A Guide To Economic Recessions

Businessman Looking Up At a Chart That Indicates A Falling U.S. Dollar

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Economic Recession Definition

A recession is a serious decline in economic activity that lasts longer than a few months. Traditionally it is identified by 2 consecutive quarters of declining GDP. Recessions usually bring drops in several economic indicators including:

  1. Income
  2. Employment
  3. Manufacturing
  4. Retail sales

The National Bureau of Economic Research (NBER), a private, nonprofit research organization that disseminates economic research to public policymakers, business professionals, and the academic community, official declares the beginning and the end of recessions. The NBER’s definition of a recession is:

… 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.

GDP, or gross domestic product, is the monetary measure of the market value of all the final goods and services produced by a country within a specific period. “Real” GDP means that the effects of inflation on that figure have been removed.

GDP is often reported annually, but is calculated quarterly as well. During some quarters, GDP can be negative while, in other quarters, it is positive. In part due to these fluctuations in quarterly GDP, NBER also keeps a close eye on the other four components of a recession: income, employment, manufacturing, and retail sales, all of which are reported monthly.

How Do Recessions Happen?

Recessions occur when the following events occur:

  1. A drop in real income: Real income is income that is adjusted for inflation, and with Social Security and welfare payments removed. When real income falls, consumers cut back on purchases, lowering demand.
  2. Lower wholesale-retail sales: Declining demand for goods and services usually results in lower sales numbers. Sales figures are adjusted for inflation and they reflect companies’ responses to consumer demand.
  3. Lower employment: Lower economic activity contributes to a fall in employment numbers as well as increases in requests for unemployment insurance assistance.
  4. A drop in manufacturing activity: As measured by the Industrial Production Report which is issued by the Federal Reserve, manufacturing usually slumps during a recession.
  5. A drop in monthly GDP estimates: NBER also looks at monthly estimates of GDP which are provided by Macroeconomic Advisers.

What isn’t reflective of a recession is the behavior of the stock market. This is because stock prices tend to be leading indicators, based on the anticipated earnings of public companies. The stock market may decline prior to an economic recession, as investors anticipate the downturn. The stock market may enter what is known as a bear market, which occurs when the market declines by 20% or more over a period of at least two months. Large declines in the stock market can contribute directly to a recession due to reductions in net wealth.

Recessions & The 5 Stages Of The Economic Cycle

A recession is an integral part of the economic cycle, which is also known as the business cycle. It is comprised of these stages:

  • Recession: growth slows, the rate of employment falls, but prices stagnate, meaning they stay the same
  • Trough: the economy hits its lowest point
  • Recovery: growth begins again
  • Expansion: the economy grows rapidly, interest rates are low and production goes up, however, inflationary pressures are building
  • Peak: when growth hits its maximum rate, imbalances in the economy occur that will be corrected by a recession

What Happens During a Recession?

The first inkling of a recession may appear in manufacturing job numbers. This is because manufacturers receive orders months in advance and, when manufacturing orders decline, so do factory jobs. Those who have lost their jobs cut back on spending and this affects other sectors of the economy.

When consumer demand falls, businesses stop hiring, unemployment rises, and consumer spending drops even further. It is at this point that some businesses start filing for bankruptcy while some households default on mortgage payments. A recession also negatively impacts recent college graduates who can’t find a decent job.

U.S. Historical Recession Examples

1. 2020 Pandemic Recession

The Covid-19 pandemic caused the worst recession since the Great Depression with the U.S. economy contracting by record amounts in 2020. In April 2020, 20.8 million jobs were lost, and the unemployment rate reached 14.7%. The unemployment rate remained in the double digits until August 2020.

The stock market experienced what is now known as the 2020 stock market crash near the onset of the pandemic. To combat this recession, the Federal Reserve lowered the fed funds rate to 0% and Congress issued $3.8 trillion in aid. In response to these measures, in Q3 2020, the economy grew by 33.1%. Officially, the recession was one of the shortest on record.

2. 2008 Great Recession

The Great Recession began in December 2007 and lasted until June 2009. The subprime mortgage crisis and the widespread use of derivatives triggered a bank credit crisis which then spread to the global economy.

In 2008, GDP shrank in Q1, Q3, and Q4, dropping 8.4% in Q4. In 2009, GDP dropped in Q1 and, in October 2009, the unemployment rate reached 10%. In Q3 2009, GDP became positive and NBER declared the recession over.

3. 2001 Dot-Com Bubble Burst Recession

Lasting just eight months, from March 2001 to November 2001, the economy contracted by 1.1% in Q1 2001 and by 1.7% in Q3 2001. This recession was caused by a boom followed by a bust in dot-com businesses. Part of that boom was caused by companies’ concerns over the change from “19XX” dates to “20XX” dates in their computer software. This recession was further exacerbated by the attack on 9/11.

4. The 1990-1991 Recession

This recession began in July 1990 and lasted until March 1991. It was caused by the 1989 savings and loan crisis, which led to higher interest rates, and the Iraqi invasion of Kuwait which led to the Gulf War. In Q4 1990, GDP dropped by 3.6% and, in Q1 1991, it dropped by 1.9%.

5. The 1980-1982 Recession

This was essentially two recessions, with the first occurring from January through June of 1980, and the second beginning in July 1981 and lasting until November 1982. This recession was caused in part by the Federal Reserve’s attempt to combat inflation by raising interest rates.

During the 12 quarters, four each in 1980, 1981, and 1982, GDP was negative in six, with the worst being Q2 1980 when it fell by 8.0%. In November and December 1982, unemployment reached 10.8% and it remained over 10% for 10 months. This recession was exacerbated by the Iranian oil embargo which reduced U.S. oil supplies, driving up prices.

6. 1973 Nixon/OPEC Embargo Recession

Beginning in November 1973 and lasting until March 1975, this recession was initiated by the OPEC oil embargo which caused oil prices to quadruple. Actions taken by then-president, Richard Nixon, were also causative factors with the wage and price controls he initiated keeping prices too high and this reduced demand. The wage controls kept salaries too high which caused companies to lay off workers.

President Nixon also removed the United States from the gold standard which caused the price of gold to skyrocket while the U.S. Dollar’s value fell, leading to inflation. In Q3 1973, GDP fell by 2.1%, in Q1 1974, it fell by 3.4% and this was followed by falls in Q3 1973 of 3.7%, 1.5% in Q4, and 4.8% in Q1 1975.

7. 1929 Great Depression

The difference between a recession and a depression is that, during a depression, the economy contracts for several years, as opposed to a few quarters.

Between 1929 and 1938, two recessions battered the U.S. economy. During the first downturn, between August 1929 and March 1933, GDP was down by 12.9% and unemployment peaked at 24.7%. Unemployment remained in the double digits until 1939.

Several factors created the Great Depression. In the Spring of 1928, the Federal Reserve raised interest rates, then the stock market crashed in 1929, wiping out much of people’s life savings. This was compounded by a 10-year-long drought in the country’s breadbasket, the Midwest, which devastated farmers and created the infamous Dust Bowl.

President Franklin D. Roosevelt’s New Deal boosted growth by 10.8% in 1934, 8.9% in 1935, 12.9% in 1936, and 5.1% in 1937. It took until the end of the drought in 1937 to finally end the second recession, and it was at that same time that the government increased spending in the ramp-up to World War II.

Global Recession Examples

The International Monetary Fund defines a global recession as “a decline in annual per-capita real world GDP (purchasing power parity weighted), backed up by a decline or worsening for one or more of the seven other global macroeconomic indicators: industrial production, trade, capital flows, oil consumption, unemployment rate, per-capita investment, and per-capita consumption”.

According to that definition, since World War II there have only been four global recessions: in 1975, 1982, 1991, and 2009. All lasted only a year, but 2008’s Great Recession was by far the worst due to the number of countries affected and the decline in real-world GDP per capita.

How Do Recessions Impact Investors & Non-Investors?

During recessions, or in anticipation of one, investors usually sell speculative investments and move into safer securities, such as government bonds. Equity investors eschew risk and move into well-established, high-quality companies that have strong balance sheets and little debt. Companies that have significant debt and weak cash flow may be unable to handle their debt payments along with the cost of continuing operations.

During recessions, one area of the stock market that generally remains more stable is the consumer staples sector. Companies within this sector produce and market: food, beverages, household goods, alcohol, and tobacco, which are products that consumers tend to buy regardless of their financial situation. Such products are often called non-discretionary, and they are the last products that consumers eliminate from their shopping lists.

Who Benefits From a Recession?

Those who have positioned themselves to profit from economic struggle may benefit from a recession. However, history has shown that it is very difficult, if not impossible, to consistently time these events. A recession may slow inflation as less money is circulating throughout the economy. The Federal Reserve and other central banks from around the world often attempt to stop recessions by stimulating the economy through lowering taxes, spending on social programs, and not considering the budget deficit. In response to the Great Recession, in 2009, Congress passed the economic stimulus package known as the American Recovery and Reinvestment Act.

Bottom Line

Even though recessions are a part of the normal economic cycle, living through them isn’t always easy. Knowing the signs of a coming recession can help both investors and non-investors alike take steps to avoid the worst effects of a recession including paying down debt and avoiding speculative investments.

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