Understanding Recession: How the Economy Slows Down

The economic crisis is a topic that is constantly present in the media. News repeatedly report that the USA or European countries could be on the brink of an economic contraction. Germany has been experiencing economic stagnation for some time now. Some experts argue that we are already in the middle of it, while skeptics point out that stock markets worldwide are still rising and many companies are reporting record results. But what exactly lies behind this often-used term, and how can a decline in economic activity be identified at all?

What is a recession really?

A recession describes a significant, widespread, and prolonged decline in economic activity. The rule of thumb states: if gross domestic product (GDP) shrinks over two consecutive quarters, economists call it a recession. A stable economic system usually shows growth, so two quarters of declining performance indicate fundamental problems.

In some countries like Germany, the definition of recession is handled a bit differently. Here, production potential is used as a measure – that is, the question: what level of economic output would theoretically be possible if all resources and labor were used optimally? The larger the gap between actual and potential output, the clearer the economic downturn becomes.

Triggers for economic contractions

Every recession has different causes. Countries that grow continuously naturally go through economic cycles – phases of expansion and contraction. But there are also external factors that can trigger declines, often unpredictably.

Inflation and interest rate hikes: Rising prices force central banks to act. They increase key interest rates to curb inflation. Higher interest rates make borrowing more expensive, leading to less investment, job cuts, and reduced spending. Businesses and consumers become more cautious, hold back money, and refrain from purchases. The economic downturn intensifies when companies cut back production and lay off staff.

Overproduction: During boom times, companies increase production to meet high demand. Once demand decreases, an oversupply of goods and services occurs, which cannot be sold. This forces companies to reduce production and lay off workers, while consumers lose purchasing power and buy even less.

Uncertainty and external shocks: When people are unsure how the economy will develop, business decisions become riskier. Wars, pandemics, or geopolitical crises make consumer behavior unpredictable in the short and long term. Companies then postpone investments and new hires, leading to a chain reaction that reduces economic activity.

Energy costs: Energy is the backbone of any economy. When oil prices and gas costs suddenly rise – for example, due to geopolitical tensions – import-dependent countries are heavily affected. Germany, which mainly imports oil and gas, was strongly impacted by such price spikes, as the energy crisis of recent years clearly showed.

Speculative bubbles: Sometimes economic bubbles form when prices for certain assets soar based on speculation, trends, or exaggerated consumer confidence. Investors buy in hopes of gains. But when they start selling, supply exceeds demand, prices plummet – the bubble bursts. The dot-com bubble of 2000 and the real estate bubble of 2008 are classic examples. The US housing crisis of 2008 directly led to a global financial crisis.

The 2008 real estate crisis vividly demonstrates how a crash can unfold: banks recklessly issued low-interest mortgages to buyers who couldn’t afford them. High-risk mortgage packages were bundled and sold on. When default rates soared, financial institutions faced serious difficulties. The real estate market collapsed, foreclosures increased. Stock markets then fell sharply, major corporations went bankrupt. Mass layoffs worldwide followed. Credit availability shrank, trust in financial stability shattered. Only drastic government interventions finally ended this recession.

Is Germany really in an economic contraction?

To answer this question, let’s look at the data. In 2023, GDP grew in the first quarter, but stagnated in the second and third quarters, and fell in the fourth quarter. Even if we don’t fully count the two stagnation phases: with a decline in the first quarter of 2024, Germany would definitely meet the recession definition.

Official figures for Q1 2024 were not yet available at that time, but leading economic research institutes forecasted a negative growth of about 0.1% compared to the previous quarter. This means the German economy was in a recession during the winter half-year 2023/24 – two consecutive quarters of shrinking performance. One could argue that the two stagnation phases of 2023 already felt like a recession, only they do not technically meet the classic definition.

Particularly noteworthy: Germany, Europe’s largest economy and historically known as an economic powerhouse, entered this downturn. How could this happen to the land of the economic miracle?

Reasons for Germany’s economic slowdown

Using the mentioned triggers, we can understand which factors hit Germany. The country was battling multiple challenges simultaneously.

A critical problem was the decline in the construction sector. The Purchasing Managers’ Index (PMI) for the construction industry fell to multi-year lows in 2023, as housing projects declined faster than since the mid-1990s. The ECB interest rate hikes massively increased the cost of available capital, causing ongoing projects to be postponed or canceled altogether.

The ongoing effects of the Ukraine war manifested in Germany mainly through exploding energy prices. Although the government put support packages in place for industry, it was unclear how sustainable these measures would be. Consumer spending measurably declined as households struggled with higher energy costs and uncertainty. Export demand from abroad also decreased, burdening German exporters.

In summary: high energy costs, rising interest rates, and reduced investments due to economic uncertainty – these factors pushed Germany into the recession cycle.

What does a recession mean for individuals?

A bitter reality of recessions: millions of people lose their jobs. When spending decreases and the economy shrinks, corporate profits also decline. To maintain margins, companies do not hire and cut staff. With rising unemployment, it becomes increasingly difficult for job seekers to find positions.

An additional effect: Workers lose bargaining power. When fewer companies are hiring, employers can push for lower wages and worse social benefits. Bonus payments are cut, salary increases are postponed. Flexible working hours or home office – luxuries that employers can do without.

Even those who keep their jobs suffer from high prices. Purchasing power declines, wages do not keep pace with inflation. The consumer becomes effectively poorer.

Another effect: Access to credit becomes more difficult. Lenders become more cautious, scrutinize creditworthiness and job security more closely. Precautionary measures make it harder for consumers to get loans for houses, cars, or major purchases – these are postponed or abandoned altogether.

The psychological impact is also significant: Financial anxiety increases. Worries about job and payment security burden well-being. This has not only personal but also economic consequences, as demoralized consumers spend even less.

Strategies for tough times

For average workers, a recession means: value your current job as long as you have it. At the same time, invest in further training to increase your marketability. A side income is a practical safeguard against economic downturns. Some people also explore alternative income sources during such phases, like trading on financial markets – something that can be done flexibly from home.

For personal finances: tighten the belt, pay off debts before interest rates rise further. Experts like the chief economist of Commerzbank forecasted a GDP decline of about 0.3% in 2024. The president of a leading economic research institute described the outlook for Germany as “more subdued.”

Opportunities in difficult market phases

For traders and investors, a recession does not have to be negative. Those betting on falling prices can profit even in downturns. The famous investor Warren Buffett aptly said: “Be fearful when others are greedy, and be greedy when others are fearful.” This means: while others hesitate to invest and are afraid, savvy investors buy stocks and other assets at favorable prices.

Besides stocks, there are other asset classes. Gold, for example, recently reached new record prices. Wars, geopolitical tensions, and natural disasters always offer short-term trading opportunities – regardless of the recession phase. Major political events like presidential elections can also move markets and create trading opportunities.

For someone active in financial markets, there is no reason to lose hope. On the contrary: volatile markets offer opportunities. Whether prices fall or rise – for traders, recession is a phase with many movements and thus potential profits. The market direction is ultimately secondary. What matters is that markets move – and you benefit from that when you use the right strategies.