The Managing Director of the IMF has recently stated that the likelihood of a recession in the coming year has grown and that the world economy has become much more gloomy. Numerous academics and financial professionals have also issued recession-related warnings. The United States, United Kingdom, Canada, Germany, South Korea, Japan, and the comprising nations of the Eurozone (European countries using the "Euro" as their official currency) are among those with a high risk of entering a recession. There is a reasonable likelihood of a worldwide recession, given how many economies are in danger. Let us dive deeper into the factors that drive economic recession and its associated remedies.
In case of Intense Economy, when there is an imbalance between the economy's total supply and total demand, which results in inflation, the economy is said to be overheated. You must be aware of the fact that inflationary pressures are wreaking widespread destruction on most global economies. At 9.1%, US inflation is at a 40-year high. Inflation is a problem in several nations, including Canada, Europe, India, and Australia. But why does inflation exist? Well, there are other variables at work. During the COVID-19 epidemic, lockdowns were implemented in most nations. As a result, the economy's overall demand decreased. Whenever market demand drops, producers drop their supply. Demand significantly increased after normalcy returned and economies started opening up. The finest illustration is the increased fuel prices because the fuel supply cannot keep up with the high-power demands. However, this is not the only factor contributing to the current demand-supply imbalance. There are other contributing factors which are outlined below:
Supply Chain Disruptions Caused by Geopolitics: There has been an ongoing conflict between Russia and Ukraine after the pandemic. Food supply interruptions have resulted from this. Ukraine provides over 40% of the world's supply of wheat. Additionally, it exports the most sunflower oil. This war-like situation has impacted the world, and many countries are experiencing a food crisis. The cost of food has gone up everywhere. The supply chain disruptions are due to China's Zero-COVID policy and the conflict between Russia and Ukraine. China primarily provides finished goods and raw materials to many sectors. China's lockdowns have driven up prices by restricting the availability of goods and commodities. This statistic raises concerns about Europe's substantial reliance on Russian natural gas. Due to the western sanctions, Russia has threatened to stop supplying gas to Europe via the Nord Stream initiative. We'll observe how the geopolitical tensions between Europe and Russia influence the European economy in the upcoming winters when energy demands in Europe are expected to increase.
Financial bubble: When anything is expensive or priced much higher than its actual value, this is referred to as an economic or financial bubble. Debt bubbles, asset bubbles, and stock market bubbles are all possible. These financial bubbles also burst like the real ones, and the results were unfavorable. It may be as significant as an economic downturn. Recession resulting from the dot-com bubble hit the world economy in the 1990s. Similarly, the housing market bubble was responsible for the global financial crisis of 2008. Even while there might not yet be a sizable bubble that could be linked to a coming recession, the stock market bubbles that formed over the 2020 fiscal year are now being burst by price corrections as we see a fall in stock prices. However, if we examine stock prices during the last two years, it becomes clear that stock values were excessive. Of course, geopolitical crises and uncertainties are also to blame for the decline in market prices. Cryptocurrency bubbles are another example of bubbles that have popped. From their peak, the prices have decreased by more than 50%. El Salvador, which legalized Bitcoin, is now paying for such a decision.
Global debt of all kinds—household, corporate, and state debt—has increased. In 2000, there was approximately $83 trillion in global debt. By 2022, this had risen to more than $300 trillion, or almost 355% of the world's gross domestic product. Such debt levels are not manageable, and public debt bubbles are already beginning to pop. If we consider Sri Lanka’s current economic problem, which has led to declining foreign exchange reserves, it is a result of political initiatives to decrease taxes and a heavy reliance on tourism, which was adversely affected by the pandemic. Many nations, not just Sri Lanka, are looking to the IMF for assistance due to their heavy debt loads. El Salvador, Pakistan, Zambia, and Ghana are a few of them.
Some potential measures that can be taken to manage inflation are listed here. Credit gets more expensive when interest rates are raised. People are encouraged to spend less as a result. To lower the economy's overall demand, this is done. Prices would drop back to reach the demand-supply balance as demand decreased. However, this can also result in a decrease in the output of commodities. In addition, many businesses would have higher debt levels due to expensive credit, and the possibility is that many companies could go out of business without higher productivity. Many businesses would either lay off workers or reduce wages to reduce costs. Higher unemployment and reduced disposable incomes would result from this. In consequence, this would further reduce economic demand. This downward trend in economic growth, which we refer to as an economic recession—is caused by the vicious cycle of falling demand leading to even lower demand.
Recessions, in the opinion of many economists, are necessary for structural corrections. Recessions are unavoidable since every business cycle has a boom (growth) and a bust (recession) phase. A slight slowdown could be an antidote to the inflationary environment. Recessions assist in eliminating unethical behaviours. "I think the most significant aspect in getting out of the crisis truly just the regenerative ability of American capitalism," stated Warren Buffet at one point. Therefore, enterprises with a capital cushion can survive, whereas those that use unsustainable business practices risk going out of business. Due to the strong expectations for economic expansion during the boom phase, investors are simple to come by for businesses. Investors poured money in without much thought to value generation. They also suffer losses when the bust phase hits. One illustration was the high stock prices in 2020. In 2008 we saw the collapse of the housing market bubble because of unethical banking and financial practices. After the crisis, the investment banking sector underwent reconstruction. Recessions are terrible for the economy, even with these pricing adjustments and reorganisations. Short-term and moderate recessions can be overcome, but long-lasting and severe ones have many detrimental effects.
Since lower economic demand is the source of the slowdown in economic growth, so it is not desirable. As a result, there can be a vicious cycle of low demand, poor production, low wages, and low demand. A lot of businesses, especially small businesses, can fail. These businesses do not have many cushions to protect them from the downturn. High-interest rates may force many companies to lay off workers and cause them to go bankrupt. Comparatively speaking, larger businesses are better equipped to weather crises than smaller ones. Unlike larger companies, small businesses cannot raise money by selling shares or issuing bonds. The downfall of numerous companies may lead to monopolies in various industries. These monopolies can then set the pricing in the economy. There would be less incentive to invest in inventions because there wouldn't be any competition.
Economic downturns can also drive people to turn their attention away from problems like climate change. Though emissions may decline in the short term due to decreased economic activity, the impacts may become apparent over time. For instance, if natural gas supply interruptions occur in the upcoming winters, Europe may revert to using coal and oil as a source of energy, delaying their ambitious goals to combat climate change. This might be harmful to the environment.
Nevertheless, the likelihood of a recession in India is very low. It will, however, be impacted by the global recession because of its integration with the world economy. Recessions may affect India's exports in the US and Europe. The recent Federal Reserve interest rate rises have influenced the Indian stock market. Foreign portfolio investment has significantly decreased in India. People are withdrawing their funds and investing them in the more secure assets of their own countries. The value of the Indian rupee has reduced as a result. High import costs would result from the high foreign exchange. This might increase our nation's trade deficits. However, the finance minister of India claims that in the long run, India is ready for such disruptions. Capital spending by the government is likely to lessen the effects of supply chain disruptions and encourage private investment. The RBI (India's Central Bank) has also raised interest rates to control inflation. As predicted by several financial institutions, the growth possibilities would be reduced. This slowness would, however, continue for a while.
About the author,
Hemant Bothra, a student from the batch of 2022-24
presents a glimpse of what recession is, how it occurs, why it occurs, and its effects of it.