What causes a recession?

A recession is generally defined as a significant, widespread, and prolonged downturn in economic activity. Economists often look at a decline in GDP for two consecutive quarters, but there is no single "cause"; rather, it is usually the result of a combination of factors that cause consumer and business confidence to falter.

Common drivers include:

• Sudden Economic Shocks: Unexpected events—such as a pandemic, a geopolitical conflict, or a sudden spike in oil prices—can disrupt supply chains and force businesses to halt production, leading to sharp drops in spending.
• High Interest Rates: When central banks raise interest rates to combat inflation, borrowing becomes more expensive for both businesses and consumers. This leads to reduced investment and lower consumer spending, which can cool an economy too quickly and trigger a contraction.
• Asset Bubbles: If prices for assets like housing or stocks rise to unsustainable levels based on speculation, the eventual "bursting" of that bubble can destroy wealth, lead to bank failures, and cause widespread panic, causing people to pull back on spending.
• Excessive Debt: When individuals, businesses, or governments take on more debt than they can manage, they may eventually be forced to prioritize paying off loans over spending or investing. This reduction in cash flow ripples through the economy.
• Loss of Consumer and Business Confidence: Economics is largely driven by psychology. If people fear that the economy is weakening, they tend to save money rather than spend it. When businesses see this decline in demand, they may stop hiring or begin layoffs, creating a self-reinforcing cycle of contraction.
• Deflation: While inflation (rising prices) is often discussed, deflation—a sustained drop in prices—can be just as damaging. If people expect prices to keep falling, they will delay purchases, which starves businesses of revenue and leads to lower wages and increased unemployment.

A recession happens when these factors combine to create a decline in the "velocity of money"—the rate at which money changes hands throughout the economy—causing growth to stall.