Issues That Lead to the Recession - Term Paper Example

Running Head: Issues that….. Topic: Issues That Lead to the Recession Order#: 510346 Topic: Issues That Lead to the Recession Table of Contents Introduction Definition of Recession Overall Impact of Recession Recession and impact on Business Recessions are damaging Plans to survive in a Recession Some issues that merit specific consideration in recession Rules and Policies to beat Recession Problems of economy to recover from a recession Lessons learnt from Recession Conclusion Thesis What are the issues that lead to the recession, the economic downturn and what exercises are necessary at the government and individual levels to meet the challenge? Introduction In this paper I discuss recession and the current economy down turn. I will define recession and its impact on the business world. The options to challenge recession and to overcome the impediments are also discussed. My second area of discussion is about investments. What are the correct investments in a recession and the revised policies and procedures put into operation by the government to combat recession. Thirdly, this report will discuss the impact of the recession and the lessons learnt from it. Definition of Recession “The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”(Business….) “A significant decline in activity across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a countrys gross domestic product (GDP); although the National Bureau of Economic Research (NBER) does not necessarily need to see this occur to call a recession.”(Recession….) Overall impact of recession Recession hurts the government in some of the vital areas that are the supporting pillars of the economy and its impact is unfavorable news for the government budget. Government borrowings rise. Tax revenues dip low due to lower income tax and corporate tax revenues. With the steep rise in the unemployment levels, the government is obliged to extend unemployment benefits to a wider section of the society. Higher borrowing leads to higher taxes and additional interest payments in the future. As shares turn unattractive, the prices begin to dip. Lower profitability and lower dividends create a depressive mood for the investors and they look out for alternative sources of investment. The fall in share prices continues in anticipation of recessionary trends prolonging. But this is only the initial phase. When recession is at its hardest phase, the developments take a strange turn. In anticipation of economic recovery, share prices begin to recover, as the prudent investor calculates that it is the favorable time to invest from the point of view of long term gains. Falling prices of shares may be due to various other factors as well, not alone recession. The normal reaction to recession is that it should result in a lower inflation rate. The highlight of recession is it reduces demand and wage inflation. The issue to be examined is what economic factors impact the recession hard. The current recession is due to rise in oil prices. The expert opinion about this inflation is, it is bound to reduce demand, will result in price wars, as the firms will make all-out efforts to retain consumers. The scenario of falling investments takes volatile shape and hampers economic growth. The vicious circle begins. The slowdown in the growth rate, with the economy expanding with a slower pace, may result in substantial fall in investment. Fall in employment opportunities is the most feared factor during recession. The demand for labor takes a down turn. Not all sectors are impacted hard in equal measure during recession. In the recent recession, employment in the housing and finance markets turned risky but the manufacturing sectors continued to function satisfactorily. The fall in unemployment levels doesn’t happen overnight during recession. It is a slow process and even during economic recovery subsequently, the gradual fall in unemployment levels may continue. Accurate prediction about the reasons for the recession is impossibility. Some intelligent ones have the premonitions but uncertainty grips them as well. Recession beats all analysis. Once it arrives, the analysts do overtime to find out the reasons. The economic factors are inflation, reduction in the buying capacity of the consumers, lack of confidence etc. The health of the market depends upon the spending power of the consumers and their willingness to buy. When the gear of the market is jammed due to steep rise in the cost of important products, gasoline, heath care and the like, economic activity takes the down turn, and an evil chain reaction happens. Companies cut expenses, economy steps are initiated, welfare projects are downsized, recruitments curtailed, surplus employees are laid off. Company profits plunge down, and investors look upon for alternative sources, by giving up stock investments. Recession and impact on Businesses Newly established business establishments or production units may find the going tough or impossible. With high set up costs, and with the teething troubles in the process of take off, they may be under compulsion to close down to escape from the position of further losses. By no means are such units inefficient, but they are unable to absorb the recession shocks and after-shocks, and may find the going tough with the jolt they received when it was their time to struggle and get established. The unique development that takes place during recession is the increase in the monopoly power. When smaller and newly established units down their shutters, the big firms get further space, and the consumer has fewer choices and will have to pay higher prices. Big firms get more market power that results in higher profits for them. Some issues relate to recession and the argument of hysteresis is one of them. This argument propounds that past is the predictor for the future. Once recession leads to unemployment, the fate of the unemployed is unlikely to take a turn for the better. It may become worse. Unemployed will find it difficult to get alternative source of employment. With no regular practice in jobs, such individuals will lose the skills, the fast technological advances and latest computer technology may render their existing skills useless, and the unemployed lot will become frustrated and de-motivated. The economic boom may not offer any solution to unemployed and the unemployment rate will remain high, with no tangible solutions in sight. With the fall in productive capacity, economy as a whole is affected. Significant fall in investments demoralizes the investment and banking circles. This doesn’t augur well for the developing economy and all favorable procedures and encouraging trends are poised to stop their onward march. Price wars and special advertisement campaigns are the normal feature of a market going through the pangs of recession. When sales are low, firms lower prices so see that inventory is not piled up in their stockyards. Firms that are into manufacturing luxury goods are adversely affected during recession as the consumer’s axe falls first on them. 5 Star hotels, manufacturers of luxury cars will be impacted by recession more than the establishments manufacturing the day to day necessities. Recessions are damaging Painted stories are sometimes graver than the actual ground realities when the market is engulfed in recession. Print and Electronic media create such a platform from where they launch relentless attack on the economy of a country and also create a scary global perspective. To create a picture of widespread global disaster works to their business advantage, as bad and sensational news catch the attention of the readers to increase the circulation of periodicals that publish articles on stock predictions. Negative news like bankruptcy of the companies, grave unemployment prospectus, falling reality estate prices, and headlines that create the fear psychosis are read by the people. The actual position may not be that hard as made out by the press. Companies may be impacted and bankruptcy may just be a created picture. The grave issue is the rise in the cost of living. The rise in food and energy prices hits the common man and the middle class hard. When the prices rise faster than the rise in wages, the obvious happens. The consumers become choosy about the things to be and not to be purchased. Capital expenditure is generally postponed, manufacturing activity slows down, and the real output per capita falls. Those who are rendered unemployed in a recession, are severely affected. Apart from the psychological stress of remaining unemployed, to survive on unemployment benefits is the worst issue in the life of an individual with self-esteem. All types of recessions do not mean the same thing to produce identical results. The factors to be examined are how long the recession will last and how deep it is? When one mentions recession, the grave specter of the Great Depression of 1930, floats in the curtain of one’s mind. Recessions of shorter durations when the employment market is marginally affected, are of not much consequence. The damaging situation for the economy as a whole happens when mass unemployment occurs and it persists for a long duration. Not all sectors of the economy are affected equally. Some sectors may even thrive during the recession. In the current recession, the real estate sector (and the construction activity) is severely affected. Plans to survive in a Recession To tackle the effects of recession, financial discipline on all fronts is needed. Recession does affect the common man (at the lowest level) and the government (at the highest level). Some of the hard issues during the recession are: Banks are less willing to lend, as such option to borrow is tough. The credit crisis affects the liquidity and the lending activities by the banks are minimal. The solution for this is simple and straightforward. Shun borrowings and indulge in this activity when absolutely necessary. If you have multiple debts, try to consolidate them into a lower interest bearing account. The interest rates will be slower during recession. Mortgage holders may stand to benefit. Unemployment problem may be acute in some of the sectors. Challenge your concern in this area, trying to get a second income, through direct part-time employment of through some online business. Unemployment insurance to cover mortgage repayments is a good option. It is better to do it immediately if not done at the time of availing the loan. No need to take a grim view of the situation. One should not worry over an issue over one which one doesn’t have control. If you lose employment take it as an opportunity to look out for new avenues and learn new skills. Recession is not going to be a permanent feature. It could even be a short-lived market correction. Profitability: The impact of recession on a small business is severe. Lower profits or no profits threaten the survival of the business unit. The solution is cost-cut, plug the leakage of income, with no compromise to the proper functioning of the business. Ways and means to increase efficiency must get top priority. Some economists glorify recession and say that with the process of recession, economy turns more efficient, as there are close checks on overhead expenses. The recession is a good opportunity to a businessman, to review the strategy of business development. If you are badly affected by downturn, adapt your business to the changing environment. The department of luxury goods takes the blow of consumer’s resistance first. Add those items that are the necessities of the common customer, so that you have a reasonable turnover under all conditions of the economic scene. The fall in profits is not a permanent feature. Look out for avenues of low-cost borrowings during the difficult period of recession. The fall in share prices is the normal trend during recession, as dividend payments are curtailed. Reset the investment portfolio after a review. Investment in gold is one of the good options. Share prices tumble in anticipation of recession than what happens when actual recession sets in. Try to catch the timings of the trade (buying and selling of shares) well, and be guided by the philosophy of provision of stop loss for shares in your portfolio. Consumer confidence plays the vital role during recession. Investors fear the imaginary issues more than what in reality is! It is business more than as usual for the media. Sensational stories are born every day, in the Print and Electronic media. Have a studied approach to the current situation. Lower interest rates during recession are good for the borrowers. When the inflation rate is low, it stands to benefit the savings front. The business prospectus may be unpleasant temporarily. When perfect discipline is not available carry on with the available discipline. You cannot change the market, but you can definitely change your approach to the market conditions. Some issues that merit specific consideration in recessions Housing: From the long-term perspective, housing has outperformed most other types of investments. It is cheaper to borrow when the credit crunch ends. During recession metals like silver and gold are always better forms of investment. The other metals like brass and copper will also rise during recession. The US economy continues to be weak, due to falling real estate prices and low interest rates. Similar is the position of dollar. Gold takes the front seat and the investor feels safe with it. The broader issues of economy need to be considered in the global context. The stupendous growth of China and India will affect the economy of US. The rising demand for raw materials in these two countries will result in rise in the prices of the metals. But this aspect needs to be judged in the context of rise in the inflation rates. Rules and Policies to Survive Recessions Recession means more work and stress for any government. In a desperate bid to contain the after-effects and after-shocks of recessionary trends and the actual state of recession, the governments formulate new policies and regulations. Cutting interest rates provides impetus for consumer spending. Low interest rates mean favorable position for mortgage interest payments. Consumers will have surplus amount at their disposal. Freeze on Subprime Mortgage Rates for a fixed duration is one way to prevent house repossession. Tax cut is also an option with the government. But its results are unsure. It may result in surplus spendable income with the consumer but the moot question is whether the consumer will exercise that option in the uncertain conditions relating to the future of the market. This step may not help contain/avoid recession. Next option is Government spending. When the Government deliberately plans the spending spree, the exercise provides a shot in the arm for the economy with the rising demand for various types of goods. But if the government has other compulsions like the budget deficit, this exercise may prove to be counter-productive. Devaluation is a policy which may help sometimes, but it will not produce long-term favorable results. Even if this step is not announced, the market forces affecting the economy, will decide the value of the currency. It is something that will happen automatically. Weaker currency will boost the export sector and may help to contain recession. Problems of the economy to recover from a recession What are the problems the economy might face in recovering from a recession or to tackle the recessionary trends? No answer to this vexed issue has been found in its finality. When we discuss this, two issues come to the fore. There has to be a rise in demand for goods or a readjustment in prices and wages is needed. Both these are difficult to achieve as recession is not a permanent feature as labor and product markets are flexible. Regaining equilibrium by reducing prices and nominal wages proportionately may be a mathematical proposition, but its practical application gives rise to another vexed issue. Trade unions will resist any such move, as cutting wages hurts the sentiments and self-esteem of the workers and the managements may not be willing to enforce cut in wages. It may also lead to mass discontent amongst the workers and lower efficiency and productivity. Monetary Policy, howsoever imaginatively framed, may prove ineffective in the given conditions. If Banks cut interest rates to stimulate demand, the normal expectation is that people should be willing to spend and invest, due to lower rates of interest. But the same may not happen. Cheapness of borrowing is just one factor. The real issue is the increase in demand. In the absence of it, the firms may not be willing to invest in the expansion projects. The impact of recession may vary between the trading countries, resulting in trading imbalance. Deflation during recessionary trends or actual period of recession is a difficult situation. People are not willing to spend, expecting the prices to fall further in the foreseeable future. Monetary policy will not produce tangible results because interest rates can not fall below 0%. Therefore, real interest rates during deflation will remain high as per working of the market forces. Lessons learnt from Recession Recession has changed the lifestyles of men, women and children. Do not spend when not necessary. When it is not necessary to spend, it is necessary not to spend! Men have begun to devote more time to the family, as they cannot afford outings. Credit cards do not command the same respectability. Economy in food, with no wastage; Right things are in demand, not the bright things. Friendships renewed, fuel saved. Turn lights and become conscious of saving energy. Treat everything with respect, giving up the attitude to discard. Respect and value nature for its blessings; Daily morning walks are better than weekly visits to the Doctor. Finally, one realizes and works out a new goal of life, knowing well that every crisis is an opportunity. Conclusion This report discusses recession and highlights the salient features about the down turn in economy. Issues that lead to recession, its impact and how does it affect the business world have been detailed. The precautions for survival in recession have also been elaborated. The paper also gives hints about good investments in a recession and the new policies of the government and controllers of economy to overcome the difficult period of recession. Finally, the paper also makes a mention of the lessons learnt from recession. References Business Cycle Dates - The National Bureau of Economic Research- The NBER does not define a recession in terms of two consecutive quarters of... -Retrieved on March 15, 2011 Recession Definition – Investopedia Recession - Definition of Recession on Investopedia - A significant decline in activity across the economy, lasting longer than a few months. - Retrieved on March 15, 2011 Read More