What is a Recession?

Recession Overview

A recession is a significant decline in economic activity that lasts for months or even years. Experts declare a recession when a nation’s economy experiences negative gross domestic product (GDP), rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time. Recessions are considered an unavoidable part of the business cycle—or the regular cadence of expansion and contraction that occurs in a nation’s economy.

During a recession, the economy struggles, people lose work, companies make fewer sales and the country’s overall economic output declines. The point where the economy officially falls into a recession depends on a variety of factors.

In 1974, economist Julius Shiskin came up with a few rules of thumb to define a recession: The most popular was two consecutive quarters of declining GDP. A healthy economy expands over time, so two quarters in a row of contracting output suggests there are serious underlying problems, according to Shiskin. This definition of a recession became a common standard over the years.

The National Bureau of Economic Research (NBER) is generally recognized as the authority that defines the starting and ending dates of U.S. recessions. NBER has its own definition of what constitutes a recession, namely “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Details on Economic Recessions

What Causes Recessions?
There is more than one way for a recession to get started, from a sudden economic shock to fallout from uncontrolled inflation. These phenomena are some of the main drivers of a recession:

  • A sudden economic shock

  • Excessive debt

  • Asset bubbles

  • Too much inflation

  • Too much deflation

  • Technological change


How Long Do Recessions Last?
The NBER tracks the average length of U.S. recessions. According to NBER data, from 1945 to 2009, the average recession lasted 11 months. This is an improvement over earlier eras: From 1854 to 1919, the average recession lasted 21.6 months. Over the past 30 years, the U.S. has gone through four recessions.


Can You Predict a Recession?
Given that economic forecasting is uncertain, predicting future recessions is far from easy. For example, COVID-19 appeared seemingly out of nowhere in early 2020, and within a few months the U.S. economy had been all but closed down and millions of workers had lost their jobs. The NBER has officially declared a U.S. recession due to coronavirus, noting that the U.S. economy fell into contraction starting in February 2020. That being said, there are indicators of looming trouble. The following warning signs can give you more time to figure out how to prepare for a recession before it happens:

  • An inverted yield curve

  • Declines in consumer confidence

  • A drop in the Leading Economic Index (LEI)

  • Sudden stock market declines

  • Rising unemployment

Conclusion on Recessions

You may lose your job during a recession, as unemployment levels rise. Not only are you more likely to lose your current job, it becomes much harder to find a job replacement since more people are out of work. People who keep their jobs may see cuts to pay and benefits, and struggle to negotiate future pay raises.

Investments in stocks, bonds, real estate and other assets can lose money in a recession, reducing your savings and upsetting your plans for retirement. Even worse, if you can’t pay your bills due to job loss, you may face the prospect of losing your home and other property.

Business owners make fewer sales during a recession, and may even be forced into bankruptcy. The government tries to support businesses during these tough times, like with the PPP during the coronavirus crisis, but it’s hard to keep everyone afloat during a severe downturn.

With more people unable to pay their bills during a recession, lenders tighten standards for mortgages, car loans and other types of financing. You need a better credit score or a larger down payment to qualify for a loan that would be the case during more normal economic times.

Even if you plan ahead to prepare for a recession, it can be a frightening experience. If there’s any silver lining, it’s that recessions do not last forever. Even the Great Depression eventually ended, and when it did, it was followed by arguably the strongest period of economic growth in U.S. history.

 

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