You’ve probably heard the term “recession” recently, but have you ever wondered what it is exactly? If you are a typical citizen, you will not bother much about what a recession is. But if you want to know how to protect your money, you may lend more ear to what expert economists say about recession.
Answer all your untapped queries about money and how you can be more up-to-date on the country’s economic status.
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What is a recession?
Did you know? Recessions are not as common as you might think.
They only happen about once every 30 years on average. So when you do hear about a recession, it’s essential to know what it is and how it affects your money and investments.
A recession is when the economy of a country is shrinking. A country’s economy can shrink for many reasons, including poor government policies and natural disasters.
It is a period of decreased economic activity, typically measured by a decline in GDP (gross domestic product) for at least two consecutive quarters. Recessions can last from 6 months to several years, depending on how bad they are. For example, the economy grows at 2% in the first quarter and shrinks at 1% in the second quarter.
The opposite is true — if growth is negative for two consecutive quarters, it’s considered a recession. It begins when the economy reaches peak activity and ends as the economy reaches its trough.
So, recession investments are still available for you to take advantage of. For example, if you’re considering buying a home or car when the economy is in a recession, think again! You’ll probably have to wait until things get better before you can get one at the price you want and with all the features you want.
It is worth noting that a recession differs from a depression, which is a much more severe economic downturn resulting in high unemployment and other severe consequences.
You may see job losses during a recession, but you’re unlikely to experience widespread unemployment.
Depression is much more severe than a recession, which may affect everyone in the country and cause lasting damage to the economy.
What causes a recession?
The leading cause of recession is a sharp decline in aggregate demand for goods and services.
When people have less money, they limit their spending on goods and services to only essential items. This restricts the demand for goods and services, which leads to fewer production orders from manufacturers.
This leads to job losses at factories, and companies eventually start laying off workers.
The causes of a recession are complex and controversial, but most economists agree that they can be traced back to an imbalance between supply and demand.
Here are three main reasons why economies go into recession:
Oversupply
Recessions happen when businesses produce too many goods and too little demand from consumers.
This oversupply of goods leads to lower prices and profits, which means companies have less money to hire people or invest in new equipment and technology.
Eventually, all these factors lead to layoffs and downsizing throughout the industry until supply matches demand again and prices rise again due to increased demand (or until another boom happens).
Uncertainty
Uncertainty about how the economy will change in the short or long term can make business decision-making riskier.
For example, wars and pandemics are two situations that can drive consumer trends unpredictable in the short, medium, and long time, thus generating economic uncertainty.
Because businesses and people hold off on spending and investment decisions, economic activity declines.
Speculation
One of the most common causes of recessions is speculation, or when investors buy something en masse to sell it at a higher price later.
Speculation can lead to economic bubbles, which are periods where prices rise due to demand or consumer confidence but fall quickly once some fewer new buyers or investors want out.
For example, during the Dutch Tulip Craze in 1637, tulips quickly became incredibly expensive and lost value when people stopped buying them.
This happened again during the 2008 housing market crash when many people bought homes they couldn’t afford because they believed home prices would keep rising.
So what needs to be done when the economy enters into recession mode? There are four ways out:
1) If government spending increases at the same time as private consumption declines – then this helps boost consumer spending again by increasing aggregate demand for goods & services
2) If government spending decreases while private consumption remains low – this also helps boost consumer spending again by increasing aggregate demand for goods & services
3) If exports increase while imports decrease – this too increases aggregate demand for goods & services as it increases net exports (exports minus imports)
4) If interest rates decrease while investment remains low – this also increases aggregate demand for goods & services and increases consumer spending.
How do you know if the economy is entering a recession?
The following are indicators that the economy may go into recession:
Unemployment rises sharply
When unemployment rises by at least 1% from the previous month’s rate and remains above the 4% level for at least six months, it’s a sign that the economy is weakening.
Inflation remains low
If inflation remains below 2% for more than 18 months, it points to weak demand and growth.
Consumer spending slows down.
When consumers spend less than they did during previous periods of growth, it indicates that they’re saving more money instead of spending it on goods and services.
Investment in new factories slows down.
When companies aren’t investing in new factories, equipment, or other assets needed for production, they’re not expecting much growth in sales either — which bodes poorly for future job creation and economic activity.
How to protect your money during an economic downturn?
Here are some steps you can take now to protect your money.
Start saving more money
If you have room in your budget, try to increase the money you save each month. This will provide some protection against any loss of income during a recession or other financial emergency.
Pay off high-interest debt
If you have a credit card or student loan debt with high-interest rates, pay it off as soon as possible. These debts can quickly eat up your paycheck and prevent you from saving for other important things like retirement or emergencies.
Consider investing in stocks
If you’ve been putting off investing because of concerns about market volatility, now might be a good time to consider getting started — especially if you’re young and want decades of investing ahead of you.
Stock market crashes come and go; over time, the stock market rises when averaged over more extended periods (like 20 years).
Consider contributing to your 401(k)
If you’re eligible, consider setting aside enough money to max out your 401(k) contribution for the year. That way, you’ll take advantage of a special tax break that allows your employer to deduct some or all of the money you contribute from your taxable income.
Consider contributing to an IRA
If you’re not eligible for a 401(k) — or if you’ve already contributed enough to get the complete tax break — consider setting aside money in an individual retirement account, which is another type of retirement plan available through many banks and other financial institutions.
Final Thoughts
It’s almost impossible to predict when a recession will happen and what the consequences of that recession might be. Some recessions have been mild, while others have been quite severe.
Even though it can be somewhat challenging to predict what events may occur during a recession, people need to take actions that might protect their finances just in case anything happens.
By planning, investing, and being careful with your money, you can avoid many problems even before they occur and hopefully keep your finances stable through any recessionary period.
