Know the Difference: Soft Landing vs. Recession
A soft landing and a recession (also known as a “hard landing”) are similar in that they both involve the slowing of economic growth. However, in the case of a recession, the decrease in economic growth is significantly more severe and sudden with recovery often taking several years.
Following is a brief outline of the characteristics of and the differences between a soft landing and a recession.
What is a Recession?
A recession is identified as a significant decline in economic activity that is widespread and lasts more than just a few months. It typically follows a period of rapid economic growth. It is often defined as two consecutive quarters of negative Gross Domestic Product (GDP) growth.
During recessions, businesses experience reduced profits, unemployment rates rise sharply, consumer spending declines and overall confidence in the economy diminishes. Recessions are often triggered by factors such as financial crises, sharp declines in investment or consumer spending, or external shocks like natural disasters.
The length of a recession is measured from the previous economic expansion peak to the trough of the downturn. An actual recession may last only a few months but recovery to the previous peak can take years.
What is a Soft Landing?
A soft landing avoids a significant downturn in the economy. It can be identified as a period of moderate economic slowdown following a period of economic expansion.
A soft landing is characterized by a gradual decline in economic activity, typically accompanied by stable inflation rates and low unemployment levels. The goal of the central banks is to affect a “soft landing” or slowing of the economy without a significant increase in unemployment or a precipitous downturn in economic growth — the avoidance of a recession.
Encouraging a Soft Landing vs. a Recession
One of the most effective and most frequently used tools to temper economic growth is interest rate adjustment. Central banks such as the Bank of Canada (BOC) adjust interest rates to manage economic growth and inflation. When inflation is high the central banks increase interest rates with the goal of slowing economic growth and decreasing inflation.
If the central banks raise interest rates too high, too fast or for too long, it can result in a recession. If the central banks raise interest rates more slowly, this can often avoid shocking the market, encouraging a soft landing.
Avoidance of Prolonged Recessions Improving
Central banks attempt to avoid recessions with several tools at their disposal. Historically, prolonged recessions have led to periods of economic depression.
In addition to adjusting the central bank lending rate, as previously discussed, central banks often utilize open market operations and adjusting reserve requirements to help deter a possible recession.
Central banks can affect the quantity of money in circulation by buying or selling government securities through “open market operations”. For example, when a central bank wants to increase the amount of money in circulation it will purchase government securities held by commercial banks and other institutions. This provides the banks and other institutions with more cash available to loan (increased liquidity) which helps to decrease interest rates.
Reserve requirements are set by central banks in that they mandate the percentage of assets that depository institutions such as commercial banks must keep on reserve at the central bank. When the central bank wants more money in circulation it can reduce the reserve requirement. Therefore, the banks have more money available for loans, causing interest rates to decline.
In recent years, recessions have been less frequent and have decreased in their longevity. This is largely a result of more favourable inventory management due to increased use of technology, more infrequent interruptions from volatility in government spending, and on aggregate a more stable housing market.
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