What is a Technical Recession and How It is Different From a Recession?

Updated November 10, 2022

Due to the pandemic, except china, every economy of the globe has entered a technical recession in the fiscal year 2020-2021. When the GDP of any country declines for two consecutive quarters is considered a technical recession. The Reserve Bank of India has dedicated a chapter on the “State of the economy” in its latest monthly bulletin for November. The idea is to provide a monthly snapshot of some of the key indicators of India’s economic health.

As part of the exercise, the RBI has started “nowcasting” which means “the prediction of the present or the very near future of “the state of the economy”. RBI has projected a very first ‘nowcast’ in its latest monthly bulletin for November where it predicts that India’s economy will contract by 8.6% in the second quarter (July, August, September) of the current financial year. India’s economy in its first quarter of the current financial year was declined by 23.9 percent which means India has entered a technical recession.

What is a Technical Recession?

The term recession means a significant contraction in economic activity which is clear from the perspective of the above statement but it’s not so simple there is still a lot to know about.

There has been talked of ‘technical recession’ as the fluctuation arose in the market by COVID-19 as well as the collapse of oil prices due to OPEC’s failure to agree on production cuts.  These fluctuations in the market resulted in a quarter of negative gross domestic product. We often confuse a drop in the stock market with a recession. While they can and frequently do happen together, they are completely different events. It’s important to note that a recession is a normal part of the economic cycle. Unfortunately, a recession can only be confirmed once we are already in it since it’s based on the previous two quarters.

When a country has 2 negative quarters of GDP, then it is said to be that the country has entered a “technical recession”  or contraction in GDP continued for two consecutive quarters is considered as ‘technical recession’. But it is due mainly to slowing growth or an isolated event rather than a major underlying cause. Technical recessions are usually short in duration and mild in severity. COVID-19 virus could absolutely cause a technical recession due to the fact that many businesses will be economically affected by it even though it is an isolated event and not a sign of broader problems with the economy. So, it could be said that fluctuation arises from isolated events can cause two negative GDP quarters but couldn’t cause the economy to fall into a deep recession.

How Technical Recession is Different from a Recession?

When a recessionary phase sustains for long enough, it is called a recession. In other words, when the GDP contracts for a long enough period, the economy is said to be in a recession while a technical recession is a term used to describe two consecutive quarters of decline in output. In the case of a nation’s economy, the term usually refers to back-to-back contractions in real GDP.

The most significant difference between a ‘technical recession’ and a ‘recession’ is that while the former term is mainly used to capture the trend in GDP, the latter expression encompasses an appreciably more broad-based decline in economic activity that covers several economic variables including employment, household and corporate incomes and sales at businesses. Another key feature of a technical recession is that it is most often caused by a one-off event (in this case, the COVID-19 pandemic and the lockdowns imposed to combat it) and is generally shorter in duration.

What is the Recessionary Phase and How Long a Recession Lasts?

There are two phases of any economy, one is recessionary and another is the expansionary phase. Together what they create is called the business cycle.  The economy of any country is measured by its GDP that includes goods and services. When there is an increase in the overall output of goods and services from one quarter to another, the economy is said to be in an expansionary phase. And if there is a decline in GDP from one quarter to another the economy is said to be in a recessionary phase.

When a recessionary phase lasts long enough it is said to be a recession and when a recession continued for years referred to as a depression. But depression is quite rare and the last time it was seen during 1930 in the USA. So, it can be said that a recession lasts for few quarters.

Causes of Recessions

A contraction in real GDP is called a recession which is primarily caused by a fall in aggregate demand. A demand-side shock could occur due to several factors like,

(i). A financial crisis- If banks have a shortage of liquidity, they reduce lending and this reduces investment.

(ii). A rise in interest rates – increases the cost of borrowing and reduces demand.

(iii). Fall in asset prices – negative wealth effect leads to less spending.

(iv). Fall in real wages- inflation outstripping nominal wage increases.

(v). Fall in consumer/business confidence also exacerbated by the negative multiplier effect.

(vi). Appreciation in the exchange rate – exports less competitive.

(vii). Fiscal austerity – when government cuts spending.

(viii). Trade war – Global economic downturn.

Recessions Can Also Be Caused By

Supply-side shock – A supply shock is a sudden and unexpected change in a cost variable such as oil prices, commodity prices, or wages. Shocks may be negative or positive. Supply shock may wear their way out of the economic system quickly, leading to a one-off effect or they may create an extended period of turbulence. For example, the oil shocks of 1970 when the rise in oil prices caused inflation and lower spending power.

Black swan event – A black swan is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. For example, the Covid-19 flu pandemic which disrupts travel, supply chains, and normal business activity. A pandemic affects both supply and demand.

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