What is a Recession?
A recession means an economy is declining and is widely understood to be a period when a national economy endures at least six months of slowing economic growth.
The term “recession” has a lot of different meanings. According to most economists, it’s when a national economy experiences at least six months of negative growth. An economy can be thought of as all activities involving money in a given territory. A declining economy in terms of a recession means businesses have fewer customers, industrial production and real incomes fall, jobs are harder to find, companies might see their stock prices fall, and less money flows. Growth should be the standard state of an economy. Businesses create and sell things, people work and spend money, banks lend and invest. But when certain economic metrics begin trending downward, it may signal a recession.
The most recent recession in America occurred not that long ago: From December 2007 to June 2009. It was so severe that this time has become known as “the Great Recession.” During these years, America and the world saw a steep decline in economic activity. This was most visible in the labor market, which saw the highest rate of unemployment in 25 years.
A recession is like when you’re driving uphill and your car stalls, causing you to drift backward for a while...
Economies are generally in a constant state of growth (driving uphill), but there are moments when this growth reverses for a time. This reversal is relatively healthy because, as we all know, no car can continue driving uphill forever without stopping to refuel. But if the drift goes on for too long, it creates adverse effects for everyone involved.
The textbook definition of a recession is when a national economy experiences at least six months of negative GDP growth. The six-month timeframe includes the length of two fiscal quarters, each of which is three months long. The financial world tends to view data in terms of three-month increments, with the first three months of the year being the first quarter.
In the U.S., the National Bureau of Economic Research (NBER) makes official declarations of recessions. While the textbook definition of a recession is two quarters of negative GDP growth, the NBER also uses monthly data in its decision, so it may not always coincide with the GDP numbers.
Gross domestic product (GDP) is the total value of all the products and services created inside a country’s borders during a given period. GDP is expressed as a percentage and is used as a general scoreboard of a nation’s economic health.
Recessions are thought to be less severe than depressions, partly because they don’t last as long.
For example, the Great Depression of the 1930s is defined by that entire decade, whereas the Great Recession of 2007 to 2009 is thought to have lasted only a few years.
A downturn generally needs to be at least six months long to be deemed a recession. But economic recessions tend to last for about one to two years. Plus, there can be lingering aftereffects for years after that.
Lower interest rates, for example, have been a side effect of the 2008 recession for the last 12 years. Interest rates were 0% from late 2008 until December 2015, meaning savers and bondholders couldn’t earn much, if any, interest during that time. In a historic first, interest rates have even gone negative in some places like Japan and several European countries.
In 2008, the U.S. housing market became a falling domino that almost took down the entire financial system.
Mortgage lenders lent money to people who usually wouldn’t qualify under conventional standards. Some financial institutions then packaged these subprime loans into debt instruments called “mortgage-backed securities,” which they sold to other banks.
Many borrowers began defaulting on their mortgages, making the mortgage-backed securities toxic assets that no one wanted to hold on to. Banks were now in a tight spot and were threatened with insolvency, meaning they were on the verge of bankruptcy.
That’s when the government and central bank stepped in. A “bailout” was created for banks deemed “too big to fail.” The concern was that their failure would have catastrophic consequences for the entire global economic and financial system.
So, rather than let the banks go belly up, the government passed a bill called the Troubled Asset Relief Program, also known as TARP. This program lent about $700 billion to the banks to prevent them from going bankrupt.
The government also enacted several fiscal stimulus programs to help ease the hard times that many Americans were experiencing. These stimulus programs included things like expansions of social welfare programs, aid to state governments, and increased infrastructure spending.
The Federal Reserve (America’s central bank) also lowered interest rates to 0% and created trillions of new dollars to purchase assets like U.S. government bonds.
A lot of things can indicate a recession. For example, you might recall seeing a lot of empty commercial retail buildings with “for lease” signs in them throughout 2008 and 2009. Or maybe you knew someone who lost their job or even their home.
These are some of the most visible effects of recessions as they occur, but economists also examine data to pinpoint the onset of a recession.
The official definition of an economic recession is at least six months of negative GDP growth, so most people use changes in real GDP (GDP adjusted for inflation) to identify a recession. However, the National Bureau of Economic Research (NBER) tracks the following indicators of recessions:
Most economists view recessions as a normal and healthy part of the business cycle. If an economy continues expanding forever, it can create excess inflation, meaning prices keep drifting upwards. A recession lets out some of the hot air in the financial system, essentially balancing things out.
No one can say for sure when the next recession will happen. There are too many complex variables to take into consideration. Plus, most of the indicators get reported after they’ve occurred and a downturn has to occur for at least six months before it’s considered a recession. That means recessions are often not announced until after we’ve already been experiencing one for awhile.
However, some indications hint that the next recession could be coming sooner rather than later. For example, in 2019, one economic indicator that has a very reliable track record of predicting recessions reared its ugly head. It’s what’s known as an “inversion of the yield curve.”
The yield curve refers to the difference between the interest rate yielded by two types of government bonds: A short-term treasury note and a long-term treasury note. Most of the time, investors demand a higher return for bonds that have a longer maturity time frame. So, a 10-year bond should yield more than a 2-year bond.
But when investors feel that risk is rising in the short-term, they pile into long-term treasuries, which are thought to be one of the safest investments. This trend causes the price of long-term treasuries to rise. And because the price of a bond is the inverse of its interest rate, that means rates on long-term bonds fall.
When rates on long-term bonds fall so far that they go below the costs of short-term bonds, you get what’s referred to as an inversion of the yield curve. This indicator was seen in 2019, which may indicate the next economic recession will occur soon. An inversion of the yield curve has accurately predicted every single recession since the 1960s, although some sources say it’s not infallible.
Is a recession coming? Well, yes – there’s always one coming.
Ever since economists can remember, there has been a “boom-bust” cycle characterized by long periods of gradual growth punctuated by short periods of rapid decline.
The only question, then, is when the next recession will hit.
As for America in 2020, it’s plausible we might see a recession during this time. Some economists believe the early signs of a recession have already appeared. But it’s not possible to say definitively yet.
Avoid trusting anyone who says to expect a recession for certain at a specific time, or any other economic trend, for that matter. People who make these claims are likely trying to influence your investment behavior because no one has that kind of exact knowledge.
However, if history does repeat itself, there could be a recession coming within 24 months of the most recent inversion of the yield curve, meaning that a recession in 2020 or 2021 is likely. But past performance doesn’t always predict future results – That’s a concept that applies to the financial world as a whole.
What is Depreciation?
A candy machine can lose value as it ages — Depreciation is how a candy-making business can account for that change in value over a specific period of time.
What is Arbitrage?
There are plenty of investing strategies out there — But arbitrage is a short-term investment tactic in which an investor aims to profit by purchasing an asset while simultaneously selling that asset at a higher price in a different marketplace.
What is an Asset?
An asset is cash or anything of value that a company, person, or other entity owns and can reasonably expect to generate cash in the future.
What is a Payday Loan?
A payday loan is an expensive, short-term loan aimed at people who need a small amount of cash to make it to their next payday.
What is Operating Income?
Operating income is a measure of the money that a business makes from its primary operations, minus the expenses it incurs to make that money, such as wages and cost of goods sold.