Difference Between Recession and Financial Crisis

Financial stability is a major goal for all of us. While this is highly achievable, matters beyond our control can limit this. Think of drastic government policies, economic structural shifts, unfavorable monetary policies, stock market crash, a currency crisis, a financial bubble or sovereign default, which may cause recessions or financial crisis. While most of these factors go beyond our control, understanding of the terms recessions and financial crises can go a long way in learning how we can prevent these disruptive scenarios. While recessions and financial crises both result in poor economic growth and stagnation, they have differences. 

What is a Recession?

This is a significant decline in economic activities in a certain region or worldwide over a given period, usually two consecutive quarters as a result of drastic government policies, economic structural shifts, and unfavorable monetary policies. Measured through gross domestic product, recessions have a negative impact on industrial production, retail sales, employment, industrial sales not to mention real income. This is as a result of a drop in spending that may be caused by a supply shock, financial crisis, external trade shock or the bursting on an economic bubble in a major economic sector. 

Since the end of the industrial revolution in the 1800s, economic growth has been witnessed globally. However, short term fluctuations have occurred, whereby major macroeconomic indicators have declined or slowed down, before returning to the normal growth scales, a situation referred to as recession. Although these situations can be temporal, the effects can have adverse effects on an economy and can take longer to recover. Governments may respond to recession through the adoption of macroeconomic policies, decreasing taxation and increasing government spending. 

What is a Financial Crisis?

This is a significant decline in the value of assets coupled with the inability of consumers to pay off their debts as well as liquidity shortages in financial institutions. This occurs as a result of a bank run or a panic whereby investors sell off their assets due to the fear of a decline in pricing followed with massive cash withdrawals from the financial institutions. A financial crisis can also occur in the event of a stock market crash, a currency crisis, a financial bubble or a sovereign default. It can occur in banks, single, regional or worldwide economies. 

Other causes of a financial crisis include:

• Uncontrollable human behavior
• Contagion- This is the thought that a crisis will spread to other institutions
• Systemic failures 
• Regulatory failures 
• Leverage- Borrowing to finance investments may cause a financial crisis in case the money is lost

Types of financial crises include currency crisis, banking crisis, international financial crisis, and speculative bubbles and crushes. Previous financial crisis scenarios include Tulip Mania of 1637, Stock Crash of 1929 and the 2007-2008 global financial crisis.  

Similarities between Recession and Financial crisis

• Both result in slow economic growth

Differences between Recession and Financial crisis

Definition

Recession refers to a significant decline in economic activities in a certain region or worldwide over a given period, usually two consecutive quarters. On the other hand, a financial crisis refers to a significant decline in the value of assets coupled with the inability of consumers to pay off their debts as well as liquidity shortages in financial institutions.

Causes

A recession is caused by drastic government policies, economic structural shifts, and unfavorable monetary policies. On the other hand, a financial crisis is caused by uncontrollable human behavior, contagion, systemic failures, regulatory failures, and leverage. 

Measure

While a recession is measured through the gross domestic product of an economy, a financial crisis does not have a unit of measure. 

Effects

While recessions result in changes in an economy, financial crises affects paper wealth. 

Recession vs. Financial crisis Comparison Table

Summary Recession and Financial crisis

A recession refers to a significant decline in economic activities in a certain region or worldwide over a given period, usually two consecutive quarters. It is caused by drastic government policies, economic structural shifts, and unfavorable monetary policies. On the other hand, a financial crisis refers to a significant decline in the value of assets coupled with the inability of consumers to pay off their debts as well as liquidity shortages in financial institutions. It is caused by uncontrollable human behavior, contagion, systemic failures, regulatory failures, and leverage. 

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