A recession represents a significant, widespread, and prolonged downturn in economic activity. Traditionally, two consecutive quarters of negative gross domestic product (GDP) growth signal a recession. However, more complex indicators are also employed to identify recessions.
Economists measure recessions by observing indicators such as nonfarm payrolls, industrial production, and retail sales. Major characteristics defining a recession include being deep, pervasive, and lasting. Due to the retroactive acknowledgment nature of some of these qualities, recessions are often declared after the fact.
Key Takeaways
- Significant Decline: Recessions indicate a substantial decline in economic activity that is pervasive and persistent.
- ** Measuring Duration**: The length of a recession is measured from the peak of the prior expansion to the trough of the downturn.
- Economic Recovery: Recessions may be brief, but full economic recovery could take years.
- Yield Curve Indicator: An inverted yield curve has predicted the last 10 recessions, although not all periods of inverted yield curve led to one.
- Unemployment Lag: Unemployment can remain high well into recovery, making rebounds feel recession-like for many.
- Risk Mitigation: Nations employ fiscal and monetary policies to minimize recession risks.
The Mechanics of Recessions
From the Industrial Revolution to the present, economies have mostly grown steadily, though recessions still occur. For instance, between 1960 and 2007, advanced economies experienced 122 recessions, although recent recessions have become shorter in duration and less frequent.
Declining consumer demand typically prompts companies to cut jobs, leading to reduced spending power and further weakened demand. The bear markets that coincide with recessions can diminish the wealth effect, reducing consumption as people feel less wealthy. Governments have adopted fiscal and monetary policies aimed at preventing severe recessions.
Typically, recessions are most identifiable after they end. Investors, economists, and employees experience recession timings differently. Equities markets may decline before an economic downturn starts. Conversely, high unemployment can linger long after the economy recovers.
Indicators Predicting Recession
There’s no guaranteed predictor for a recession, but an inverted yield curve has preceded the last 10 U.S. recessions since 1955. Normal yield curves see short-term yields lower than long-term yields. When the curve inverts, short-term bond rates surpass long-term ones, indicating traders expect near-term economic weaknesses and eventual interest rates cuts.
Investors pay heed to leading indicators like the ISM Purchasing Managers Index, the Conference Board Leading Economic Index, and the OECD Composite Leading Indicator to forecast recessions.
Causes of Recessions
Several theories explain why recessions occur, ranging from economic changes, financial factors, psychological influences, or a combination of these elements. Economic theories highlight structural industry shifts; financial theories focus on credit growth and accumulation of risks; psychological theories emphasize boom-and-bust cycles.
Recessions vs. Depressions
Since 1854, the U.S. faced 34 recessions, with five notably significant downturns since 1980. Severe recessions might push the GDP down 5%, while typical recessions lead to a 2% decline. Depressions are newly-defined deeper, long-lasting recessions.
During the Great Depression, U.S. economic output shrank by 33%, stocks plunged by 80%, and unemployment spiked to 25%. The real GDP fell by 10% during the 1937-38 recession, with 20% unemployment.
Recent Recessions
The COVID-19 pandemic is a prime example of an economic shock causing a recession, as observed during the brief downturn in 2020. Analysts regularly debate recession status, especially given conflicting economic indicators.
By late 2022, conflicting economic data indicated that employment continued rising despite GDP contraction. The Federal Reserve Bank’s metrics affirmed that the U.S. economy wasn’t in a recession. Even U.S. Treasury Secretary Janet Yellen, in February 2023, was optimistic based on job creation and unemployment rates.
What Happens During a Recession?
Economic output, employment, and consumer spending generally see a decline during a recession. Central banks, like the U.S. Federal Reserve, often cut interest rates to support economic activity. The government’s budget deficit may widen as tax revenues fall while increased spending is directed to various social programs.
When Was the Last Recession?
The most recent U.S. recession occurred in 2020 due to the COVID-19 pandemic, concluding in April 2020 after two months of economic turmoil despite being brief.
How Long Do Recessions Last?
Historically, U.S. recessions since 1857 averaged 17 months. However, more recent ones, post-1980, have lasted around less than 10 months.
Bottom Line
Recessions pose significant, pervasive, and prolonged economic challenges. While traditionally defined by consecutive quarters of negative GDP, recessions involve complex evaluations hallmarked by increasing unemployment that propels further economic decline. Since the Great Depression, tools like fiscal and monetary policies have been pivotal in cushioning against economic downturns and guarding against deep depressions.
Related Terms: depression, economic growth, gross domestic product, unemployment, inflation
References
- National Bureau of Economic Research. “Business Cycle Dating”.
- National Bureau of Economic Research. “Business Cycle Dating Procedure: Frequently Asked Questions”.
- International Monetary Fund. “Recession: When Bad Times Prevail”.
- International Monetary Fund. “Fiscal Policy: Taking and Giving Away”.
- International Monetary Fund. “Monetary Policy: Stabilizing Prices and Output”.
- Federal Reserve Bank of San Francisco. “Current Recession Risk According to the Yield Curve”.
- National Bureau of Economic Research. “U.S. Business Cycle Expansions and Contractions”.
- Federal Reserve Bank of St. Louis. “The Great Depression: An Overview”.
- Federal Reserve History. “Recession of 1937-38”.
- National Bureau of Economic Research. “Business Cycle Dating Committee Announcement, July 19, 2021”.
- Raymond James. “Is the U.S. economy experiencing a growth recession?”
- The Federal Reserve Bank of St Louis. “NBER based Recession Indicators for the United States from the Period following the Peak through the Trough”.
- ABC News. “Treasury Secretary Janet Yellen Rejects Recession Fears, Says Economy is ‘Strong”’
