What Happens During a Recession?

• In a recession people tend to save money because there is a fall in confidence. If people expect to be made unemployed then you don’t want to spend and borrow, it is less risky to save.
• The paradox of thrift states that in a recession people are nervous so save more. This makes the recession worse because it causes a further fall in consumption. People think they are doing a good, responsible thing to save, but actually they are making the recession worse.
• In recessions, interest rates tend to fall. Because inflation is lower and Central Banks wish to try and stimulate the economy.
• The government will also try to use expansionary fiscal policy. This involves cutting taxes and increasing government spending. It will cause higher government borrowing (higher budget deficit) Expansionary fiscal policy may not work in the long run due to crowding out.
• In the US the authorities are trying both lower interest rates and lower taxes.
• The problem with lower interest rates is that it is causing a further devaluation of the dollar.
• Also lower interest rates may not actually  help increase spending if confidence is low (e.g. because of falling house prices)
• There is a limit to how much the government can cut taxes because government borrowing is already quite high. US national debt is about 65% of GDP. In the recession this will definitely increase.
• Stock Markets fall because firms make less profit. There is also the danger firms may go out of busines.