servicing increases. The economy suffers greatly as a result of the rise in bankruptcies and debt defaults. The housing bubble that burst in the middle of the 2000s and caused the Great Recession is the most notable example of how an unsustainable debt-driven recession might occur.

Asset Bubbles

Investment decisions influenced by emotion can have negative economic effects. When the economy is going well, investors may get overconfident and get carried away with their optimism. When evaluating the pattern of behavior brought on by the disproportionate increases in the stock market in the late 1990s, former Federal Reserve Chair Alan Greenspan is sometimes credited with coining the term “irrational exuberance.” The stock market and the real estate industry bubbles are caused by irrational excitement. When these bubbles burst, it can result in panic selling, which might then cause a market crash and a recession.

An Excessive Amount of Inflation

A general tendency where prices keep on rising over time is referred to as inflation. Although inflation is not always negative in and of itself, it may harm the economy if it spirals out of control. One method that central banks may employ to control inflation is to raise interest rates, although doing so would unintentionally slow the pace of economic growth. Inflation skyrocketed during the 1970s. The Fed quickly increased interest rates, which decreased economic activity but helped to break the cycle.