What Causes a Recession to be a Recession?

Several factors determine what is designed as a recession. A group of economists in the National Bureau of Economic Research, NBER, in Cambridge, Massachusetts, officially declare when the recessions begin and when they end in the United States. This group has a long list of criteria that start with a diminishment in production and an increase in unemployment and includes many other factors; amongst these how fast the companies receive new orders. Sometimes these other factors make the NBER consider that the economy has reached a peak and has entered into a recession, even when the production is not diminishing.  

Adjusting Inventories, Not Prices
John Maynard Keynes not only discovered that rigid prices caused recessions, but he also developed a model that has had an enormous influence and that is still presented in many texts of macroeconomics. The model has a very complete focus on managing macroeconomics and it received the name of keynesism, which was a focus that favored important government interventions in the economy instead of non-interventional policies of laissez faire that other people prefer.

To be fair, we need to point out that keynesism has been highly criticized and is not the great panacea of macroeconomics. But the part we are presenting does not cause controversy. It explains how an economy adjusts itself to equilibrium, which is a point in which added supply equals added demand, after an economic impact in a term that was so short that the prices do not even change at all.

The Keynes model focuses the attention on the inventories of goods that the companies produced but have not yet been sold. According to Keynes, the changes in the inventories guide the companies to increase or decrease production during the situations where the prices are rigid and cannot serve as signs of what should be done.

To see the novelty of the idea of the inventories of Keynes, it is necessary to understand that if the prices were to change, then the prices (not the inventories) would guide the companies in the decisions about the amount that should be produced.

• If the prices were increasing, a company would know that their product is popular and that they should increase the production thereof.

• If the prices were decreasing, the company would know that their product is not selling well and that they should probably reduce the production thereof.

In an economy with fixed prices, however, the companies need another way of deciding whether they should increase or decrease the production. Keynes realized that the key is to observe the changes in the inventories.