Recession: What is it? Should you be worried now?

Even since the US Fed started winding up pandemic-era liquidity from the financial system, the debate over a possible recession has begun.

By definition, a recession is a temporary economic phase in which trade and industrial activities decline and it is generally identified by a fall in the gross domestic product (GDP) in two successive quarters.

US weekly jobless claims fell while the first-quarter economic contraction was confirmed as the gross domestic product fell at a 1.5 annualized rate last quarter versus markets' expectation of a contraction of 1.3 percent. This is the second estimate of US GDP; the initial assessment showed the economy contracting by 1.4 percent.

Besides, the number of Americans filing new claims for unemployment benefits fell last week, consistent with a labour market that remains tight amid strong demand for workers despite rising interest rates and tightening financial conditions, reported Reuters.

What is a recession?

A recession is a vivid and significant decline in economic activities over several months or even years. An economy is considered to be experiencing the phase of recession when GDP falls into the negative territory for at least two consecutive quarters, demands fall, industrial production and corporate profits shrink, wholesale and retail sales decline, consumer sentiment is low and the level of unemployment is high.

For example, the US witnessed a phase of recession after the global financial crisis in 2008-2009. Known as the 'Great Recession in financial and media parlance, it was said to be the most severe economic recession in the US since the Great Depression of the 1930s.

In fact, the US has witnessed four recessions in the last 40 years - the Gulf War Recession (1990-1991), the Dot Com Recession (2001), the Great Recession (2007-2009), and the Covid-19 Recession (2020).

A recession is different from a depression. Depression is a stronger, longer and more severe version of a recession. Recessions are mild while depressions are more severe.

Causes of a recession

There are some financial, sudden economic shocks and other factors that indicate the economy is going through a phase of recession.

Let us try to understand it this way. For a country like India, which is one of the biggest importers of crude oil, a sharp jump in oil prices due to geopolitical tensions can be a major shock. If the geopolitical issues remain unresolved for a prolonged period, it will distort the fiscal maths of the country, push the inflation higher and trigger a slowdown in economic activities and demand. So, higher crude oil prices for a prolonged period is a real factor which can cause a recession in India.

Then there are financial factors behind a recession. Financial experts say that when an economy sees an insufficient money supply during the early stages of a slowdown after witnessing an over-expansion of credit during expansion periods, the risk of recession becomes stronger.

This appears to be the situation now when the world witnessed a strong influx of liquidity during the Covid-19 pandemic and now it is going through the phase of liquidity tightening when the growth is yet to pick up the pace.

Excessive debt, higher inflation or deflation, and asset bubbles are some of the other factors that cause a recession.

Indicators of a recession

An indicator of recession in the US is an inverted yield curve in which yields on longer-term debt fall below the yields on short-term debt.

In a normal economic situation, yields on longer-term bonds are higher than those on short term bonds. When the opposite happens, i.e. long-term yields fall below the short-term yields, it indicates investors are worried about a recession. This phenomenon has predicted past recessions many times.

Rising unemployment, a long bearish phase of the stock market, a higher rate of unemployment, and a sustained fall in industrial production and other economic indicators show that the economy is falling into the grip of a recession.

Should you be worried?

While the risk of recession looks real, economists and experts are of the view that it may not last long.

Former Federal Reserve vice chair Alan Blinder, in a conversation with CNBC, said: “A recession is pretty likely.”

CNBC reported: "Blinder foresees any downturn coming next year, as opposed to later in 2022, and that a recession is not an absolute certainty." And if there is indeed a recession, he thinks it will be a mild one.

Media reports quoted International Monetary Fund First Deputy Managing Director Gita Gopinath saying that the world economy has a buffer against recession but it is not out of question.

As reported by Mint, the managing director of the IMF sought to dispel the gloom this week, saying a global recession isn’t in the cards but “it doesn’t mean it’s out of the question."

Speaking at the World Economic Forum's annual meeting in Davos, Switzerland, Gopinath said, "As yet we do not see a systemic sovereign debt crisis, but the risk ahead is salient."

Gopinath further said that advanced economies will be back on track by 2024, but developing economies will be 5 percent below where they would have been otherwise.

Upcoming global economic data, the Ukraine war and the situation in China will be the major indicators to tell us if our concern over a recession is valid or not. However, so far, it looks that the world is unlikely to see a major recession and even if it occurs, it will be a milder one.

Many rating agencies have trimmed their global growth forecasts and they did have raised concerns over inflation, aggressive rate hikes and the Ukraine war, yet they do not see the world slipping into a long and severe phase of a recession in the near term.