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.

Syllabus descriptionCorresponding cause‑categoryTypical triggers
Decrease in total demandDemand‑side

• Drop in consumer confidence → lower consumption

• Fall in business confidence → reduced investment

• Decline in export demand (global slowdown)

• Contractionary fiscal policy or cuts in government spending

Decrease in the quantity of resourcesSupply‑side (quantity)

• Short‑run loss of labour (e.g., strikes, demographic shifts)

• Reduced capital stock (e.g., damage to factories, low investment)

• Diminished availability of key inputs (oil, raw materials)

Decrease in the quality of resourcesSupply‑side (quality) / External shocks

• Productivity shocks (technology failure, poor management)

• Rising input costs that erode real productivity (oil price spikes, wage pressures)

• Financial crises, credit crunches, geopolitical events that disrupt trade and investment

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.

IndicatorTypical behaviour during a recessionRole in determination
Real GDPNegative growth for ≥ 2 quartersOfficial criterion
Unemployment rateSharp increaseMonitoring
Consumer Price Index (CPI)Falls or rises very slowly (deflationary pressure)Monitoring
Industrial productionDeclineMonitoring
Retail salesFallMonitoring
Business investmentContractsMonitoring

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)

AD–AS diagram showing a left‑ward shift of Aggregate Demand (AD) during a recession, resulting in a lower level of real GDP and a higher price‑level unemployment gap.

Key formulae (LaTeX notation)

Real GDP growth rate:

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

where \$Yt\$ = 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).