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Predictors of a recession
Although there are no completely reliable predictors, the following are regarded to be
possible predictors.
In the U.S. a significant stock market drop has often preceded the beginning of a
recession. However about half of the declines of 10% or more since 1946 have not been
followed by recessions. In about 50% of the cases a significant stock market decline came
only after the recessions had already begun.
Inverted yield curve, the model developed by economist Jonathan H. Wright, uses yields
on 10-year and three-month Treasury securities as well as the Fed's overnight funds
rate. Another model developed by Federal Reserve Bank of New York economists uses
only the 10-year/three-month spread. It is, however, not a definite indicator; it is
sometimes followed by a recession 6 to 18 months later.
The three-month change in the unemployment rate and initial jobless claims.
Index of Leading (Economic) Indicators (includes some of the above indicators).
Causes of a recession
Many factors contribute to an economy's fall into a recession, but the major cause is inflation.
Inflation refers to a general rise in the prices of goods and services over a period of time. The
higher the rate of inflation, the smaller the percentage of goods and services that can be
purchased with the same amount of money. Inflation can happen for reasons as varied
as increased production costs, higher energy costs and national debt.
In an inflationary environment, people tend to cut out leisure spending, reduce overall
spending and begin to save more. But as individuals and businesses curtail expenditures in an
effort to trim costs, this causes GDP to decline. Unemployment rates rise because
companies lay off workers to cut costs. It is these combined factors that cause the economy to
fall into a recession.
Other reasons could be high interest rates.
High Interest Rates Cause Recession
High interest rates are also a cause of recession. That's because it limits liquidity, or the
amount of money available to invest. In spite of the stock market decline in March 2000,
the Federal Reserve continued raising interest rates to a high of 6.25% in May 2000. The Fed
didn't start lowering rates until January 2001, and lowered them about 1/2 points each month,
resting at 1.75% in December 2001. This kept interest rates high when the economy needed
low rates for cheap business loans and mortgages.
One of the causes of the current recession was that the Fed was also slow to raise interest
rates when the economy started to boom again in 2004. Low interest rates in 2004 and 2005
helped created the housing bubble. Irrational exuberance set in again as many investors took
advantage of low rates to buy homes just to resell. Others bought homes they couldn't afford
thanks to interest-only loans.
Spurt in demand of products of a particular sector (like it was the cause of 2001 recession, in
which dot com companies were the pioneers of business regime), etc.
Overview: In trading, there has not been as much impact of recession on Indian economy as
for other countries. This is only because of its lower export relying nature.
Impact on India:
• A slowdown in the US economy is bad news for India.
• Indian companies have major outsourcing deals from the US.
• India's exports to the US have also grown substantially over the years.
• Indian companies with big tickets deals in the US are seeing their profit margins
shrinking.
• More people have sold the shares in the indian share market than they bought in the
recent weeks. This has added to the fall of sensex to lower points.
• One danger meanwhile is of a dip in the employment market. There is already
anecdotal evidence of this in the IT and financial sectors, and reports of quiet
downsizing in many other fields as companies cut costs.
• More than the downsizing itself, which may not involve large numbers, what this
implies is a significant drop in new hiring -- and that will change the complexion of
the job market.
• Many companies has laid off their staffs, the number of tourists inflow to india has
come down, companies have cut down compensations and perks etc, government and
other private companies are reluctant in starting new ventures and starting new
projects etc.
• Projects that are halfway to completion, or companies that are stuck with cash flow
issues on businesses that are yet to reach break even, will run out of cash.
• one of the casualties this time could be real estate, where building projects are half-
done all over the country and in this tight liquidity situation developers find it difficult
to raise finances.
• The only way out of the mess is for builders to drop prices, which had reached
unrealistic levels and assumed the characteristics of a property bubble, so as to bring
buyers back into the market, but there is not enough evidence of that happening.
• Consumers are also frozen in this sudden glare of the headlights.More expensive
money means that floating rate loans begin to bite even more; even those not caught
in such a pincer will decide that purchases of durables and cars are not desperately
urgent.
• At the heart of the problem lie questions of liquidity and confidence.
• What the RBI needs to do, as events unfold, is to neutralise the outflow of FII money
by unwinding the market stabilisation securities that it had used to sterilise the inflows
when they happened.
• This will mean drawing down the dollar reserves, but that is the logical thing to do at
such a time.
• If done sensibly, it would prevent a sudden tightening of liquidity, and also not allow
the credit market to overshoot by taking interest rates up too high.
• Meanwhile, there is an upside to be considered as well.
• The falling rupee (against the dollar, more than against other currencies) will mean
that exporters who felt squeezed by the earlier rise of the currency can breathe easy
again, though buyers overseas may now become more scarce.
• Overheated markets in general (stocks, real estate, employment-among others) will all
have an element of sanity restored.
• And for importers, the oil price fall (and the general fall in commodity prices) will
neutralise the impact of the dollar's decline against the rupee.