- A recession is a phase of decline in general economic activity that is usually defined when an economy experiences a decline in its gross domestic product in two consecutive quarters.
- Other recession indicators include rising unemployment, falling retail sales, slowing production growth and a decline in real personal income.
- While uncomfortable and alarming, it's important to understand that recessions are a natural occurrence in the modern economy.
- You can find more stories on the Business Insider homepage.
In business, the word "recession" is a term that no one ever likes to hear.
But apart from the experience of an impending financial crisis, growing unemployment and great fiscal uncertainty, what exactly is a recession?
What is a recession?
A recession is a major economic downturn across the economy that lasts more than a few quarters.
In particular, the term is typically defined as a period in which gross domestic product (GDP) falls in two consecutive quarters. This prevailing train of thought was Popularized by economist Julius Shiskin in 1974.
But the truth is that there are a variety of indicators that determine whether we are in a recession.
A better way to understand how experts define recessions is to compare them to how Supreme Court Justice Potter Stewart described his notorious opinion of obscenity: economists know when they see it.
The National Bureau of Economic Research (NBER), the private, nonprofit research group responsible for tracking the start and end dates of US recessions, offers offers to help define recessions a wider range of economic indicators These include employment rates, gross domestic income (GDI), wholesale and retail sales, and industrial production.
In a recession, you can feel these effects in different ways: unemployment claims are increasing, spending habits are changing, sales are slowing and economic opportunities are dwindling.
In practice, recessions are characterized not only by a slump in real GDP, but also by a decrease in real personal income, a decrease in manufacturing sales and production, and an increase in unemployment rates.
Recessions and the business cycle
To understand the macroeconomic variables that make up recessions, Giacomo SantalegoPhD, lecturer in economics at Fordham University, said it is important to recognize the relationship between recessions and the business cycle.
An economic cycle tracks the ups and downs of US economic activity with a view to a long-term growth trend. As the cycle tracks the wide up and down movements of economic indicators, it is often an economic policy focus.
Indeed, recessions are considered a normal part of the business cycle. According to the NBERThere have been 33 recessions in the United States since 1857.
Business cycles are understood to mean four different phases:
- Extension: This phase is a phase of economic growth. It is often characterized by an increase in employment and an increase in consumer spending and demand, which leads to an increase in the production and costs of goods and services.
- Summit: The highest point in an economic cycle, indicating when an economy has peaked. This is usually viewed as a turning point in the contraction phase.
- Contraction: A period characterized by a decline in economic activity, often characterized by falling GDP, rising unemployment and other related economic indicators. If growth shrinks, the economy will go into recession.
- Trough: The lowest point in an economic cycle that marks the "bottom" of economic activity. The trough is a turning point, followed by a new wave of expansion.
It is important to note that business cycles do not occur at predictable intervals. Instead, they are irregularly long and their severity is reflected in the economic variables of the time.
What causes a recession?
Generally speaking, expansion and growth in an economy cannot last forever. A significant decline in economic activity is usually triggered by a complex, interrelated combination of factors, including:
Economic shocks. An unpredictable event that causes widespread economic disruptions such as natural disasters or terrorist attacks. The most recent example is the recent COVID 19 outbreak.
Loss of consumer confidence. When consumers are concerned about the economic situation, they slow down their spending and keep everything they can. Because nearby 70% of GDP depend on consumer spendingthe whole economy can slow down drastically.
High interest rates. High interest rates make it expensive for consumers to buy houses, cars, and other large purchases. Companies are reducing their spending and growth plans because the financing costs are too high. The economy is shrinking.
Deflation. Unlike inflation, deflation means that product and asset prices fall due to a sharp drop in demand. When demand drops, sellers' prices also try to attract buyers. People are shifting their purchases, waiting for lower prices, which leads to a continuing downward spiral or slow economic activity and higher unemployment.
Asset bubbles. In a wealth bubble, prices for things like tech stocks in the dotcom era or real estate before the Great Recession are rising rapidly because buyers believe they will keep rising. But then the bubble bursts, people lose what they had on paper, and fear sets in. As a result, people and businesses are retreating and giving way to a recession.
How long do recessions last?
Due to the unpredictability of recessions, it is difficult to assess how long they last.
"At some point the markets turn around," says Santangelo. "What is causing this economic turnaround? The same thing at the top: things that are unpredictable."
The NBER follows a Business cycle dating process This is retrospective, waiting for enough data to be released when we reach the phase of the cycle. However, what we can do is look at the insights from past recessions:
The Great Recession (December 2007 – June 2009)
At that time, the Great Recession was the worst and deepest economic downturn since the Great Depression. This was the result of real estate bubbles and complex investments called derivatives.
Although it only lasted 18 months, the recession had a profound impact on the following decade, as the recovery – the path from bottom to top – can take years.
While the housing market has recovered, there are currently millions of Americans who still haven't regained what they lost. This shows that a rising tide will only raise all boats if they can reach each of them.
Dot-com recession (March 2001 – November 2001)
The dotcom recession was the result of a bubble in technology stocks as the commercial use of the Internet grew rapidly. In addition, the Y2K problem – the fear that computers and software would collapse because double-digit numbers were used for years – caused massive amounts of one-time purchases.
The ability to own technology attracted more individuals and institutions and pushed up share prices. But like any bubble, it couldn't last, especially after 9/11 rocked the country.
One reason for the short term of eight months was the economic impetus from the George W. Bush administration's tax cuts and the Federal Reserve's interest rate cuts.
Gulf War Recession (July 1990 – March 1991)
This eight-month recession was triggered by several factors: an increase in oil prices, a shift in jobs and production to Mexico and Canada with the start of NAFTA, a two-year rate hike by the Fed, and a slowdown in defense spending with the end of the Cold War .
The end of the Gulf War helped stabilize oil prices, causing the economy to bottom. However, the recovery was difficult: unemployment rose to 7.8% in 1992.
The final result
What makes a recession a recession apart from the subjective feeling of a "bad" business cycle, where everything slows down, people lose wealth and unemployment increases?
The short answer: there are many factors that define a recession. Understanding that they are part of the normal ups and downs of the economy can help you prepare and survive the inevitable downturns.