Recession vs. depression

Although some world politicians are still in denial, the global economy is heading into recession which might be difficult to get out of. Economic experts define recession as ‘a significant decline in economic activity spread across the economy, lasting more than a few months’. This economic slowdown is evidenced in a lowering of production as a result of decreased demand which in turn leads to loss of jobs, tightening of spending and further lowering of demand, thus completing a vicious circle. If measures taken by governments to break the circle fail, we might talk of depression, characterised by bankruptcies, high unemployment, inflation and restriction of credit. Recession is sometimes seen as a natural phase in the business cycle in which periods of expansion are followed by decline, while depression is a more severe condition.

Some of the terms in this lesson are regarded as the culprits for recession while others are measures undertaken by governments in an attempt to curb it. The first sign that recession might be setting in was the credit crunch. At one point the price of money as a commodity increased, leading banks to raise interest rates not only on loans made to private citizens but, more importantly, on money lent to investment banks. When giants such as Merrill Lynch and Lehman Brothers went bankrupt, the US Congress passed the Bailout Act thus indicating that things were getting out of control. Bailout is a short-term measure of injecting (tax-payers’) money into failing banks to help them bridge liquidity problems. The question arises as to why tax payers’ money should be spent because banks made mistakes. The answer lies in the fact that if these banks were to collapse, they would take the whole economy down with them, and not only that of the USA, but the economies of the whole globally interconnected world.

It all started with the subprime mortgage crisis. Banks started lending money to citizens whose credit record was not sound enough to support banks’ confidence in their ability to repay the loan. Since the loans were secured by a mortgage on the property, banks were not overly concerned as they could always sell the property to recover their money. Credit was very cheap back then and interest rates low, which created a bubble and it was just a matter of time before the bubble would pop or burst. When a bubble is created, the value is generated artificially, and people buy overvalued assets in the expectation of selling them on at an even higher price.

Now it is obvious that we will all have to deal with the consequences of living on borrowed money, as some Americans themselves have already started admitting.