What causes a recession?

Investment Question
What causes a recession?
According to the National Bureau of Economic Research (NBER), recession is defined as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in

• real gross domestic product (GDP),
• real income,
• employment,
• industrial production and
• wholesale-retail sales".

More specifically, recession is defined as when businesses cease to expand, the GDP diminishes for two consecutive quarters, the rate of unemployment rises and housing prices decline.

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.

(For more on this topic, see All About Inflation.)

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.

For further reading, see
Recession-Proof Your Portfolio and
Recession: What Does It Mean To Investors.

This question was answered by Chizoba Morah.

http://www.investopedia.com/ask/answers/08/cause-of-recession.asp?ad=feat_fincrisis