The market or wider economy may collapse, or just ‘go bad’ if there is a financial downturn. It could be due to a specific event (such as a terrorist attack) or the impact of a specific set of circumstances (such as the global pandemic and the subprime mortgage market crisis which led to an international banking crisis followed by a global financial recession).
What Is a Global Recession?
A global recession is an extended period of economic decline around the world. A global recession involves more or less synchronized recessions across many national economies, as trade relations and international financial systems transmit economic shocks and the impact of recession from one country to another.
The International Monetary Fund (IMF) uses a broad set of criteria to identify global recessions, including a decrease in per capita gross domestic product (GDP) worldwide. According to the IMF’s definition, this drop in global output must coincide with a weakening of other macroeconomic indicators, such as trade, capital flows, and employment.
- A global recession is an extended period of economic decline around the world.
- The IMF uses several criteria to analyze the occurrence, scale, and impact of global recessions.
- Global recessions involve synchronized recessions across many interconnected economies.
- The effect of a global recession on individual economies varies based on several factors, including their degree of connection to and dependence on the global economy.
Understanding Global Recessions
Macroeconomic indicators have to wane for a significant period of time to classify as a recession. In the United States, it is generally accepted that GDP must drop for two consecutive quarters for a true recession to take place, based on analysis by the National Bureau of Economic Research (NBER), which is considered the national authority in declaring and dating business cycles. For global recessions, the IMF plays a role similar to the NBER.
While there is no official definition of a global recession, the criteria established by the IMF carry significant weight because of the organization’s stature across the globe. Unlike the NBER, the IMF does not specify a minimum length of time when examining global recessions. In contrast to some definitions of a recession, the IMF looks at additional factors beyond a decline in GDP. There must also be a deterioration of other economic factors, which include trade, capital flows, industrial production, oil consumption, the unemployment rate, per‑capita investment, and per-capita consumption.
Ideally, economists would be able to simply add the GDP figures for each country to arrive at a “global GDP.” The vast number of currencies used throughout the world makes the process considerably more difficult. Though some organizations use exchange rates to calculate the aggregate output, the IMF prefers to use purchasing power parity (PPP)—that is, the amount of local goods or services that one unit of currency can buy rather than the amount of foreign currency it can buy—in its analysis.
History of Global Recessions
Up until 2020, according to the IMF, there have been four global recessions since World War II, beginning in 1975, 1982, 1991, and 2009. In 2020, the IMF declared a new global recession, which it dubbed the Great Lockdown, caused by the widespread implementation of quarantines and social distancing measures during the COVID-19 outbreak. This is the worst global recession on record since the Great Depression.
Contagion and Insulation
The impact and severity of the effect of a global recession on a country vary based on several factors. For example, a country’s trading relationships with the rest of the world determine the scale of impact on its manufacturing sector. On the other hand, the sophistication of its markets and investment efficiency determine how the financial services industry is affected.
The interconnection of trade relations and financial systems among countries can help to spread an economic shock in one region into a global recession. This process is known as contagion.
Example of a Global Recession
The Great Recession was an extended period of extreme economic distress observed around the world between 2007 and 2009. World trade plunged by over 15% between 2008 and 2009 during this recession. The scale, impact, and recovery of the downturn varied from country to country.
The U.S. experienced a major stock market correction in 2008 after the housing market collapsed and Lehman Brothers filed for bankruptcy.5 Economic conditions had already turned down by the end of 2007 and major indicators such as unemployment and inflation hit critical levels with the collapse of the housing bubble and ensuing financial crisis.
The situation improved a few years after the stock market bottomed in 2009, but other nations experienced much longer roads to recovery. Over a decade later, the effects can still be felt in many developed nations and emerging markets.
According to economic research conducted for the NBER, the United States would have suffered limited shocks to its economy if the 2008 recession had not originated within its borders.6 This is mainly because it has limited trading relationships with the rest of the world in comparison to the size of its domestic economy.
On the other hand, a manufacturing powerhouse such as Germany would have suffered regardless of the robustness of its internal economy because it has a vast number of trade linkages with the rest of the world.
- The DJIA, the S&P 500, and the NASDAQ indexes all are indicators of the current state of the stock markets.
- They reflect investor confidence and thus may be indicators of the health of the overall economy.
- Other indicators such as GDP more directly measure the direction of the wider economy.
Each of these indexes was created as a way to capture the status of the stock markets or a sector of the markets from one day (or one moment) to the next. They indicate whether “the markets” as a whole are up or down, a little or a lot.
Leading Indicators and Indexes
Each of the three most closely followed indexes has its own history and its own followers among financial professionals and the media.
- The DJIA also referred to as the Dow, is the old original, created in 1896. It tracks just 30 companies, all leaders in their industries. The word “industrial” in the name dates from an era during which the most important American companies were its industrial titans. To this day, it is the most highly used and frequently quoted of all the leading stock market indicators.2
- The S&P 500 Index is made up of 500 stocks from across all industry sectors. Some investors consider it to be a more accurate gauge of the markets as a whole because it has broad representation and it’s value-weighted. That is, each component’s weight in the index is proportionate to its market value.1
- The Nasdaq Composite Index tracks more than 3,000 stocks listed on the Nasdaq Stock Exchange. Because of the makeup of that exchange, the index includes many younger companies large and small, particularly in the technology, biotechnology, and pharmaceutical sectors.3
These three indexes serve as important indicators of the health of the markets overall. Other indicators are used to track the immediate past performance of the economy, and to forecast its future.
Lagging and Leading Indicators
Most other economic indicators are government reports or surveys that only make sense in the context of time. That is, if an indicator is up compared to a month earlier, the economy is strengthening. If the indicator is down this month, the economy is weakening.
Some consider the S&P 500 to be an accurate gauge of the markets as a whole because it has broader representation and is value-weighted.
The economic indicators most often used by analysts and investors include gross domestic product (GDP), the Consumer Price Index (CPI), the nonfarm payroll report, and the Consumer Confidence Index. There are others, such as manufacturing orders and building permits, that are of particular relevance to investors in certain sectors.
Indicators are either lagging indicators or leading indicators. Lagging indicators allow analysts to track the direction of the economy, or a substantial component of it, over time. Leading indicators suggest which way it’s going next. The manufacturing orders number, for instance, indicates how much demand buyers see for new products during the upcoming months.
The Big Numbers
No indicator is more closely watched over time than GDP. This measures the total value of all goods and services produced in the U.S. It reflects all of the consumption that has occurred in both the public and private sectors. GDP reports are issued quarterly and annually. The number for the second quarter of 2020 was $19.41 trillion.
CPI tracks the cost of living in the U.S. by tracking the prices of a mixture of consumer goods and services.
The monthly nonfarm payroll report tracks the health of the job market by measuring the hours and salaries of most (but not all) nonfarm workers. It omits government employees, self-employed workers, and employees of non-profit groups as well as farmworkers.
The consumer confidence index is another leading indicator. This closely-watched survey assesses the degree of optimism or pessimism that consumers feel for the economy and their own financial security. This logic is that the more optimistic consumers are, the more money they will be willing to spend in the near future.
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