Recession indicators and what they tell you about the future?
What does it mean by a “Recession”?
A recession is a section of a period where the economy is declining. This means that the trading of goods and industrial activities of a country is significantly reduced. This period of economic decline is generally labeled as a “Recession” when the fall in GDP (Gross Domestic Product) happens over two consecutive quarters of a year.
Causes of Recession
There are believed to be various causes for the Recession to occur. We shall explore a few to have a firmer grasp on the topic.
· Nominal factors
The economist school of thought called monetarism teaches us that recession is the direct result of the over and above usage of credit during the boom period of a business cycle. It gets aggravated by inadequate credit availability and supply of money during the initial stages of a downturn.
There is a cause- and- effect relationship between real factors and monetary like interest rates and bonds. These financial factors have an important place in predicting economic slowdowns, and they have a close relationship with the interest rates.
· Real factors
The fundamental and real-world factors have a directly proportional relationship with the recession period. Any such outside changes can have an immediate effect on the direction of the economy. A sudden tamper to the structural shifts and external pressure on the economic ecosystem can start a recession.
For example, if a company develops a modern tech invention, that can leave a whole slew of unskilled laborers obsolete or out of their job. Thus, could have a spiral impact on the balance of wage and company profits.
· Psychological factors
This is in our very human nature; to speculate and try to peak into the future. The psychological factors include paranoia, distrust, and fear of the unknown. The speculation game can sometimes even lead an economy into a recession when this could have been avoided. People will not invest or buy government-issued bonds if they believe that the currency value will falter.
The government has to take its citizens in a vote of confidence, which can be difficult, especially if the recession period is already on the horizon.
Recession indicators are actual data-driven economic signals. These signals are generated by economists and analysts by using data presented to them by governments and non-profit organizations. Recession indicators help to predict the present and future business cycles in order to help the economy to move along smoothly. Following are some of the recession indicators.
Unemployment refers to the rate of potential employees not currently hired. The number of employees who are unable to find a job is heavily dependent on the situation of the economy. Perhaps, the companies are unable to afford to employ new members of the labor force who refuses to work on low wages.
This indicator has cause and effect relationship with recession. If more laborers are not employed, then this increases the burden on social services done by the government.
· The Yield Curve
The most sought out indicator by economists is the “yield curve.” The Yield Curve refers to the graphical representation of the interest rate of a bond. The term yield means different rates of interest set by the Treasuries where the period lasts over the course of the duration of the maturity of the bond in question. These bonds are government-issued, and the higher the interest rate, the higher the maturity duration. The curve takes all the values into account to fairly compare them to the previous interest rates changed over time.
When the Yield Curve is morphed into an inverted shape, it means investors are looking for higher interest rates at a shorter maturity duration. This is a big red flag indicating the arrival of an impending downturn cycle in the near future.
· Gross domestic product
The GDP of the economy is the deciding factor for the entire business cycle. GDP is the total revenue generated by a market ecosystem and has a direct relation with the Recession. When there is a prolonged decline in GDP, then it is showcasing a steady drop in the economy.
Sometimes referred to as the “Barometer” of economic growth because it quickly relays the future downturns (if any) by just monitoring the quarterly data. If the two successive quarters are declining GDP, then a recession is most likely to happen.
However, in a long-run study, GDP highs and lows can happen in an ultimately upward economic growth trend line. If this is the case, then two consecutive declining quarterly reports would not mean the start of the recession period.
· Leading Economic Index (LEI)
LEI is specifically designed to provide a future signal for the business cycle since most of the indicators are lagging. The ‘Conference Board’ releases datasets often to have a more insightful look into the future economic cycle. If there is a continuous drop in the LEI, then by pattern, then the beginning of the recession period can be found.
· Confidence indexes
This is the most human emotional-based indicator, but it is just as important as the others. Confidence indexes are all about the vote of trust in the currency. Do people trust the stability of the dollar or their own local currency against the dollar to invest more in it? Do they want to put aside a fraction of their income in a savings account or not? Should they halt their investments until the dark clouds of Recession and depression are cleared?
The confidence index being low is a directly proportional indicator of recession and can even prolong the period if the trust in the economy is not regained soon.
Effects on the future due to recession
The recession period is the downtrend of an economic graph. It begins with the declining GDP and the higher rate of inflation. The prices of everything go up while the wage rate remains the same or possibly decreases.
The buying prowess of ordinary citizens plunges so they cannot afford products sold in the markets, thus reducing the corporate profits causing them to cut the labor force to save money. The fall of consumption rates causes inflation to go down, which leads to higher unemployment. This domino effect is the characteristic of a recession period.
Another effect of such a period is people take their savings out of the bank and seldom invest any. The consumers and government reach a deadlock where the cash flow suffers the most.
When a recession period is not urgently tackled by monetary and fiscal adjustments, then it is further lowered into an economic depression.
The economy is not solely dependent on facts and figures but also depends on human feelings, which are difficult to predict. All the recession indicators provide an educated guess into the business cycle’s future but are not one hundred percent sure.
There are some indicators that are more accurate than others, such as GDP gives a pretty good idea of where the economy is currently standing but cannot precisely predict the exact beginning, peak, or end of a recession period.
Economists use the data and analyze it to the best of their knowledge and more than often aid the government in taking positive steps in the right direction to help the economy out of the slums of a recession and into the upward trend of a booming period.