When it comes to finances, your own pocketbook is enough to worry about. There are bills, budgeting, saving, and investing. But whether you realize it or not, there are massive economic factors that filter into your everyday personal finances. One macroeconomic concept that can throw a wrench in your carefully curated financial plans: a recession.
What Is a Recession?
A recession is a period of slowed or negative economic growth that affects a specific region or entire country. Recessions typically last several months.
The National Bureau of Economic Research (NBER) officially declares recessions. While its exact definition has slightly shifted in recent years, a couple of things remain the same: recessions spread across the economy and affect several markets, and they have prolonged negative impacts.
What Happens During a Recession?
When a region or country is experiencing an economic recession, a number of things can occur:
- Negative GDP growth
- Higher unemployment rates
- Decrease in real income (income adjusted for inflation)
- Drop in industrial production and wholesale-retail sales
- Business and bank failures
- Asset prices plummet
- Fluctuations in the stock market
A decline in real GDP is one of the leading indicators of a recession. Gross domestic product (GDP) is the total value of goods and services produced in a region or country during a given period. When GDP drops, that can mean that the region or country has entered a recession.
Previously, if an area experienced two consecutive quarters of economic decline — or a decline in real GDP — the NBER recognized it as an economic recession.
Today, the definition is a little bit different. Now, the NBER says a recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
Each economic recession is measured against three criteria: depth, diffusion, and duration. While all three have to be met to some degree, the severity of each can vary.
Example of a recession
In 2020, the U.S. experienced an economic recession with the onset of the COVID-19 pandemic. U.S. GDP decreased 34.3% in Q2 of 2020. It then increased 38% in Q3 and another 6.0% in Q4.
Technically, there was only a single quarter of economic decline, but it affected several areas of the economy, including employment and sales.
This is a prime example of how depth, diffusion, and duration can ebb and flow from recession to recession. While the duration of the recession in early 2020 was relatively short, the depth and diffusion of the virus’s economic impact catapulted the country — even the world — into a an economic crisis.
What Causes Recessions?
There are a number of theories as to why recessions begin. Here are three of the most widely accepted explanations:
- Economic influence
- Financial influence
- Psychological influence
For the record, a recession may also start as a result of any combination of these causes.
There is a camp of economists that believe massive, industrial changes usher in recessions. This may look like: artificial intelligence eliminating job opportunities, geopolitical conflict, or a global pandemic forcing countries into lockdown and thereby decreasing retail production. All of these things have a profound impact that can lead to economic decline.
Another camp of economists believes that finances are largely to blame for recessions. This rationale assumes that lenders issue credit liberally pre-recession, and at lower rates. When the time comes for borrowers to repay their debts, they struggle and default.
Alternatively, a massive switch in credit issued by lenders can lead to a recession. For instance, if lenders initially issue a lot of credit but flip the switch and under-extend credit to consumers, this can trigger a recession.
There is a final rationale that places a great deal of power on the citizens of an area to influence recessions. In essence, if people have spent a period of time over-indulging or spending their cash freely, but then they drastically stop spending, this can negatively impact the economy. This may happen if the citizens of the area get word that a recession is approaching, increasing the likelihood that they’d go into a hyper-conservative spending mode, only worsening the effects of the recession. In effect, both supply and demand for products and services decrease.
Are We In a Recession?
As of May 24, 2022, the U.S. is not currently in a recession. However, economic research and reports by the SEC indicate that the country could be headed for one.
The U.S. economy bounced back from mass unemployment and shutdowns brought on by the COVID-19 pandemic. However, inflation, rising interest rates, and increased government spending could foreshadow a recession in the coming months. To stabilize prices risks triggering a recession.
Difference Between Recession and Depression
Economic downturn signals both recessions and depressions. However, depressions are much more severe and last longer than recessions, usually a year or more. A prolonged recession can turn into a depression.
The Great Depression was the most recent depression in the U.S. It reached its peak from 1929–1933 and had several defining characteristics, including:
- Unemployment rate of 24.9%
- Thousands of bank failures
- Significant decrease in housing prices
- Collapse of international trade
The effects of the Great Depression were felt far beyond 1933. Eventually, the depression and decreased economic activity spread worldwide. The Great Depression only ended in the U.S. once the country mobilized for World War II, with millions of people joining the armed forces and picking up well-paying defense jobs.
Recent Recessions in U.S. History
The U.S. has experienced 12 recessions since World War II, some more detrimental than others.
The period from 2009 to 2020 is considered the longest period of economic growth in the U.S. Unfortunately, it screeched to a halt with the onset of the COVID-19 pandemic. Economic decline lasted only one quarter. Although short-lived, this recession was characterized by sky-high unemployment, mass business and industry shutdowns, lockdowns for many countries around the world, plummeting retail sales, a stock market crash, and more.
The period of negative economic growth from 2007–2009 was known as the “Great Recession”, and at the time, it was the most significant decline that the U.S. had experienced since the Great Depression in the 1930s.
Just before the recession, the U.S. underwent a housing bubble. During a housing bubble, demand for real estate exceeds supply, causing real estate prices to increase. The Great Recession burst the mid-2000s housing bubble, so lenders dropped mortgage interest rates to encourage homeownership. However, feeling the financial effects of the recession, new homeowners couldn’t even afford these lower interest rates.
This ushered in a full-scale financial crisis. Real GDP decreased 4.3%, and unemployment hit 10.6%.
Along with the new millennium came widespread uncertainty for Americans and businesses. Dot-com businesses had bubbled up in the decade prior, but the Y2K scare wreaked havoc, as much of the population worried about how technology would transition from 1999 to 2000.
The 9/11 terrorist attacks also created disarray, eventually rippling through the stock market, airline and insurance industries, and other major sectors.