A state of the economy that occurs when there is a slowdown or downturn of economic activity for two consecutive quarters or more. The slowdown is a manifestation of increased unemployment above its natural (long-run) rate and plummeting real output (GDP).
Economists generally disagree on the reasons for a recession because it may be caused by a reduction in aggregate demand (consumption), a reduction in aggre gate supply (production), or exogenous shocks. In trying to explain a recession, the two major schools of thought can broadly be classified in terms of demand and supply. Others believe that the economy can correct itself through built-in stabilizers such as unemployment compensation and tax receipts.
The fundamental challenge confronting policymakers when an economy is in a recessionary state is to design effective policies that will get the economy out of a recession and onto a path of recovery. Proponents of the demand-side theory believe in expansionary policies that will stimulate consumption, because it is believed that the effects of such a policy will have an immediate effect on the prospects of recovery if the policies are well targeted at those who will spend to get the economy out of a recession.
Supply siders believe that incentives should be created to stimulate production so that the unemployed could become employed, earn income, and increase spending. Supply siders also believe that the stimulation of production is good for long-term investment.
Remedial policies to get out of a recession fall into two broad categories: expansionary fiscal (tax cuts and/or increased government spending) and expansionary monetary (reduction in the interest rate and/or an increase in the money supply).
Critics of policy intervention argue that policies are futile because of lags (delay in getting the desired results). Lags have the potential to drive the economy off its natural course. Fiscal policy has a long inside lag because it takes a longer time for fiscal policy to be agreed on; monetary policy has a long outside lagbecause it takes a longer time for monetary policy to take effect. For more information, see Case and Fair (2003), Mankiw (2006), and McConnell and Brue (2008) in the bibliography.
Business Cycle (economics, public administration), Fiscal Policy, Monetary Policy, Stabilization
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