What Is a Recession?
A recession occurs when economic conditions worsen across the entire economy for several months or more. Here’s how it could affect you.
July 7, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment adviser before making investment decisions.
The economy tends to run in cycles. In general, it expands until it reaches a tipping point, at which point progress slows. This can be a minor dip or a more extended crash and is often referred to as a recession. But what does a recession mean, exactly?
You’ve surely heard the word recession before. The Great Recession back in 2008 shook the world, causing widespread unemployment and a massive stock market crash. But sometimes, recessions are brief — like the 2020 recession triggered by the COVID-19 pandemic.
There’s a lot to learn about what the term does and doesn’t mean. Let’s dive in.
How do we define a recession?
A recession is a period of temporary economic decline during which time trade and industrial activity decrease.
In other words, a recession is when economic activity slows down.
Economic activity is often measured in terms of gross domestic product (GDP); the total value of all goods and services produced in a specific country during a certain period. If GDP figures are going up, the economy is in expansion. If they are going down, the economy is in a recession.
A recession is often measured by a drop in GDP for at least two consecutive quarters (six months). However, the 2020 recession lasted only two months but is still commonly referred to as a recession. Since 1900, typical recessions last 15 months, on average.
What are the characteristics of a recession?
A recession has various characteristics. Some are obvious at the moment but others may not be clear until after the recession ends.
Slowdown in spending
Recessions are often triggered by a slowdown in spending — both from consumers and businesses (or the government).
Drop in GDP
Recessions typically involve a drop in GDP.
As consumers spend less money, businesses reduce costs — often through layoffs or temporary furloughs.
Declines in asset prices
Recessions often cause a drop in asset prices. The stock market, real estate market and other public markets may crash.
Drop in consumer confidence
Recessions can create a vicious cycle. As companies announce layoffs, consumers fear they may be next — so they cut back on their spending. This causes a drop in economic activity, which can further exacerbate cutbacks in businesses and unemployment.
In many cases, the federal government will step in to attempt to stabilize the economy by decreasing interest rates, which stimulates spending and investment. Or it may announce legislation that provides direct stimulus — as we saw during the 2020 recession.
How could a recession impact me?
Now that you know what a recession is, how might it affect everyday people?
Looking at the list above, it’s easy to see how a recession could affect you. Job losses are common. Many employers announce layoffs to cut expenses. Your job security may suffer in a recession.
If you have investments, they are likely to decline in value. The stock market tends to decline during economic recessions. In significant recessions, the housing market might also crash.
And when a recession is paired with inflation, everyday expenses can increase — putting further strain on your finances.
What happened in the last recession?
The last recession was in early 2020, as the coronavirus spread throughout the world. It was a very intense, very brief recession that was unlike any other in modern history.
As the U.S. economy went into lockdown, tens of millions of Americans lost their jobs. The Dow Jones stock market index crashed 37% in a matter of weeks. Economic panic spread throughout the world.
Congress acted quickly, passing massive economic stimulus packages that bolstered the U.S. economy. Among other measures, stimulus bills sent checks directly to American households and bolstered state-level unemployment programs.
The result was that the economy bounced back very quickly. Certain industries — tourism, restaurants, etc. — were hit hard, but overall, economic activity stabilized within months.
Without significant government intervention, most experts believe that the 2020 recession could’ve sparked a full-blown depression. The difference between a recession and a depression is primarily in the intensity and length of the downturn.
Can we predict recessions?
The economy tends to progress in cycles of expansion and recession. So, it’s easy to know that a recession’s coming — but when it’s coming is notoriously difficult to predict.
Often, recessions are sparked by unexpected events. For example, the 2020 recession was caused by a global pandemic, while the 2008 recession was caused by a unique financial crisis.
Most economists view business cycle fluctuations as being driven by random forces, like unforeseen shocks.
Nonetheless, experts and investors attempt to predict recessions. But as for reliablypredicting one, it’s a difficult task indeed.
How to prepare your finances for a recession
It always helps to be prepared. Here are some things you can do to protect your finances from potential downturns.
Save up an emergency fund
Having an emergency fund to cover three to six months' worth of expenses can help provide a buffer in case you lose your job or have unexpected expenses pop up.
Build an investment plan
Managing your investments should be done carefully. To avoid overreacting during a market crash, it’s wise to engage in investment planning practices and build a diversified investment portfolio.
Examine your budget
Having a budget can help keep your finances on track and identify where your money is going each month and where you could cut back, if necessary.
Make a plan
Do you have a plan for if a recession happens? What if you or your partner loses a job? Having these discussions ahead of time can help prepare you for the worst.
Pay down debt
If you have high-interest debt, make paying it off a priority. This can help free up space in your monthly budget and can help you strengthen your overall financial wellbeing.
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