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Economic Crisis: Meaning, Cause and Consequence

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Definition

Economic crisis is a sudden deterioration in the economic situation and prospects of a country or economic area. It may affect only one sector for a limited period of time or spread throughout the global economy for several years.

So, when it is a simple slowdown in activity, where production does not necessarily decrease, but increases slightly, we speak of a recession (Generally, a country is said to be in recession when it experiences a decline in GDP for two consecutive quarters).

So when it is a sustained decrease in production, as during the great crises of the 19th century or during the period of the 1930s, we speak of an economic depression.

I- Evolution of crises

Previously, at the time of the industrial revolution, the economic crisis was known as a “mixed crisis”, since the agricultural crisis, which originated from a series of poor harvests, which reduced the purchasing power of peasants and urban workers through the rise in food prices, ended up affecting industry.

However, with economic development, mixed crises will disappear. And from the second half of the 19th century onward, the mechanisms of crises have become similar. They begin with a financial crisis that manifests itself in a stock market crash and bankruptcies due to a speculative bubble, and then spread to the real economy.

Moreover, the 1929 crisis began with the famous “Black Thursday” of October 24, which resulted in heavy losses for savers and banks, the latter then reducing their loans to the economy, and creating the starting point of a vicious deflationary circle.

Furthermore, the Covid-19 crisis escapes this logic, because it is not a banking or financial crisis that then affects the real economy. It is a crisis of the real economy of an exogenous nature that affects the supply and demand of goods and services.

Since the containment policy condemns to the closure of a certain number of activities deemed non-essential, similarly the supplies of many companies have been slowed down due to the logistics problem on an international scale, which negatively affects the supply of goods and services.

Concerning the deterioration in demand, it is due to the decline in income of unemployed workers and the difficulties of the self-employed, and also to the preference for household savings in a context of crisis.

The combination of these factors has created a situation of stagflation, characterized by the coincidence of two phenomena: stagnation and inflation, a situation that is very detrimental to economies since it makes the room for maneuver of States to counteract this type of crisis very limited.

II- What are the causes of an economic crisis?

There is usually no single factor that explains the occurrence of an economic crisis. It is often a combination of parameters, including :

  • The financial crisis which brings together, under the same name, the banking, stock market, exchange rate and public debt crises;
  • The social crisis that arises from a people’s lack of confidence in its economy;
  • Monetary policy which can lead to an economic crisis if it is not sufficiently adapted to the situation of a country and consequently generates an economic bubble of overinvestment;
  • Political instability caused by wars or revolts;
  • The excessive public deficit resulting from a poor economic policy conducted by a State which, in order to redress the public accounts, pursues a strict budgetary policy such as austerity which can cause an economic crisis through the reduction of global demand.

III- What are the consequences of the economic crisis?

Most economic crises that have shaken the global economy have had a significant impact on the labor and employment markets. Numerous business bankruptcies explain rising unemployment rates and a decline in the Gross Domestic Product (GDP) of affected countries.

Internationally, these countries are generally faced with rapidly growing external debt. Furthermore, tensions between countries can arise during a global economic crisis.

Roughly speaking, we can say that the economic crisis generally translates – depending on its temporality – into :

  • GDP decline;
  • Fall in stock market values;
  • Increase in the number of business bankruptcies;
  • Increase in unemployment;
  • Increase in debt;
  • Social tensions;
  • Deterioration of thewell-being of the population.

IV- What are the different past and future economic crises?

The world has experienced several economic crises over the past two millennia, each of which has had a greater or lesser impact on the global economy.

The main economic crises are :

  • The 1929 crisis, better known as the stock market crash of October 1929, which occurred in the United States, spread to other capitalist countries and led to a 15% drop in global GDP;
  • The 2008 financial crisis or the subprime crisis, which initially appeared in the United States, then very quickly spread to the rest of the world and caused harmful repercussions on the global economy and on theinternational trade by generating a global recession;

V- Economic crisis and reform of development policies

In recent years, financial regulatory frameworks and mechanisms have been reduced or even completely dismantled, and at the same time, new financial players (hedge funds, private equity funds, etc.) and increasingly complex financial products (securitization and derivative credit) have developed without control, favoring the emergence of a “shadow banking system”.

Financial intermediaries and rating agencies, which were supposed to objectively assess risks, found themselves both judge and jury, since their income (transaction fees) was a function of the growth in the credit market.

It is in this sense that the principle of market self-regulation has also of course been undermined by conflicts of interest.

Faced with this alarming situation, marked by the disorganization of markets and price systems, the return of the strategic State is urgently needed to contribute through incentives to stabilize the situation and to mitigate volatility which is detrimental to the economic situation.

However, the success of state policy will depend on balanced intervention. Too strong, and it risks destroying incentives and private initiative. Too weak, and it will not be enough to recreate a certain order in the markets and ensure the success of expansionary fiscal policy.

For this, appropriate measures to be put in place at national and international level to circumvent the crisis can take the form of initiatives such as :

  1. National fiscal and financial recovery programs;
  2. Restore credit markets;
  3. Financial support for sectors or branches of activity most affected by the crisis;
  4. Tax incentives;
  5. Granting of subsidies;
  6. Payment of cash bonuses or interest-free loans to consumers to stimulate demand;
  7. Opening of trade;
  8. Stimulation of real aggregate demand;
  9. Breaking the process of shifting power from non-financial companies to finance;
  10. Limit shareholder control over companies, which are increasingly demanding shareholder value. By prioritizing the short term over the long term, we must go back to the causes of this change and closely study its consequences in order to propose an appropriate response;
  11. Further strengthen the regulation of the financial system in order to restore public control of the markets, and put an end to the excesses of speculation andregulate the movement of speculative private capital;
  12. Giving birth to a new model of green growth;
  13. Review international prudential standards that allow central banks to ensure financial stability without having to raise their interest rates too drastically. This involves tightening credit allocation rules and central bank asset purchase rules;
  14. Establish new, fair international economic relations based on genuine partnership and mutually supportive cooperation;
  15. Concerted global actions to stop :
  • The fall in global global demand;
  • The contraction of international trade in goods and services.

Conclusion

Faced with the resurgence of crises and the seriousness of their impact on the global economy, the adoption of a new global approach based on the control of macroeconomic imbalances, excessive deficits and debt developments is the best remedy to limit their occurrence.

52 thoughts on “Economic Crisis: Meaning, Cause and Consequence”

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