The economy is not always in a state of constant growth. It naturally experiences periods of expansion and contraction, forming what economists call the ‘business cycle’. While economic growth is generally the trend, this cycle involves peaks of high activity and troughs of lower activity. A recession occurs when the economy enters a trough, characterized by weakened or negative output growth. This slowdown often leads to job losses and a rise in unemployment rates. Although a universally accepted definition of recession remains elusive, there’s a broad consensus that it signifies a period of declining economic output coupled with a significant increase in unemployment. The exact identification methods, however, can vary.
Recessions can be incredibly challenging for individuals and businesses, leaving lasting scars on society and the economy. Therefore, central banks and policymakers actively work to minimize both the frequency and severity of these economic downturns, with monetary policy being a primary tool in their arsenal. (Further reading: Economic Growth Explained and Monetary Policy: An Overview).
This article will delve into the nature of the business cycle, explore various approaches to defining a recession, and examine historical recessions, highlighting their consequences.
Decoding the Business Cycle
The business cycle describes the recurring fluctuations in economic output growth around the economy’s long-term growth trend, known as ‘potential output’. Output is measured as real Gross Domestic Product (GDP), while potential output represents the maximum sustainable level of production an economy can achieve when all its resources – labor, capital, natural resources, and technology – are fully utilized without causing excessive inflation.[^1]
A typical business cycle consists of four distinct phases: expansion, peak, contraction, and trough. During an expansion, consumer demand for goods and services increases, businesses hire more employees, and wages and prices tend to rise. This phase culminates in a peak of economic activity. Conversely, a contraction sees a decrease in household demand, businesses reduce their workforce, and the growth of wages and prices slows down. This phase reaches its lowest point at the trough of economic activity.
It’s important to note that business cycles are not uniform; they vary in length and duration of each phase. Expansions typically last longer than contractions, and the overall cycle length is influenced by numerous factors, including policy responses implemented at different stages.
Defining a Recession: What Does It Really Mean?
While there’s no single, universally agreed-upon recession definition, common descriptions converge on key indicators related to economic output and labor market performance.
Weak Output and Rising Unemployment: Key Indicators
A recession can be characterized as a sustained period of weak or negative real GDP growth, accompanied by a significant and parallel increase in the unemployment rate. Beyond these core indicators, recessions often manifest in a range of other economic weaknesses. Household spending and business investment typically decline, loan defaults among households and businesses rise, and business closures become more frequent. The unemployment rate, due to its sensitivity and correlation with these broader economic issues, serves as a reliable and timely summary indicator of negative economic trends.
The “Technical Recession” Definition
The most frequently cited definition, particularly in media, is that of a “technical recession.” This definition points to two consecutive quarters of negative real GDP growth. Often found in economics textbooks and widely used by journalists, this metric offers a simple and easily quantifiable benchmark. Using this definition, Australia notably avoided a recession for 29 years following the early 1990s downturn. This extended period without a technical recession is unusual historically for Australia and most advanced economies, which typically experience recessions roughly every seven to ten years.
However, the “technical recession” definition has limitations:
- Weak Growth Can Still Hurt: GDP growth can be sluggish, even without being negative, and still lead to significant job losses and financial hardship for households.
- GDP Volatility: GDP components can be volatile. Two consecutive quarters of negative growth might be a misleading signal of the actual underlying economic trend.
- Data Revisions: GDP measurements are subject to revisions as more complete data becomes available. Initial negative quarterly growth figures could be revised to positive, or vice versa, again potentially giving false recession signals.
To address these shortcomings, some analysts consider alternative measures of economic output. For example, focusing on two consecutive quarters of negative GDP per capita growth adjusts for population growth’s influence on economic activity. Others may exclude volatile sectors like agriculture to smooth out fluctuations and get a clearer view of underlying trends.
The NBER Approach: A Broader Perspective
The National Bureau of Economic Research (NBER) in the United States, a leading authority on business cycles, adopts a different, more comprehensive approach. The NBER defines a recession as a significant decline in economic activity spread across the entire economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. While acknowledging that most recessions do involve two consecutive quarters of negative real GDP growth, the NBER emphasizes that this isn’t always the case. They consider a wide array of economic indicators beyond just GDP, recognizing the complexities and potential inconsistencies in GDP measurements (as detailed in Economic Growth Explained). However, NBER’s recession determinations for the US are not formulaic, are made retrospectively, and are not readily transferable for real-time or international application.
Unemployment-Based Recession Rules
Economists have also proposed recession definitions based solely on unemployment rates. These rules typically signal a recession when the unemployment rate rises by a specific threshold within a defined period. The advantages of unemployment-based rules are their simplicity, timeliness, and reduced susceptibility to data revisions compared to GDP figures. However, their primary limitation is that unemployment rates alone may not capture downturns reflected in other crucial economic indicators, such as underemployment or broader economic inactivity.
Recession vs. Depression: Understanding the Difference
Like “recession,” “depression” lacks a rigid, singular definition. However, a depression is essentially a much more severe and prolonged recession. Depressions are characterized by extended periods of declining economic output and very high unemployment rates that can last for years.
The scale and duration of a depression often lead to widespread negative economic consequences across multiple countries. Some definitions emphasize this global aspect, describing a depression as a severe recession impacting one or more economies globally.
Historical Recessions and Depressions in Australia
Throughout history, Australia has experienced periods of significant economic weakness recognized as recessions or depressions. There are also instances where economists debate recession classifications due to varying definitions.
Notable Australian Recessions
1974–1975 Recession: Triggered by a global oil crisis that quadrupled oil prices, this recession was exacerbated by domestic wage pressures, leading to stagflation – a combination of falling output, rising unemployment, and high inflation. (Unemployment peaked at 5.5%, inflation at 18%).
1982–1983 Recession: Globally entrenched high inflation from the 1970s, amplified by excessive money supply growth and expansionary fiscal policies, prompted central banks to tighten monetary policy to curb inflation, resulting in recessions worldwide. In Australia, this was compounded by drought. A swift recovery followed the drought’s end, aided by the floating of the Australian dollar and economic reforms. (Unemployment peaked at 10.5%).
1991–1992 Recession: This recession stemmed primarily from Australia’s efforts to control excess domestic demand, speculative property markets, and inflation. High interest rates, coupled with recessions in other countries like the US, contributed to the downturn. (Unemployment peaked just over 11%).
Australian Depressions
The Great Depression of the 1930s: A global economic catastrophe, the Great Depression was characterized by its unprecedented depth and length. Australia’s unemployment rate reached as high as 30% according to some contemporary records, though later estimates suggest a peak closer to 20%. The social and economic consequences were profound, highlighting the severe potential costs of economic policy failures.
The Depression of the 1890s: Following a boom fueled by resources and property, a withdrawal of foreign investment and a collapse in wool prices triggered a severe financial crisis in Australia, which at the time lacked its own currency to buffer the shock. This depression resulted in deeper production falls and higher unemployment than the Great Depression, and significantly shaped Australia’s political and economic landscape, contributing to labor organization, the formation of the Labor Party, and ultimately, Federation.
Other Economic Downturns
Australia has also experienced shorter periods of economic slowdown, most notably during the Global Financial Crisis (GFC) of 2008-2009.
Global Financial Crisis (2008–2009): The GFC triggered extreme stress in international financial markets and banking systems, leading to significant economic downturns and job losses globally. Australia fared relatively well due to a robust financial system, strong trade ties with China, and effective macroeconomic stimulus. While Australia experienced only one quarter of GDP decline, unemployment and underemployment did rise sharply. (Further reading: The Global Financial Crisis Explained).
The COVID-19 Pandemic’s Economic Impact
The COVID-19 pandemic caused rapid and substantial economic contractions worldwide, including in Australia. Public health measures necessitated the immediate suspension of many economic activities, leading to an exceptionally rapid fall in output and surge in unemployment. Australian GDP fell by a record 7% in the June quarter of 2020, and unemployment peaked near 7.5%. However, the economy rebounded as restrictions eased and vaccination programs progressed, supported by substantial monetary and fiscal stimulus.
Long-Term Consequences of Recessions
Recessions carry significant and potentially long-lasting social and economic costs. Central banks and policymakers prioritize sustainable economic growth to avoid unnecessary downturns. When negative economic shocks occur, they implement stimulus measures to prevent recessions and minimize the adverse impacts on households and businesses.
However, recessions can have persistent long-term effects. Job losses during recessions can lead to long-term unemployment for some individuals, even after economic recovery. Skills can become outdated, or employers may perceive them as such. Recessions can also accelerate structural economic changes, leading to a “ratchet effect” where unemployment rates tend to remain higher after each recession and are slow to decline to pre-recession levels.
The increased unemployment and business failures associated with recessions create economic hardship that is unevenly distributed across society. This can limit opportunities for affected households and have long-term consequences on health, education, skills development, and social mobility. Business failures represent a permanent loss of productive capacity, especially damaging when innovative or specialized businesses are lost.
Furthermore, recessions can increase a nation’s public debt. Governments face reduced tax revenue alongside increased expenditure on social welfare and economic stimulus measures. These long-term effects underscore the importance of understanding and mitigating recessions.
[^1]: Explain potential output and its significance in economic analysis. – OECD
