Definition of recession

Government and the Macro‑economy – Economic Growth (Syllabus 4.5 – 4.7)

4.5.1 Definition of recession

A recession is “a period of sustained decline in a country’s real gross domestic product (GDP), identified when real GDP falls for two or more consecutive quarters.” It is normally accompanied by a fall in other key macro‑economic indicators such as output, employment and consumer spending.

4.5.2 Causes of a recession

The syllabus groups the causes of a recession under three alternative descriptions. The table shows how the three cause‑categories (demand‑side, supply‑side, external shocks) map onto these descriptions.

4.5.3 Consequences of a recession

Recessions affect all groups in the economy and have implications for the government’s macro‑economic aims.

• Consumers
  • Real incomes fall → reduced purchasing power (affects the aim of economic growth).
  • Lower consumer confidence → cut back on non‑essential spending (reduces aggregate demand).
  • Higher borrowing costs if banks tighten credit (can hinder price stability).
• Workers
  • Unemployment rises as firms cut production (direct impact on the aim of full employment).
  • Reduced hours or wages for those who remain employed.
  • Greater reliance on unemployment benefits and other welfare payments (pressure on redistribution and fiscal balance).
• Firms
  • Sales and profits decline → lower investment and R&D (affects growth and future productivity).
  • Investment postponed or cancelled (reduces capital formation).
  • Increased risk of bankruptcies, especially for highly leveraged businesses.
• Government
  • Tax revenues fall while demand for welfare payments rises – pressure on the fiscal balance and public debt.
  • Higher borrowing needs may increase public debt (relevant to sustainability of public finances).
  • Political pressure to intervene, influencing the aims of redistribution, employment and price stability.

Link to macro‑economic aims (Syllabus 4.6)

• Economic growth: Output falls, investment declines.
• Full employment: Unemployment rises sharply.
• Price stability: Deflationary pressure or very low inflation.
• Balance of payments: Export demand may fall, worsening the current account.
• Redistribution: Increased reliance on welfare benefits widens fiscal pressures.
• Environmental sustainability: Lower output can reduce pollution temporarily, but policy responses may affect long‑term sustainability.

How a recession is measured (Syllabus 4.5.2 – indicators)

The official determination of a recession is based **solely on real GDP**: two or more consecutive quarters of negative real‑GDP growth. The other indicators are used by statistical agencies and policymakers to *monitor* the depth and breadth of the downturn.

Difference between a recession and a depression (Syllabus 4.5.3)

• Recession: Moderate, relatively short‑term decline (typically months to a few years) with a fall in output and employment.
• Depression: Severe, prolonged downturn lasting several years, characterised by a much larger fall in GDP, very high and persistent unemployment, and often deep deflation.

Typical government responses (Syllabus 4.5.2)

1. Expansionary fiscal policy – increase government spending or cut taxes to boost aggregate demand.
2. Expansionary monetary policy – lower policy interest rates, undertake quantitative easing, or provide liquidity to the banking system.
3. Targeted support programmes – enhanced unemployment benefits, job‑creation schemes, subsidies for severely affected industries, and training/re‑skilling programmes for workers.

Suggested diagram (Syllabus 4.7)

Key formulae (LaTeX notation)

Real GDP growth rate:

$$g = \frac{Y_t - Y_{t-1}}{Y_{t-1}} \times 100\%$$

where $Y_t$ = real GDP in the current quarter, $Y_{t-1}$ = real GDP in the previous quarter.

Unemployment rate:

$$U = \frac{\text{Number of unemployed}}{\text{Labour force}} \times 100\%$$

Example (optional)

The global financial crisis of 2008‑09 provides a classic illustration. In many advanced economies real GDP fell for three consecutive quarters, unemployment rose sharply, and governments responded with large fiscal stimulus packages (e.g., the US $800 bn ARRA) and aggressive monetary easing (e.g., the US Federal Reserve’s quantitative easing programmes).