What Is A Recession?

A recession is a significant decline in economic activity that lasts for months or even years. Experts declare a recession when a nation’s economy experiences harmful gross domestic product (GDP), rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period. Recessions are considered an unavoidable part of the business cycle—or the regular cadence of expansion and contraction that occurs in a nation’s economy.

Official Recession Definition

During a recession, the economy struggles, people lose work, companies make fewer sales, and the country’s overall economic output declines. The point where the economy officially falls into a recession depends on various factors.

In 1974, economist Julius Shiskin devised a few rules of thumb to define a recession: The most popular was two consecutive quarters of declining GDP. A healthy economy expands over time, so two quarters in a row of contracting output suggests there are serious underlying problems, according to Shiskin. This definition of a recession became a common standard over the years.

The National Bureau of Economic Research (NBER) is generally recognized as the authority that defines U.S. recessions’ starting and ending dates. NBER has its own definition of what constitutes a recession, namely “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

The NBER’s definition is more flexible than Shiskin’s rule for determining what a recession is. For example, the coronavirus could potentially create a W-shaped recession, where the economy falls one quarter, starts to grow, then drops again in the future. This would not be a recession by Shiskin’s rules but could be under the NBER’s definition.

What Causes Recessions?

There is more than one way for a recession to start: from a sudden economic shock to fallout from uncontrolled inflation. These phenomena are some of the main drivers of a recession:

A sudden economic shock: An economic shock is a surprise problem that creates severe financial damage. In the 1970s, OPEC cut off oil supply to the U.S. without warning, causing a recession, not to mention endless lines at gas stations. The coronavirus outbreak shut down economies worldwide and is a recent example of a sudden economic shock.
Excessive debt: When individuals or businesses take on too much debt, the cost of servicing the debt can grow to the point where they can’t pay their bills. Growing debt defaults and bankruptcies then capsize the economy. The housing bubble in the mid-aughts that led to the Great Recession is a prime example of excessive debt causing a recession.
Asset bubbles: When investing decisions are driven by emotion, bad economic outcomes aren’t far behind. Investors can become too optimistic during a strong economy. Former Fed Chair Alan Greenspan famously referred to this tendency as “irrational exuberance” in describing the outsized gains in the stock market in the late 1990s. Irrational exuberance inflates stock market or real estate bubbles—and when the bubbles pop, panic selling can crash the market, causing a recession.
Too much inflation: Inflation is the steady, upward price trend over time. Inflation isn’t a bad thing per se, but excessive inflation is a dangerous phenomenon. Central banks control inflation by raising interest rates, and higher interest rates depress economic activity. Out-of-control inflation was an ongoing problem in the U.S. in the 1970s. To break the cycle, the Federal Reserve rapidly raised interest rates, which caused a recession.
Too much deflation: While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and businesses stop spending, undermining the economy. Central banks and economists have few tools to fix the underlying problems that cause deflation. Japan’s struggles with deflation throughout most of the 1990s caused a severe recession.
Technological change: New inventions increase productivity and help the economy over the long term, but there can be short-term adjustment periods to technological breakthroughs. In the 19th century, there were waves of labor-saving technological improvements. The Industrial Revolution made entire professions obsolete, sparking recessions and hard times. Today, some economists worry that AI and robots could cause recessions by eliminating whole categories of jobs.

Recessions and the Business Cycle

The business cycle describes how an economy alternates between periods of expansion and recessions. As an economic expansion begins, the economy sees healthy, sustainable growth. Over time, lenders make borrowing money more accessible and less expensive, encouraging consumers and businesses to load up on debt. Irrational exuberance starts to overtake asset prices.

As the economic expansion ages, asset values rise more rapidly, and debt loads become larger. At a certain point in the cycle, one of the phenomena from the list above derails economic expansion. The shock bursts asset bubbles crash the stock market and make those large debt loads too expensive to maintain. As a result, growth contracts, and the economy enters recession.

What’s the Difference Between a Recession and a Depression?

Recessions and depression have similar causes, but the overall impact of depression is much, much worse. There are more significant job losses, higher unemployment, and steeper declines in GDP. Most of all, depression lasts longer—years, not months—and it takes more time for the economy to recover.

Economists do not have a set definition or fixed measurements to show what counts as a depression. Suffice it to say, all the impacts of depression are more profound and last longer. In the past century, the U.S. has faced just one depression: The Great Depression.

The Great Depression

The Great Depression started in 1929 and lasted through 1933; the economy didn’t recover until World War II, nearly a decade later. During the Great Depression, unemployment rose to 25%, and the GDP fell by 30%. It was the most unprecedented economic collapse in modern U.S. history.

By comparison, the Great Recession was the worst recession since the Great Depression. During the Great Recession, unemployment peaked at around 10%, and the recession officially lasted from December 2007 to June 2009, about a year and a half.

Some economists fear that the coronavirus recession could morph into a depression, depending on how long it lasts. Unemployment hit 14.7% in May 2020, which is the worst level seen since the depths of the Great Recession.

How Long Do Recessions Last?

The NBER tracks the average length of U.S. recessions. According to NBER data, from 1945 to 2009, the average recession lasted 11 months. This is an improvement over earlier eras: From 1854 to 1919, the average recession lasted 21.6 months. Over the past 30 years, the U.S. has gone through four recessions:

The Covid-19 Recession. The most recent recession began in February 2020 and lasted only two months, making it the shortest U.S. recession in history.
The Great Recession (December 2007 to June 2009). As mentioned, the Great Recession was partly caused by a real estate market bubble. The Great Recession wasn’t as severe as the Great Depression; its long duration and severe effects earned it a similar moniker. Lasting 18 months, the Great Recession was almost double the length of recent U.S. recessions.
The Dot Com Recession (March 2001 to November 2001). At the turn of the millennium, the U.S. faced several major economic problems, including fallout from the tech bubble crash and accounting scandals at companies like Enron, capped off by the 9/11 terrorist attacks. Together these troubles drove a brief recession, from which the economy quickly bounced back.
The Gulf War Recession (July 1990 to March 1991). At the start of the 1990s, the U.S. went through a short, eight-month recession, partly caused by spiking oil prices during the First Gulf War.

Can You Predict a Recession?

Given that economic forecasting is uncertain, predicting future recessions is far from easy. For example, COVID-19 appeared seemingly out of nowhere in early 2020, and within a few months, the U.S. economy had been all but closed down, and millions of workers had lost their jobs. The NBER has officially declared a U.S. recession due to the Corona virus, noting that the U.S. economy fell into contraction starting in February 2020.

That being said, there are indicators of looming trouble. The following warning signs can give you more time to figure out how to prepare for a recession before it happens:

An inverted yield curve: The yield curve is a graph that plots the market value—or the yield—of a range of U.S. government bonds, from notes with a term of four months to 30-year bonds. When the economy functions normally, yields should be higher on longer-term bonds. But when long-term yields are lower than short-term yields, investors are worried about a recession. This phenomenon is known as a yield curve inversion, predicting past recessions.
Declines in consumer confidence: Consumer spending is the primary driver of the U.S. economy. Surveys showing a sustained drop in consumer confidence could be a sign of impending trouble for the economy. When consumer confidence declines, people tell survey takers they don’t feel confident spending money; if they follow through on their fears, lower spending slows down the economy.
A drop in the Leading Economic Index (LEI): Published monthly by the Conference Board, the LEI strives to predict future economic trends. It looks at factors like applications for unemployment insurance, new orders for manufacturing, and stock market performance. If the LEI declines, trouble may be brewing in the economy.
Sudden stock market declines: A significant decline in stock markets could signify a recession since investors sell off parts and sometimes all of their holdings in anticipation of an economic slowdown.
Rising unemployment: It goes without saying that if people are losing their jobs, it’s a bad sign for the economy. A few months of steep job losses is an ample warning of an imminent recession, even if the NBER hasn’t officially declared a recession yet.

How Does a Recession Affect Me?

You may lose your job during a recession as unemployment levels rise. Not only are you more likely to lose your current job, but it also becomes much harder to find a job replacement since more people are out of work. People who keep their jobs may see cuts to pay and benefits and struggle to negotiate future pay raises.

Investments in stocks, bonds, real estate, and other assets can lose money in a recession, reducing your savings and upsetting your retirement plans. Even worse, if you can’t pay your bills due to job loss, you may face the prospect of losing your home and other property.

Business owners make fewer sales during a recession and may even be forced into bankruptcy. The government tries to support businesses during these challenging times, like the PPP during the coronavirus crisis, but keeping everyone afloat during a severe downturn is hard.

With more people unable to pay their bills during a recession, lenders tighten standards for mortgages, car loans, and other types of financing. You need a better credit score or a larger down payment to qualify for a loan which would be the case during more normal economic times.

Even if you plan to prepare for a recession, it can be a frightening experience. If there’s any silver lining, recessions do not last forever. Even the Great Depression eventually ended, and when it did, it was followed by arguably the most crucial period of economic growth in U.S. history.