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by Valentino Piana (2015)



1. Summary features of this phase in the business cycle
2. Typical pathways in key economic areas
3. Key events
4. Winners and losers
5. Influence on election outcomes
  6. Possible countervailing developments  
  7. Transition to the next phase  


Summary features of this phase in the business cycle

Slowdown of GDP growth leading to under-utilization of workforce and capital. Depletion of human and physical capital. Reason-based anger and pessimism in the social groups most hurt by the crisis.

Typical pathways in key economic areas

Domestic business dynamics

A majority of sectors and firms face losses and turnover decline. A few - more stable - ones maintain the aggregated GDP from falling in absolute terms. Capacity utilization is decreasing and new investment projects are postponed or canceled.

At the beginning of recession, negative suprises fail expectations in GDP, sales and profits.

Innovation face difficult entry into the market and in the purchased baskets of households. Rate of diffusion of innovation slows down. Market exit prevails on market entry (which in turn is largely due to fringe firms).

Foreign trade

Imports fall more than GDP. If foreign trade partners maintain healthy growth, so that country exports are rising, the trade balance improves (more or less drastically).

Demand-oriented FDI are canceled: only resource-oriented FDI may continue. Possibly foreign purchase of depreciated assets occur relatively late in the recession.

In another setting, an export-oriented country with just a few competitive products (whose sales and profits are key to private and public revenues) can be triggered into recession by a fall in prices and quantities sold abroad. Here the transmission to the domestic economy, with falling employment in the export sector reducing domestic demand and a chain of negative developments is in the context of decreasing trade surplus (or increasing trade deficit).

Labour market

At first, employers slow down work pace, overheads are cut (with a reduction in average received monthly wage), with falling hours worked, possibly due to shift of full-time jobs to part-time schedules.

If firms think that the recession will be short and many workers have cumulated firm-specific skills, firing are postponed. But as the recession continues and defy inversion, firms act with no restrain to cut the number of their workforce.

The increased risk of remain unemployed or to accept a worse paid job lead to precautionary savings. Together with falling household income, this depresses consumption.

Public finance

Tax revenue falls (the more so if the taxation is not progressive). Subsidies to unemployed people rise. Deficits soars. Public debt-to-GDP ratio rapidly worsens, with both variables moving unfavourably.

If the GDP slowdown was triggered by a government cutting expenditure and raising taxes in order to keep deficits under control, their attempt (possibly temporarily successful until the economy reacts) are self-defeating. Only if compensated by export-led and investment-led growth (in a context of monetary expansion) such attempt would be successful.

Depending on political orientation by current government, the worsening public balance becomes at the forefront of attention and restrictive fiscal policies worsen the crisis. A fiscal expansion, by contrast, while temporarily worsening the deficit, might relauch the economy into recovery. The political orientation, possibly the result of electoral promises and mandate, must face internal and international stakeholders' position, especially tough if public debt is couples by external debt (and/or it is owned by foreigners).

Financial markets

Asset prices go down, possibly leading to foreigners purchases. The number of real estate transactions (and related loans) are drastically reduced. Prices fall especially in peripheral areas, with extension the further the crisis advances.

Stock exchange may have temporarily bump, especially if the interest rates are reduced by the central bank, but the overall trend is downward sloping until recovery would be taking place. In certain cases, for such upward inversion it's enough that the recovery of the specific firms whose shares are object of transactions in the stock exchange is in sight.

Price level and real interest rates

If recession was triggered by increased oil prices in oil-importing countries, stag-flation takes place, with high imported inflation, transmitted to trasport- and energy - related services, thus to physical goods and possibly to indexed wages. If the central bank reacts to such inflation with a rise of real interest rates (so steeply rising the nominal rates), recession worsen. Non-fully-indexed wages begin to decrease in real terms (domestically), so domestic demand, already squeezed in its investment component by the high interest rates (applied both to existing corporate debt and to potential new loans) is drastically depressed.

How quickly the inflation is tamed and interest rates are driven down (even to lower-than-normal as a contrast policy to recession) is key for avoiding further degradation of the economy.

If, by contrast, recession was triggered by domestic policies and the end of investment phase by companies, than the slack of production capacity may give rise to a restrain of inflation.

Some firms, in the attempt to cover fixed costs with a lower number of sold units, might try to increase prices, what further depresses their sales, especially if other firms do the opposite and cut prices. So with the average price level increase slowing down, corporate results are more widely dispersed, with the former group usually going bankrupt and the other surviving. The bankruptcies shift demand of their customary clients to the others, which help them.

Key events

Singular events occurring during the recession phase, marking it both in reality and in the media, are plant shutdowns, company bankruptcies and market exits.

Winners and losers

Recession hits harder and earlier the middle class and the poor. The rich can be more or less isolated from the crisis, unless it contains an important component of stock exchange crash and falling asset prices.

Much depends on the specific programs of the government, which might ease conditions to certain social group (and / or worsening others' ones).

Influence on election outcomes

When the economy is at the centre of voters' information and decisionmaking, elections in the recession phase of the business cycle tend to favour the current opposition, especially if it can attribute the difficulties to the government and / or it has strongly appealing policies to exit the crisis.

Possible countervailing developments

The weak GDP growth hides large company-level and sector-level divergent dynamics. The crisis of some long-standing but fragile incumbents may open the way to aggressive new entrants with innovative approaches to the market.

Excessive prices of the booming phase can be corrected down to more reasonable levels, offering particularly optimistic investors the opportunity to buy and re-orient. The speed of asset and workforce reallocation to firms and sectors is key for the duration of the recession.

Transition to the next phase

Recession can degenerate to depression (with absolute falls in GDP and price levels), 1. if its causes are strong enough, 2. if the country was particularly vulnerarable and not resilient or 3. if the authorities double down restrictive fiscal or monetary policies.

In milder conditions, recession is followed by recovery, provided a sufficiently large positive shock is applied to reverse the downturn and the trough is reached and left behind.


GDP time series for most country of the world (1946-2007)

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