The strength and stability of the economy of a country depends majorly on several factors, such as consumer confidence, market trends, health crises, armed conflicts, the goods and services it can produce. Numerous economic downturns have occurred through the years and this has harmed the finances of businesses and people across the world. Now while governments are not always successful in coming out great in all economic downturns, they do their best to take actions to avoid it at all levels. There is a constant risk that economic downturns would occur, there are causes of economic downturns and there are also effects to it.
Causes of Economic Downturn
The economy can go through several cycles of highs and lows and can come to a peak and decline after a while. When the economy goes down, there is an economic downturn. Once the economy shrinks for two consecutive quarters, then it means that the economy has had a downturn. Generally, this is marked by an indicator that is tagged as the GDP or gross domestic product. Now, it is possible to confuse slowdown and downturn, however they are two different things.
In a slowdown, the growth indicators of the economy are positive, although they grow at a much slower rate than how they did in the previous quarter. In a downturn, the growth indicators of the economy are negative and they are falling more and more. Now there are several causes of economic downturn and they all have different effects. Economies, companies and firms that experience growth are likelier to fall into economic downturns as part of the economic cycles. However, some factors may arise that may cause recession and many of them are usually not preventable or even anticipated. Here are the three likely causes of economic downturns:
- Speculation – In general, when the price of a product or item suddenly peaks and rises due to customer confidence, market trends, or speculations, economic bubbles are formed. Investors make use of this opportunity to buy it all up, hoping that in return of an increase in price, they will earn. However, the moment that they begin to sell it off, the supply of the products or items exceeds the demand for them as there are fewer buyers. This makes prices go down and for the economic bubble to burst. Speculation as a cause of economic downturn is what happened to the housing market in 2008.
- Uncertainty – Not having an idea or inclination to how and when the economy will change makes decision making in business attract much risk. Pandemics and wars are two unpredictable situations that can make the trends of consumers hard to decipher in the long, medium and even, the short term and this, in turn, generates uncertainty in the economy. Economic activities decline and then give birth to economic downturns when firms, companies, and individuals hold off on decisions on investment and spending.
- Oversupply – Another massive cause for economic downturns is oversupply. In every economic boom, firms and companies, tend to increase their production level to ensure that they meet the demand of their consumers. However, when the demand peaks and then starts to decline, the oversupply or excessive supply of services and goods in the market that have not been consumed or bought can lead to an economic downturn. With this cause, companies and firms start producing less of the goods and services, start to downsize and the consumers begin to lose purchasing power. All in all, consumption falls, production fails, and there is an economic downturn because there is a lack of cash flow and impact on the gross domestic product.
It is important to note that the longer the economic downturn, the harder the effects are and the reversal or solution to those effects.