What actually causes a recession?

Most recessions start with a sudden, widespread drop in spending. Something rattles everyone at once: a financial crisis, a bubble bursting, a disaster such as a pandemic. Households buy less, and because one person's spending is somebody else's income, the caution spreads. Shops sell less, companies earn less, and when they expect things to slow down they cut jobs and save instead of investing. The newly jobless spend even less, and the slowdown feeds itself.

Economists have a name for the cruel twist at the heart of it: the paradox of thrift, popularized by John Maynard Keynes. Putting money aside for a rainy day is wise for one family. But if a whole population decides to save more at the same moment, companies' revenues fall, output shrinks and incomes drop, so in the end total saving stays the same or even falls. Everyone did the sensible thing, and everyone ended up poorer.

The spark usually comes from money itself. Banks may suddenly tighten credit, which cuts business investment and consumer spending. A central bank may raise interest rates too fast and choke off demand. Or a bubble pops: prices driven up by excessive risk-taking come crashing down. That is how the Great Depression began with the 1929 Wall Street crash. By 1933, a quarter of American workers were unemployed and 9,000 of the country's 25,000 banks had gone out of business.