What is a Recession?

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Definition:

A recession is a significant economic downturn that affects many industries and lasts more than a few months.

🤔 Understanding recessions

A recession is a significant and broad decline in economic activity that lasts a while, typically at least a few months. Some economists define a recession as two consecutive quarters of declining gross domestic product (the value of everything the country produces within its borders), adjusted for inflation. During a recession, unemployment tends to rise and inflation tends to fall. Even though recessions can be painful for consumers and companies, they are a normal part of the business cycle and they’re usually pretty brief. In the US, the National Bureau of Economic Research (NBER) officially documents when recessions begin and end. The most recent recession started in February 2020, and as of Nov. 2020, the NBER hasn’t called an end date.

Example

Up until 2020, the last significant recession in the US lasted from December 2007 to June 2009. Known as the “Great Recession,” it was the longest dip in economic activity in the US since World War II. The Great Recession occurred after many homeowners defaulted on their mortgages — That means they stopped making payments. If you’ve ever heard of the “subprime mortgage crisis,” that refers to this period in history when many home buyers received loans they probably shouldn’t have qualified for.

As foreclosures increased, banks found themselves in financial trouble and stopped lending as much. Unable to borrow, businesses were forced to cut costs and investments, which led to layoffs and further reduced consumer spending. Millions of Americans lost their homes and jobs, and the poverty rate increased.

Takeaway

A recession is kind of like driving your car downhill...

If you’re driving uphill, you can’t keep climbing forever — At some point, you hit a peak and go back downhill. The same is true for the US economy. It’s normally in a state of growth (driving uphill), but dips are a normal part of the cycle. If the car (economy) drives down a big hill for quite a while, that’s akin to a recession. Eventually, the terrain may flatten out, and the car may start another ascent.

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What is the official definition of a recession?

There’s no single definition of a recession. In general, the term describes a period in which economic activity declines significantly. Many experts define a recession as two consecutive quarters of falling economic output. This is usually measured through gross domestic product (GDP), or the value of everything a country produces within its borders, adjusted for inflation.

However, this is not the official definition. The National Bureau of Economic Research (NBER), a private nonprofit that announces the start and end of recessions in the US, has a broader description: Any significant decline in economic activity that affects many sectors and typically lasts more than a few months. The NBER looks at quarterly GDP growth when declaring a recession, but it also considers many other factors, such as employment, personal income, and industrial output.

What is gross domestic product (GDP)?

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.

Recession vs. depression explained

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.

How long does a recession tend to last?

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.

What is a recession vs. a depression vs. a bear market?

There isn’t an official distinction between a recession and a depression. The National Bureau for Economic Research doesn’t distinguish between the two — It calls any significant, broad, and lasting decline in economic activity a “recession.”

Many people use the term “depression” to describe a particularly bad recession. In the US, the most recent period that fits the bill was the Great Depression, the longest and most severe recession in modern times. It began in August 1929 and lasted nearly four years, with gross domestic product (GDP) falling by 30%, and unemployment exceededing 20%.

A bear market, on the other hand, is a period when stock prices are falling and investors are generally pessimistic about the stock market. Specifically, many economists define a bear market as a drop of more than 20% over at least two months in an index that reflects the overall market, such as the S&P 500.

Bear markets and recessions sometimes coincide, but they’re not the same thing. Bear markets describe a drop in stock prices, while recessions relate to a reduction in economic activity. The stock market and the economy are not identical, and stock prices may rise even when GDP falls.

What are signs of a recession?

To the average person, the most visible signs of a recession might be layoffs, foreclosures, or businesses shutting down — or maybe experiencing these hardships themselves.

The National Bureau of Economic Research looks at declines in some of the following as indicators of recessions:

  • Gross domestic product (GDP), or the value of everything produced in the US, adjusted for inflation
  • Gross domestic income (GDI), which measures incomes earned and costs spent to produce GDP, adjusted for inflation
  • The employment rate
  • Industrial production
  • Wholesale retail sales, adjusted for price changes
  • Personal income, adjusted for inflation
  • Monthly consumer spending, adjusted for inflation

How long do recessions last?

In the US, recessions have been relatively brief. Since the National Bureau for Economic Research started tracking business cycles — their records go back to 1854 — recessions have lasted for about 17 months on average. Between these downturns, the economy has expanded for an average of more than three years.

The longest US recession on record lasted five and a half years, going from October 1873 to March 1879. Known as the Panic of 1873, it was triggered by the collapse of firms financing railroad construction. The second-longest recession, the Great Depression, went from August 1929 to March 1933. And the Great Recession, which started in December 2007, lasted about 18 months.

What can the government do about a recession?

The government often tries to shorten recessions and expedite recovery through two types of policies:

Fiscal policy: This involves legislators adjusting tax levels and government spending. In a recession, the government may adopt an expansionary fiscal policy — reducing taxes and boosting spending. The goal is to increase demand for goods and services by putting more money in the pockets of consumers and businesses. For example, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020 to address the economic fallout from the COVID-19 pandemic. The government spent more than $2 trillion on aid to unemployed workers, small businesses, and more.

Monetary policy: This involves the Federal Reserve changing interest rates and the supply of money. During a recession, the Fed may cut interest rates and expand the money supply. Again, the point is to boost overall demand by encouraging individuals and companies to spend more money. For example, the Fed cut interest rates to nearly 0% in March 2020, a month after the pandemic ushered in a recession.

What happened during the 2008 recession?

The Great Recession, which lasted from December 2007 to June 2009, started when the U.S. housing bubble burst. Starting in 2001, banks began issuing more low-interest home loans to millions of customers who wouldn’t have previously qualified. This led to greater demand for mortgages and over time, rising home prices. Many of these homeowners had adjustable-rate mortgages, meaning that their interest rates would change (typically, increasing) after a period of time. When the rates rose, many borrowers could no longer afford payments on their loans, and many were hit with a double-whammy when they discovered that their homes were worth less than their mortgages. (In other words, they were slated to pay more than the homes were worth.)

As homeowners defaulted and foreclosures spread, banks started to struggle. (Many had originated these loans and now they weren’t being paid.) As a result, banks couldn’t lend as much, even to qualified consumers and businesses. Without access to financing, companies had to cut expenses and investments, including jobs. Higher unemployment, which peaked at 10%, meant less demand for products and services, further fueling the economic contraction. Despite legislation geared toward stimulating the economy, millions of Americans lost their savings, homes, and jobs.

Was there a recession in 2020?

According to the National Bureau of Economic Research, a recession began in the U.S. in February 2020. (The organization actually made the call in June 2020, since it could only observe the economic decline when looking backward.) Triggered by the coronavirus pandemic, the downturn ended the longest period of expansion on record, which lasted more than a decade. This moment fit the NBER’s definition of a recession because economic output dropped significantly across a wide range of industries and lasted more than a few months. The organization has not signaled an end to the recession as of October 2020, which means the economy has not officially begun a period of recovery.

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The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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