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Understanding Recession

A recession is a macroeconomic term that refers to a significant decline in economic activity, lasting more than a few months.

There is no single way to predict how and when a recession will occur. You may hear that a recession occurs when the real GDP growth rate is negative for two consecutive quarters or more. And yes, the most important indicator of a recession is real GDP, which is a measurement of everything businesses and individuals produce. It's called "real" because the effects of inflation are stripped out.

When the real GDP growth rate first turns negative, it could signal a recession, but sometimes growth will be negative and then turn positive in the next quarter. That's why the US’s National Bureau of Economic Research (NBER) monitors the following four factors/ indicators using monthly data, and when these economic indicators decline, so will GDP:

1. Real income: measures personal income adjusted for inflation. Transfer payments, such as Social Security and welfare payments, are removed. When real income declines, so do consumer purchases and demand.
2. Employment: the employment rate and real income together tell the commissioners about the overall health of the economy.
3. Industrial production: the commissioners look at the manufacturing sector's health, as measured by the Industrial Production Report.
4. Retail sales, adjusted for inflation: tell commissioners how companies are responding to consumer demand. 

Recessions and the business cycle

To understand the variables that constitute recessions, it's important to acknowledge the relationship between recessions and the business cycle.

A business cycle tracks the up-and-down fluctuations natural to any capitalistic economy. Because the cycle traces the wide-ranging upward and downward comovements of economic indicators, recessions are considered to be a normal part of the business cycle. According to the NBER, there have been 33 recessions in the United States since

Business cycles are understood as having four phases:

Expansion: This phase represents a period of economic growth, also considered the "normal" phase of the business cycle. It is often characterized by an increase in employment and a swelling of consumer spending and demand, which leads to an increase in the production and cost of goods and services.

Peak: The highest point of a business cycle that signifies when an economy has reached its crest of output. Here, there's nowhere to go but down, sending the economy into a contraction phase. This can happen for any number of reasons, either investors get too speculative and create an asset bubble or industrial production starts outpacing demand.

Contraction: A period that is marked by a decline in economic activity often identified by a rise in unemployment as well as a bear market. Additionally, GDP growth falls under 2%. As growth contracts, the economy enters a recession.

Trough: A trough is a turning point that marks the bottom of a business cycle's economic activity and marks the start of a new wave of expansion and a new business cycle.

It's important to note that business cycles do not occur at predictable intervals. Instead, they are irregular in length, and their severity is reflected by the economic variables of the time. That said, the average post-World War II business cycle lasted 65 months, according to the Congressional Research Service.

Why does a recession occur?

Numerous economic theories attempt to explain why and how the economy might fall off of its long-term growth trend and into a period of temporary recession. There are a variety of reasons recessions occur. Some are associated with sharp changes in prices, which lead to a steep drop in spending. For example, a sudden, sustained spike in oil prices due to a geopolitical crisis might simultaneously raise costs across many industries or a revolutionary new technology might rapidly make entire industries obsolete.

The spread of the COVID epidemic and the resulting public health lockdowns in the economy in are an example of the type of economic shock that can precipitate a recession.

Some recessions, like the global financial meltdown, are rooted in financial market problems. Sharp increases in asset prices and overexpansion of credit often coincide with an accumulation of debt.

As corporations and households get over-extended and face difficulties in meeting their debt obligations, they reduce investment and consumption, which in turn leads to a decrease in economic activity.

In some countries with strong export sectors, recessions can be the result of a decline in external demand. Adverse effects of recessions in large countries are rapidly felt by their regional trading partners, especially during globally synchronized recessions.

To sum up, a significant decline in economic activity is usually triggered by a complex, interconnected combination of factors, including:

• Economic shocks - an unpredictable event that causes widespread economic disruption, such as a natural disaster, a war, a terrorist attack, or latest COVID outbreak
• Loss of consumer confidence - when consumers worry about the state of the economy, they slow their spending and save whatever money they can. Because close to 70% of GDP depends on consumer spending, the entire economy can drastically slow
• High-interest rates - high-interest rates make it expensive for consumers to borrow money. This means that consumers are less likely to spend, especially on major purchases like houses or cars
• Asset bubbles - in an asset bubble, the prices of investments like tech stocks in the dot-com era or real estate before the Great Recession rise rapidly, far beyond their fundamentals. These high prices are supported only by artificially inflated demand, which eventually dissipates, and the bubble bursts. At this point, people lose money, and confidence collapses. Consumers and companies cut down on spending and the economy goes into recession
• Deflation – is the situation when product and asset prices fall because of a large drop in demand. As demand falls, so do prices as sellers try to attract buyers. Consumers see this downward trend and wait for those prices to fall, further reducing demand.

Impact of a recession

1. High unemployment - as businesses seek to cut costs, unemployment rates increase, especially among the low-skilled workers, due to companies and even government agencies laying off staff as a way of curtailing expenses.
2. Drop in output and business closures - a fall in output tends to last until weaker companies are driven out of the market, then output picks up again among the surviving companies.
3. Higher government borrowing and less tax revenue - governments will see a fall in tax revenue as a result of a recession. It’s because companies make less profit and workers receive lower income. Also, rising government spending on welfare payments, such as unemployment benefits, housing benefits, and income support causes an increase in the budget deficit and government debt.

A recession is often portrayed as a short-term event. However, the consequences of high unemployment, falling incomes, and generally reduced economic activity can have lasting consequences.

Biggest recessions

Over the centuries there have been many fiscal disasters, economic crashes, and global crises. Here are some of the biggest recessions:

1. The Great Recession ( - ): The Great Recession was the worst and deepest economic downturn since the Great Depression ( to , a crisis that shrank the U.S. economy by 50% within five years, and around 15 million people were out of work). The Great Recession was a result of bubbles in real estate and complex investments called derivatives. The recession lasted 18 months but had a profound impact on the decade to follow. US households lost 25% of their aggregated wealth. Many employees with defined-contribution retirement plans saw their retirement savings evaporate.
2. Dot-Com Recession (March to November ): The dot-com recession was the result of a bubble (also known as the dot-com boom) in technology stocks as commercial use of the internet rapidly expanded. The internet was a hot topic during the s and this led many investors to predict a profitable future in internet-based businesses. This resulted in increased investment in tech startups, which drove their price shares to higher levels. The value of many tech companies nosedived after investors realized these companies had little to no hope of turning over a profit. This led to panic selling and triggered a recession in March , leading many companies to close.
3. Gulf War Recession (July to March ): This recession was spurred by multiple factors: an oil price spike, the move of jobs and manufacturing to Mexico and Canada, and two years of Fed interest rate increases. The end of the Gulf War (an armed campaign waged by a United States-led coalition of 35 countries against Iraq) helped stabilize oil prices, which allowed the economy to hit its trough, but recovery was difficult. Unemployment continued to rise even after the recession, hitting its peak at % in , a year after the recession was officially over. 

How to fight the Recession?

The most popular, or most recommended, policy for any country to dig itself out of recession is an expansionary fiscal policy or fiscal stimulus. This can be usually a two-pronged approach – tax sops and increased government spending. Also, by lowering interest rates, the central banks can put more money back into the pockets of businesses and households.

In the end: Is a Recession the same as Depression?

As stated previously, a recession can be described as two consecutive quarters of declines in quarterly real (inflation-adjusted) GDP and lasting more than a few months.

While there is no standard definition for depression, it is commonly defined as a more severe version of a recession. Economists can say that repeated periods during which real GDP falls are called recessions if they are mild and depressions if they are more severe.

In the end, there is a well-known joke economists like to tell regarding the difference between the two:

“When your neighbor loses their job, it’s a recession. When you lose your job, that’s depression!”

Racial Identity: Getting another job as a person of color is so difficult, no matter how talented you are.