A recession is a substantial, widespread economic contraction that leads to less activity economy-wide. Experts offer two basic definitions of a recession.
Most economists agree that a technical or official recession is marked by two consecutive quarters of economic decline. Technical recessions may see little economic impact if the decline is slight.
A real recession results in circumstances that most people worry about, which is a scenario in which an economic contraction across the economy leads to fewer jobs and higher credit card bills.
What happens in a recession?
True recessions lead to periods of economic struggles for businesses and consumers alike. Typically, as spending slows across the entire economy, companies make fewer sales.
To combat these losses, they may lay off employees or reduce rates of production. In turn, unemployment rises and households face financial struggles as wages are slashed.
Asset and financial markets, such as the housing or stock markets, may also see prices decline as investors move to safer investments. Altogether, these factors result in a shrinking economy, otherwise known as a recession.
What causes a recession?
Recessions can occur for multiple reasons. Sometimes, one or two factors can shock an economy into a recession. Other times, several factors combine to set off a cascade of recessionary events.
Declining demand
When economic demand declines, consumers buy fewer products, so businesses slow production. To cut costs, businesses may reduce investments or slash payroll, driving up unemployment while depressing spending. Declining demand contributes to, or is a factor of, most recessions in U.S. history.
Sudden shock to the economy
An economic shock is a sudden, major event that shocks an economy into a recession, meaning that demand plunges and unemployment soars. The COVID-19 pandemic is an example of an economic shock that sparked an unexpected recession.
Excessive debt
When banks extend too much debt, they face an increased risk of default. If too many borrowers can’t repay their loans, banks may be unable to stay in business, and the financial system can collapse as a result. Excessive risky debt — particularly mortgages — was a major contributing factor to the Great Recession in 2008.
Volatile financial markets
Volatile financial markets can lead to asset bubbles when investors bid the price of an asset too high. When the bubble bursts, panic selling or overextended debt can crash the market, taking the economy with it.
The Great Recession of 2008 was the direct result of banks underwriting too many risky mortgages on increasingly overpriced houses. When borrowers couldn’t pay their debts, the housing market crashed, and banks struggled to recoup their losses.
High inflation
Inflation occurs when the cost of goods and services rises over time. Around 2% of inflation per year is considered healthy. But high inflation, as the U.S. experienced in 2022, can spark a recession in a few ways.
For example, as costs rise, businesses may lay off workers, reduce production and hike prices. These circumstances are increasing inflation while driving up unemployment.
If the Federal Reserve tries to curb inflation by hiking interest rates, borrowing money gets more expensive, which depresses demand by lowering spending. The double-dip recession of the early 1980s is largely blamed on the Federal Reserve for spiking interest rates to tamp down the sky-high inflation of the 1970s.
Deflation
Deflation occurs when the price of goods and services falls economy-wide, leading to the dollar being able to buy more than before.
Deflation has several causes, and it may help household budgets when at play in moderation. However, too much deflation can cause wages to fall, spending to slow and unemployment to rise.
Together, these factors increase the risk of economic contraction. Deflation contributed to one of the worst economic downturns of all time, that being the Great Depression in the 1930s.
Is 2022 a recession?
The year 2022 is both a recession and not a recession. Allow us to explain.
The United States entered a technical recession in 2022, meaning the country experienced two quarters of declining growth in a row. However, economic data suggests that a real recession hasn’t happened yet because of the following reasons:
- Labor markets remain strong.
- Unemployment is still low.
- Spending remains high despite stubborn inflation.
- Corporate earnings continue to reach remarkable highs.
Inflation vs recession
Inflation occurs when the price of goods and services rises, while the definition of recession means that economic activity slows down. As a potential cause of recession, the stubbornly high inflation of 2022 has made some economists and consumers nervous that a recession is just around the corner.
Unfortunately, governments have few tools that can tackle inflation. Generally, central banks rely on interest rate hikes, which increase the cost of borrowing money for consumers and businesses.
As borrowing costs rise, businesses and consumers spend less, which can ease demand and lower inflation. However, if interest rates get too high too quickly, the economy may slow down faster than anticipated, causing a recession.
How long do recessions last?
There is no definite timeline for how long a recession could or will last. According to data from the National Bureau of Economic Research, the average recession between 1945 and 2001 lasted a period of 10 months.
However, that’s just an average. The range is anywhere from two months, such as the COVID-19 recession of 2020, to 18 months, like the Great Recession of 2008). While the COVID-19 recession lasted a mere two months rather than the typical two quarters, the depth and severity of the recession spurred economists to label the short-lived decline a recession.
What is a recession? Something to watch out for
Knowing the definition and meaning of a recession is only part of the battle. The key to surviving one is staying prepared. Stockpiling your emergency savings, keeping your resume up-to-date and sticking to a budget can help you make it through as unscathed as possible.
FAQs
What should you do in a recession?
During a recession, it’s essential to slash expenses, stick to a budget and update your resume. While you may not be laid off, it never hurts to be prepared for the worst.
Will there be a recession in 2023?
It’s hard to say with certainty that 2023 will see a recession. While 2022 entered a technical recession, stubborn inflation and a strong labor market have prevented a real recession from setting in so far. Truthfully, only time will tell.
What happens to people in a recession?
During a recession, people may be laid off, face stagnant wages or have their wages cut. They may have to budget more or dip into their savings to afford basic expenses. Another possibility is having to move to lower cost-of-living areas.
