The current US economy is in a 'recession', or at least, that's the term that the financial news services are calling it. As this series of articles will explore, there may be deeper meanings to a lot of the terms, but first, we're going to start with terminology.

What we call a recession is more correctly called an economic contraction. Prior to World War II, it was called a depression, until the Great Depression made the country shy of using the term for anything short of a major calamity. Economic contractions (and periods of economic growth) are periods where the market adjusts pricing and productivity levels to match the actual demand in the market. Due to interference in the markets, (and the general chaos of markets in general), there are always trailing and leading indicators on demand and productivity.

A very simple illustration is that a company makes widgets; we'll say that the widget is an iPhone and the company is Apple. The company has a brilliant marketing strategy, and drums of great demand for their product; enough demand for the product goes through that they can ramp up production, in doing so, they invest capital in inventory, buy larger lots and get economies of scale – everyone benefits. The consumer gets their product, the company makes a bit more profit on each one, and so long as there are always more consumers wanting the product, the process looks like it can go on forever.

Unfortunately, the process can't go on forever. When the number of consumers who want a new iPhone is substantially lower than the inventory that's available to be sold, the market has reached saturation, and the company needs to cut back on production. This means that the people who manufactured iPhones have to reduce the shifts at the plants that were making them, the people who were selling them and getting commissions are making less money, and in both cases, these people are spending less money.

Multiply this by every industrial sector in an economy, and you get a recession, a period where the economy either doesn't grow, shrinks, or grows at a rate of expansion that's less than expected. There's a roughly five to eight year cycle that these patterns – accumulated from thousands of businesses working in competition and cooperation with each other – tend to follow, with larger cycles running in thirty and sixty year spans.

Recessions are part of the normal business cycle; in most business cycles, there's usually a market correction and a slowdown, followed by a reallocation of capital. While recessions are usually painted by the news as being horrible times for average Americans, the reality is that the vast majority of successful new businesses – the ones that redefine industries – happen during recessions.

The reason for this is two-fold, The first is that people who would otherwise not bother to start a business for risk of losing a comfortable job get unemployed, and many of them decide to try to market their skills freelance, focusing on meeting the needs of businesses that could no longer afford their former employer; this sort of inherent quest for market efficiency is one of the driving engines of capitalism.

The second reason is that one of the common responses to a recession is that banks and other lending institutions start looking for new customers; there are usually incentive programs for starting up new businesses. During periods where the economy is growing steadily, the general effort of the lending cycle is to maintain existing growth curves, not take new risks on new businesses.

However, when the economy shrinks, and there's a recession, there are unhappy voters, and these voters have political clout when measured en mass. What this usually means is that the government tries to intervene in the business cycle, trying to soften the blow of the recession, or give the economy a soft landing. If those phrases ring bells, that's because they've been used often, and recently.

Unfortunately, the easiest way for the government to soften the blow of a recession is to pump money into the economy; while this used to be done by 'running the printing presses', there are subtler ways to do it now. This process is usually funded by sending out treasury bills – asking other people to lend the government money; the end result is that absent market signals, this money chases the same number of goods (or even a reduced number of goods, due to altered production) and we get inflation.

This is one article of a five part series on the economy. Please use the links below to view the other economic articles in this series.

• Inflation
  
• Hyperinflation
  
• The Depression
  

Copyright © 2009 Robert Lee. All Rights Reserved.