[David Waring]

I received the below questions from one of our viewers today which I am posting here so we can all benefit from the discussion:

That was a very good explanation. So, what exactly happens if there is a recession. I mean what are the impacts? will there be huge job loss or will there be inflation?

This is a good question which we are going to go into in detail on in a video series on the fundamentals of trading however the short answer is as follows:

First lets define what a recession. A recession is defined as 2 consecutive quarters of negative economic growth.

So to answer your question there is no way to know exactly what is going to happen if there is a recession until it happens. When there is negative growth in an economy this normally results in job losses however the severity of the job losses is going to depend on how severe the economic slowdown is. In general the more severe the economic slowdown the greater the job losses will be.

In regards to prices you can have either deflation (a situation where prices decrease on average), you can have inflation (a situation where prices increase). When inflation happens during a recession this is what is known as stagflation, or you can have prices remain constant. There are a number of factors which would cause prices to fall, rise, or stay constant the most important for which being:

1. What Happens with interest rates and the Money Supply.

2. What happens with global demand for commodities such as oil.

3. What happens with the exchange rate of the US Dollar (or the currency of whatever country we are reffering too)

For more detailed information on each of these subjects please see the following:

Definition of a recession

How stuff works guide to the economy and recession

Investopedia Guide to Inflation

Guide to Deflation

Hope that helps. If anyone else has any input on this or if there are any other questions please feel free to post them below.

Best Regards,
Dave

I hear from everyone that the economy is controlled by consumer spending...the more the spending, the better is the economy. It is believed that if consumer stops spending it will affect US economy greatly. What I don't understand is how spending is linked to markets/economy/recession??

Excuse me if i am very naive.. new to business terminologies.

[David Waring]

Hi Srinivas07,

The economy of a country is basically made up of businesses that produce goods and services which they try to sell at a profit and in so doing employ a large percentage of the population, consumers who buy the goods and services that those companies produce, and the government which produces public services such as schools and roads and in so doing also employs a good chunk of the population.

The size of an economy is measured by something called Gross Domestic Product (GDP) which is basically the final value of all goods and services produced in a country for the year or whatever time period you are looking at.

If the GDP for a country is growing that means its economy is growing which means that more people are going to be employed, businesses overall are more profitable etc etc.

Conversely if the GDP for a country is not growing or is declining then this means its economy is not growing or even shrinking which means that less people are going to be employed businesses overall are less profitable etc etc.

Now, the GDP for the US economy is well over $10 Trillion a year. Of that well over $10 Trillion, around 60% of that number comes from consumer spending. (the other part comes from business and government spending).

With the above in mind if the consumer slows their spending this has the potential to have a dramatic affect on GDP, possibly to the point where the GDP growth would be negative.

Now a recession is defined as 2 consecutive quarters of negative GDP growth. So you can see there the link between a slowdown in consumer spending having the potential to create negative GDP growth and drive the US economy into recession.

Now onto the stock market. Whether the stock market goes up or down is basically a reflection of how much people think the companies that make up the stock market are worth. One of the key factors here is how much they think those companies are going to earn going forward from selling their products and services. So if the overall economy is expected to be good then overall the stock market should go up because businesses overall are expected to make more money and are therefore worth more. Conversely if the overall economy is expected to be bad then the stock market should go down because businesses overall are expected to make less money and are therefore worth less.

So you can see the link there that if the consumer starts spending less and the economy as a result starts doing poorly then the stock market goes down.

I have simplified things here due to time and space constraints but there is a lot of good resources out thereon the internet if you search around which can help you learn more about this. Here is a good one to start with:

How Does US Economy Work - Understanding How the US Economy Works

Best Regards,
Dave

Thanks for a wonderful explanation. Will bounce back with more questions soon

[David Waring]

my pleasure thanks for contributing to the community.

Best Regards,
Dave