Business cycles and Keynesian explanations of recessions

¶ … Causes of Recessions: Comparison and Contrasting of Theories that Explain the Causes of Recessions

The Causes of Recessions

A recession can be defined as two or more consecutive quarters of declines in economic activity, normally indicated by changes in household income, industrial production, real gross domestic product (GDP), employment, and wholesale retrial sales. According to Knoop (2010), a recession is usually characterized by a drop in the stock market, a decline in housing prices, increased rates of unemployment, business contractions, and consecutive declines in the GDP.

Some triggers of full blown recessions may include inflation, supply and demand shocks, financial crises and exchange rate fluctuations that affect international trade. However, Knoop (2010) states that economists often rely on business cycle data to study macroeconomic relationships that may point to a recession. Business cycles, which are the expansions and contractions in the levels of economic activities, often have peaks and troughs that can be easily predicted using macroeconomic variables. For instance, pro-cyclical variables in business cycles often fall as the GDP falls and rise as it rises. These include investment, employment and consumption. On the other hand, counter-cyclical variables, such as unemployment, are negatively correlated to the GDP; while acyclical variables have no consistent correlation with the GDP (Knoop, 2010). Therefore, when business cycles contract, it signifies a decline in pro-cyclical variables and an increase in counter-cyclical variables in a given period, which often signifies the onset of a recession.

Economists have different ways of explaining recessions. For example, John Keynes, one of the most influential economists in the 20th century came up with the Keynesian theory, central to understanding the Great Depression that lasted from 1929 to 1938. According to Keynes (2013), a recession occurs where an economy has idle factories, little spending, and unemployed workers. In a normal economy, during upturns of the business cycle, majority of the people are employed and people are willing to spend money - however, during downturns, the confidence of consumers is shaken and they react by saving their money. A vicious cycle then ensues, where people hoard their money to survive through difficult times, as times get more difficult because too many people are hoarding money (Keynes, 2013).

Karl Marx, a German economist, was more concerned with factors that cause upturns and downturns in the business cycle. Marx opined that capitalism often led to destruction because excessive shifts of income from labor to capital would often lead to excess capacity accompanied by lack of aggregate demand, which caused economic downturns (Megill, 2002). Marx's conclusion was that internal contradictions to capitalism often caused major economic crises.