What is a recession?

A recession can be explained as a significant decline in economic activity over a period of months or years, in a particular country or region.

In economics, a recession is generally recognised as two consecutive quarters of negative economic growth. This is reflected by gross domestic product (GDP) and other monthly indicators such as rising levels of unemployment, falling retail sales, contracting measures of income and manufacturing.

The NBER officially declares recession, but does not necessarily rely on two consecutive quarters of negative economic growth as measured by GDP to call one, often using reported monthly data to make its decision instead

There is no single indicator to predict how and when a recession will happen. The meaning of recession is interpreted differently by economists.

Causes of a recession

There are a number of events that can lie behind a recession.

• Economic factors. Recessions can be caused by economic shocks brought about by a spike in oil prices, financial panics, excessive debts, structural shifts to the economy, uncontrolled inflation or some combination of all the drivers. 

• Financial factors. A recession is characterised by a series of business, bank failures, slow or negative growth in production and rising level of unemployment. It is a normal part of the business cycle, which alternates between periods of expansion and recession. 

• Political factors. During economic expansion, the economy is growing and asset value is rising. This incentivises lenders to make it easier and less expensive to lend money. Cheap credit could lead to an increase in debt loads, and it may become too expensive to maintain, leading to defaults. If this happens, it can cause asset values to plunge, a phenomenon also known as an asset bubble, causing a recession.

Indicators of a recession

• Gross domestic product. In many economics spaces the start of a recession is considered to be when a particular country or region records two consecutive quarters of negative GDP growth. However, this is just a general rule and the NBER relies on a variety of economic data to declare a recession.

• Unemployment rate. Unemployment typically rises sharply during a recession and declines slowly in terms of expansion.

• Consumer spending. Higher inflation rates during a recession tend to lead to consumers having disposable income. This in turn leads to a decline of consumer spending, particularly on non-essentials.

• Stock market. The stock market can be a reliable indicator for when a recession is due to start or end. The market tends to start showing negative returns early on due to negative sentiment, poor financial results, or both. The stock market also tends to show recovery before a recession officially ends.

Recessions throughout history

The US has gone through four recessions over the past 30 years. According to NBER data, the average recession lasted 17 months after 1854.

• The Covid-19 Recession (February 2020 to April 2020) – Lockdown measures implemented to slow the spread of the coronavirus in the US caused a contraction in manufacturing activities and services. Lasting two months, it was the shortest recession in US history.

• The Great Recession (December 2007 to June 2009) – Caused in part by a bubble in the real estate market and mass defaults in subprime mortgages.

• The Dot Com Recession (March 2001 to November 2001) – Accounting scandals at companies like Enron, coupled with the economic shock brought by the 9/11 terrorist attacks led to a brief recession.

• The Gulf War Recession (July 1990 to March 1991) –  This eight-month recession was partly caused by spiking oil prices during the First Gulf War.

The impact of a recession on the economy

Recessions tend to impact many aspects of the economy. This includes businesses seeing a decline in sales and therefore profits, often leading to cost-cutting effects including layoffs, further contributing to unemployment rates.

This in turn can have an impact on individuals. Businesses slowing their hiring can lead to fewer jobs being available for school leavers and graduates and people in employment not receiving sufficient pay increases to allow them to deal with rising inflation. Further resulting in lower consumer spending.

Conclusion

So, put simply, what is a recession? Though many economists define a recession as two quarters of negative GDP growth, the NBER, which officially declares a recession, takes into account many factors including real income, employment and industrial production.

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