What is a Recession?
In the nation’s history, there have been nearly 50 recessions, from the Panic of 1873 to the brief 1926 slump. Over the last 20 years alone, there have been three major recessions in the United States, each economic downturn having its impact on the country in various ways.
The 2001 recession ended a decade of growth, but it was short-lived (eight months) and shallow. The 2007-2009 Great Recession (18 months) dismantled the housing market, collapsed the financial sector, and led to the bailout of corporations. The COVID-19 crisis was one of the most significant and unique recessions in history, with 24 million people losing their jobs in only a couple of months. Millions of Americans have still not recovered to this date.
Each event forced the federal government to open Uncle Sam’s wallet and bust the budget while also pushing the Federal Reserve to expand monetary policy in extraordinary ways.
Despite the economic hardship spawned by recessions – job losses, corporate bankruptcies, and market readjustments – they are an inevitable part of the ebbs and flows of every economy. In many cases, they can make the economy more prosperous in the long term by encouraging greater competency, liquidity, and efficiency.
That said, aside from being loosely classified as an economic downturn, what exactly is a recession?
What is a Recession?
The most basic explanation for a recession is when the gross domestic product (GDP) growth rate contracts for at least two consecutive quarters.
The National Bureau of Economic Research (NBER), a non-profit research organization that conducts and shares economic research for policymakers, universities, and corporations, is the source for announcing when recessions begin or end, monitoring stages of the business cycle. The entity assesses the following several economic indicators to highlight whether an economy is in an expansion or contraction phase:
- Real income
- Wholesale-retail sales
- Monthly GDP estimates
The Bureau of Labor Statistics (BLS) uses the following factors to determine if an economic downturn or recession has arrived:
- A two-point increase in the unemployment rate of at least six percent.
- A 1.5% drop in real gross national product (GNP).
- A 1.5% decrease in non-farm payroll employment.
- A slide in manufacturing over a six-month period.
- A reduction in employment in more than 75% of industries for six or more months.
In the COVID-19 recession, we witnessed a prime example of an economy on very shaky ground. The GDP collapsed at an annualized rate of 38 percent, 16 million jobs were eliminated in less than a month, the unemployment rate hit double-digits, and consumer spending cratered 17 percent. It was a devastating blow to the U.S. and the effects are still being felt today.
The Causes of a Recession
So, what causes an economic recession? Several elements are associated with these declines in economic activity, from investment to consumer confidence, to inflation. Recessions are typically caused by a complex combination of factors.
Let’s take a look at some of the more common factors that can cause a significant slowdown in economic growth:
- Financial Factors:
- High interest rates: The central bank starts to tighten monetary policy by raising interest rates which makes it more expensive for people and businesses to borrow money to spend or invest.
- Falling housing prices: As homeowners lose equity in their homes, they are unable to use leverage for consumer spending.
- Credit crunches: Banks and other financial institutions are less likely to lend, slowing the growth of the economy.
- Asset bubbles bursting: Whether in housing or stocks, this creates a domino effect for other sectors of the broader economy.
- A Loss of Confidence:
- Loss of consumer confidence: Consumers stop spending, and retail sales slow.
- Market crash: A lack of investor confidence drains capital from businesses.
- Government Intervention:
- Price / Wage controls: These lead to job losses and sliding consumer demand.
- Too much / too little regulation: Safeguards can both prevent and cause changes in demand, employment, and inflation.
As these factors unfold, they negatively impact consumption, investment, government spending, exports, and imports. This is because these components of the economy are interconnected.
Benefits of a Recession
A recession can cause enormous pain for nearly everyone. But despite the hardships, there is a silver lining as there are several overarching benefits to an economic downturn.
Recessions can cure inflation and make the cost of living more affordable. Studies have found a self-employment boom near the end of the recession and at the beginning of the recovery. The broader economy becomes a well-oiled machine as the more productive businesses absorb assets from the unproductive firms. Efficiency and innovation soar following a recession.
What Does a Recovery Look Like?
The post-recession recovery comes in various shapes and sizes. It can be an on-again, off-again recovery. Or it can benefit only a particular group of people.
- W-shaped: A sharp decrease in GDP, followed by a significant rally, followed by another substantial decline. This is a double-dip recession.
- V-shaped: A monumental collapse followed by a fast and strong recovery.
- U-shaped: A recession without a fast rebound, taking up to 24 months to return to pre-recession levels.
- L-shaped: A collapse in the economy without a substantial recovery.
- K-shaped: The economy recovers in various sectors at different times and rates.
- Swoosh: A steep decline followed by slow recovery.
How to Survive a Recession
You might be wondering if there are any measures you can employ to shield yourself from the harmful effects of a recession. The answer is yes and you can read more about how to prepare for a recession here. The two most effective methods to build your financial security are saving as much money as you can when working, and by living within your means (or avoiding debt where you can).
Smart financial management includes finding ways to make your money work harder for you, such as opening a Finch account, helping you create a plush financial cushion to better weather any economic storm clouds, whether a minor downturn or a full-blown recession!