Tuesday, January 22, 2008

What is a recession?

A recession is a smaller, shorter version of a depression. The technical definition is when the Gross Domestic Product declines for two consecutive quarters or longer.

The primary effect on ordinary people is that unemployment rises. The two reasons are that businesses lay people off because the market for their goods and services declines. They also stop hiring. People who have jobs are less secure in their jobs. Those who have secure jobs are less likely to get raises, or they get smaller ones. People are afraid to quit jobs because it may be much harder to get another one. Tax revenues fall so governments other than the Federal government have their budgets shrink and have to cut spending sharply because only the federal government may run a deficit. Counties, cities, and states can't. Since a lot of state spending is already mandated, often for schools and highways, the amount of the rest of the programs and the employees in them is generally cut sharply. Kids graduating fewer job opportunities. Pensions do not rise as fast as prices and have a built-in lag since adjustments are not made until the end of the year in which the price increases occurred. Business profits and investment opportunities shrink so the stock market tanks. (I have lost a quarter of my portfolio since October 11.)

When the unemployment rate goes above 7% (it is about 5% right now) the federal government adds an up-to-13 week extension to the amount of time one can draw unemployment benefits. Overall the nation becomes poorer. In practice that means that the overall cost of living becomes more expensive compared to the total amount of wages and salaries paid in the country. This can happen either by prices rising faster than wages and salaries, or by prices remaining stable while total wages and salaries fall. Because so much of ordinary people's spending is fixed ( i.e. non-discretionary -- rent/mortgage, utilities, insurance, debt payments, medical, etcetera) a relatively small decline in real incomes produces a substantial decline in discretionary spending (going out to dinner, electronic toys, travel, presents, etcetera). Even if the percent decline in real income were the same for rich as for poor, the effect on the poor would be substantially greater because a much larger percentage of our incomes are non-discretionary spending.

In the current environment, it also becomes harder to spend even if one has the money. With their huge loan losses, lenders are going to make qualification standards much stiffer than they were last year so items like new cars and houses will become less available. Overall life becomes a little grayer, a little more limited.

2 comments:

  1. SomeAHole FromNewJersey3:09 PM

    Volatility, that's the name of the game. When we were in high school, the market would move a couple of points a day. If it went up or down 10 points, that was a big deal. Then came the eighties and nineties, when the market would go up or down twenty or thirty points a day. Now we are in a period of hundred point shifts.

    It’s like the “Global Weather Change,” everything is just more extreme now. We need bring in Al Gore. He’ll save the day. Actually of all the Gores, I think I prefer Leslie.

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  2. Context is another name for the game. When we were in high school the Dow was around 600, so a change of 10 points was indeed a big deal. Now it is around 12,000 so it takes 200 points for the deal to be as big as 10 was then.

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