Your guide to the recession…
Jan 30th, 2009 by Jamie Bradley
Recession is a term that represents six successive months of economic decline suffered by that economy; but what exactly causes this to happen?
First of all, a period of six months in business terms is more commonly as two quarters and two successive quarters of ‘negative economic growth’ is the recipe for recession.
Recession does not suddenly occur because of one thing or another, nor can it disappear just as quickly. When many people hear the term ‘recession’ they tend to think that the country has suddenly contracted some sort of generic financial virus that affects certain aspects of the economy such as trade, interest rates and company profits.
Recession is nothing more than terminology used to refer to the fact that an economy has spent six months in financial downfall.
This is essentially measured by the country’s overall Gross Domestic Product.
GDP, as it is also known, refers to the summative value of goods and products on sale at retail price throughout the country. In order to correct the total valuation against inflation, the cost is measured against a chosen base year, which currently sits at 2003, and altered to match inflation levels in that year.
Consumer Price Index (CPI) then takes account for the rate in percentage by which the overall value of retail goods has risen or fallen over the past month.
If GDP falls continuously for six months, then we refer to that as two quarters of negative economic growth, which, as we know, denotes an unquantified period recession. So, what determines when and why GDP falls and how is it controlled.
Well, in order for us to pinpoint the cause of this recession, we have to go back a few stages; all the way back to 2007 in fact and the infamous collapse of Northern Rock. Following severe mismanagement of funds and complacency with mortgage retail predictions, the bank plunges into debts amounting to £25 billion in November.
The problems at Northern Rock undoubtedly caused a moral panic, which not only affected the confidence of share holders and consumers, it also extended to the banks and because of it, they became afraid to lend to one another as they were unsure whether the institution they were lending to were actually solvent.
This, in turn, caused the quarterly interest rate at which British banks lend to one another, known as Libor (London Inter Bank Official Rate), to soar to its highest level in nine years, falling just short of 6.8% in September of that year.
Because central bankers were offering loans to consumers at interest rates as low as 1%, this meant that banks did not want to adhere to 6.7975% Libor and became short of funds due to risky lending to borrowers with instable funds.
Therefore, as more banks were losing out on capital in a time of such economic deprivation, not only were loans much more difficult to come by, the government decided to bail the banks out and pump money into, what is effectively, a bottomless pit. This meant companies who needed an injection of cash to pay off debts were unable to do so and the price of stock increased subsequently.
In September 2008, inflation rates consequently reached a peak of 5.2%, more than double the target of 2.5%, lowering the strength of the pound against foreign currency. This meant that international trade slowed down as raw materials became more expensive for retail companies to buy in. Therefore, stock levels dropped and as a result, economic growth followed suit and fell and continued to throughout October and November.
With Christmas on the horizon and many retailers offloading stock at reduced prices, combined with the government’s 2.5% V.A.T. cutbacks, this meant that GDP continued to fall for the second successive quarter of the year and what we have is a recession.
Recession is also generally synonymous with falling inflation rates and that’s exactly what’s currently happening. With the UK potentially starring deflation in the face, it means that companies are susceptible to falling profits and will ultimately find themselves going bust.
Unemployment figures have already reached a critical figure of 1.92 million; the lowest in over a decade. If more companies do follow the same fate as the likes of Woolworths, then you can expect that figure to keep rising and economic growth to continue falling.
It is largely expected that the UK will be in recession throughout 2009 and well into 2010. The main concern is that consumers have lost confidence in the banks and until they entrust them with their money and, in turn, put more capital into the economy, the recession will continue and with it, the hope for a near future of economic prosperity.
By Jamie Bradley
