It’s official – we are now in a recession. What does this mean and should we be worried? Firstly, let’s look at what the term recession means. Economists define a recession as two consecutive quarters of negative economic growth. During a recession we see less economic activity – people spend less and as a result, businesses suffer. When businesses don’t do well, they may respond with staff layoffs, so unemployment increases. This creates a downward spiral as increased unemployment further decreases the amount of money consumers spend.
However, there are some benefits to being in a recession, so its not all bad.
A recession is a good antidote for inflation. Inflation occurs when demand outstrips supply – that is, when there is a high level of spending by consumers that suppliers find difficult to keep up with. We have seen this over the last couple of years, with extreme shortages of some goods and services. People have had to go on waiting lists to buy things they want, and have had to wait weeks or months to get a tradesperson. These are signs of an overheated economy, fuelled by low interest rates and massive Government spending. A recession is a cooling off period that takes the heat out of inflation and takes the pressure off suppliers. Inflation has caused considerable pain for people on low incomes or with high expenses, such as young families. For these people, recession is a welcome relief.
There are other wider benefits of a recession. The economy works in a cycle – in simple terms we go from ‘boom’ to ‘bust’. However, there is an upward trend to each cycle, so the level of economic activity in this recession is likely to be higher than the level of economic activity in previous recessions. The fact is, we would be unlikely to have this long term growth if we didn’t have recessions. Let me explain why.
When we are in a boom period, with excessive spending and shortages, even poorly managed companies can succeed. Our economic resources are limited, and to get the most out of them, they need to be used efficiently and effectively. When we have a recession, poorly managed or inefficient companies are usually the first to suffer. As they shrink or shut down, they release resources (people, money and time). These resources are then freed up for more efficient companies, or for new industries. Recessions can be a great time for innovation, as companies have to work smarter to succeed. Think of a recession as a period of time when there is a clearing of poor performers, leaving our economy in better shape for growth.
It’s important to remember that a recession is a natural part of the economic cycle. If there is one thing for sure, a recession is always followed by a period of strong growth. The only uncertainty is how long the recession will last and how soon economic growth will return.
This will be determined by a number of factors including the state of the global economy, and the actions of our policy makers, particularly the Reserve Bank. Interest rates are strong lever for influencing the speed at which our economy operates. High interest rates will slow the economy down and low interest rates will speed it up. The challenge of the Reserve Bank is to keep interest rates at a level that will promote economic stability. It’s not possible to keep an economy on a completely even keel, but we need to avoid wild swings from boom to bust, as that creates a high level of disruption and uncertainty.
So as consumers, how do we respond to a recession? The key message here is that we will always have recessions. Just as night follows day, a period of economic growth will be followed by recession. We need to use the boom periods to prepare for the lean times. How often have you heard the term “Make hay while the sun shines”? When the economy is booming, life is good, but we need to use this time to prepare for the not-so-good times. That means keeping debt to a minimum, using low interest rates as an opportunity to reduce the size of a mortgage rather than to spend more, and use high incomes to set aside savings for when life gets tougher.
That’s easier said than done for those on low incomes who, even in the boom times, struggle to save. Recessions are a time when communities need to help each other; a time to be generous to those less fortunate than us.