Omar Bennett
Recessions are a normal part of the economic cycle, and they occur when there is a broad decline in economic activity. While there is no official definition of a recession, it is generally understood as a significant and prolonged downturn in economic activity, often lasting more than a few months. Recessions are typically characterised by a decline in gross domestic product (GDP) and real income, increased unemployment, reduced consumer spending and demand, and lower corporate profits and investment. The COVID-19 pandemic is a recent example of an economic shock that triggered a global recession.
| Characteristics | Values |
|---|---|
| Duration | Recessions typically last about a year, but there is no fixed duration. The average U.S. recession since 1857 lasted 17 months, while the average since 1980 lasted less than 10 months. |
| Definition | A recession is a significant, prolonged, and widespread decline in economic activity. |
| Indicators | Two consecutive quarters of negative gross domestic product (GDP) growth, though other indicators include declining corporate profit margins, falling industrial production, a deteriorating labour market, slower payroll growth, wage stagnation or decline, and a housing market slowdown. |
| Unemployment | Rising unemployment is a key indicator of a recession. |
| Severity | Routine recessions can cause GDP to decline by 2%, while severe ones might set an economy back by 5%. |
| Depression | A depression is a particularly severe and long-lasting recession, though there is no commonly accepted definition. During the Great Depression, U.S. economic output fell by 33%, stocks plunged 80%, and unemployment hit 25%. |
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What You'll Learn
There is no official definition of a recession
While there is no official definition of a recession, it is generally understood to be a period of economic decline. Recessions are a normal part of the economic cycle, and they are the opposite of economic expansion. They are characterised by a broad and significant downturn in economic activity, typically lasting longer than a few months.
A common rule of thumb is that two consecutive quarters of negative gross domestic product (GDP) growth indicate a recession. However, this is not a universally accepted definition. The National Bureau of Economic Research (NBER) in the United States, for example, uses a broader definition that considers various measures of economic activity, including production, employment, real income, and sales. The NBER's Business Cycle Dating Committee defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators".
The European Union has adopted a similar definition to the NBER's, integrating GDP with other macroeconomic indicators such as employment. This comprehensive approach allows for a more nuanced understanding of the depth and breadth of economic downturns, which can inform policy strategies for stabilisation and recovery.
Recessions are often triggered by external or internal factors, such as financial crises, trade shocks, supply shocks, economic bubbles bursting, or large-scale disasters. They can cause negative chain reactions, such as lower levels of employment, worsening corporate performance, deteriorating stock market results, and higher borrowing costs for consumers and businesses.
While there is no clear definition of a "depression", it is generally considered to be an extremely severe form of recession, with a decline in GDP exceeding 10%.
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Two consecutive quarters of negative GDP growth
A common definition of what constitutes a recession is "two consecutive quarters of negative GDP growth". This definition is often cited by economists and the media, and it is a rule of thumb for signalling a recession. However, it is important to note that the National Bureau of Economic Research (NBER), the official arbiter of recessions in the US, does not use this definition. Instead, they define a recession as "a significant decline in economic activity that is spread across the economy and lasts more than a few months".
Despite this, the two-quarter definition is still widely used and is seen as a simple way to identify a recession. This definition is also used by other countries, such as the United Kingdom and Canada, which further adds to its prominence. Using this definition, a recession is indicated when there is a fall in Gross Domestic Product (GDP) for two successive quarters. GDP is the sum of all the goods and services produced in a given period, so a decline in GDP indicates a contraction in economic growth.
This definition of a recession is straightforward and easy to understand, which may contribute to its popularity. It provides a clear threshold for identifying a recession, which can be useful for policymakers and economists. By having a simple rule, it becomes easier to recognise a recession and take appropriate action. This definition also aligns with the idea of a recession as a prolonged, broad, and significant downturn in economic activity.
However, critics argue that this definition is too simplistic and does not capture the full complexity of recessions. Recessions can vary in length, severity, and impact, and there are other factors beyond GDP that can indicate a recession. For example, the NBER takes into account a range of data points, including real income, employment levels, industrial production, wholesale retail sales, and GDP. They assess these indicators comprehensively to determine if there is a sustained economic decline across multiple parts of the economy.
While the two-quarter definition can be a useful rule of thumb, it is important to consider the broader context and other economic indicators to fully understand a recession.
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Recessions are caused by imbalances in the market
A recession is a significant and prolonged downturn in economic activity. Recessions are generally characterised by two consecutive quarters of negative gross domestic product (GDP) growth, although there are more complex ways to assess and classify downturns.
Financial factors can also contribute to recessions. Credit growth and the accumulation of financial risks during good economic times can lead to the contraction of credit and money supply when a recession hits. For example, sharp increases in asset prices and speedy credit expansion can coincide with a rapid accumulation of debt, making it difficult for corporations and households to meet their debt obligations. This, in turn, leads to reduced investment and consumption, resulting in a decrease in economic activity.
Geopolitical factors can also cause market imbalances that lead to recessions. For instance, the Asian financial crisis in the 1990s was caused by an imbalance where too much money was invested in factories, creating overcapacity and financial difficulties for many companies.
It is important to note that there is no single, sure-fire predictor of a recession, and various economic variables can be either the cause or the result of recessions. However, changes in certain variables, such as asset prices, the unemployment rate, interest rates, and consumer confidence, can be useful in predicting recessions.
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Unemployment rate rises
A recession is a significant, prolonged, and broad economic decline. It is a normal part of the economic cycle, but it can be challenging for individuals and businesses. While there is no official definition of a recession, it is often characterised by two consecutive quarters of negative gross domestic product (GDP) growth. However, economists consider various other factors when determining whether an economy is in recession, and there are more complex ways to assess and classify downturns.
Unemployment is a key indicator of a recession. As demand for goods and services falls, companies may lay off staff to cut costs. This leads to a reduction in consumer spending, further decreasing demand and potentially causing more layoffs. This negative feedback loop can have lasting detrimental effects on the economy and workers.
During the 2007-2009 recession, the US unemployment rate rose from 4.7% to 10% between April 2008 and October 2009. The COVID-19 pandemic caused a much shorter two-month recession, but the unemployment rate still climbed from 3.5% in February 2020 to 14.7% in April 2020. This was unusual as unemployment usually peaks later in the recovery phase.
The relationship between unemployment and recessions is well-established, with unemployment rising rapidly at the start of a recession and then declining slowly as the economy recovers. This dynamic can be observed in historical data, with frequent recessions leading to an overall upward trend in unemployment over time.
Unemployment during recessions can have long-term effects. People who lose their jobs during deep recessions may struggle to re-enter the labour market, and long-term unemployment can harm public health and the economy's productive potential. Governments use fiscal and monetary policies to manage unemployment during downturns, providing aid to those who need it most and boosting aggregate demand to avoid further job losses.
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Recessions are part of the economic cycle
There is no universally agreed-upon definition of a recession, but it is generally accepted that it refers to a period of decline in economic activity. Recessions are often defined as two consecutive quarters of economic contraction or negative economic growth, as measured by gross domestic product (GDP). However, this is a simplistic definition, and it is often more useful to consider a broader set of measures of economic activity, including employment, income, sales, and industrial production.
The National Bureau of Economic Research (NBER) in the US, for example, uses a broader definition and considers a range of indicators to determine if a recession has occurred. These include nonfarm payrolls, industrial production, and retail sales. The NBER also states that a recession must be deep, pervasive, and lasting. Since some of these qualities may not be evident when a recession first begins, many are only identified retroactively, and it is often clearest that a recession has occurred after it is over.
Recessions can be caused by various factors, such as financial crises, external trade shocks, adverse supply shocks, the bursting of an economic bubble, or large-scale anthropogenic or natural disasters (e.g. pandemics). They can also be caused by imbalances in the market, such as banks lending more money to homebuyers than they can afford to pay back. Recessions are often marked by slowing economic growth, declining corporate profit margins, weakening business investment, falling industrial production, and a deteriorating labour market.
While it is challenging to predict when a recession will occur, its duration, or its financial impacts, there are some early warning indicators that can be useful. For instance, equity markets often decline before an economic downturn, and other "soft" consumer signals, such as slower travel, may also appear. Identifying the early stages of a recession is crucial for policymakers as it allows for early intervention to potentially mitigate the impact.
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Frequently asked questions
A recession is a significant, widespread, and prolonged downturn in economic activity. It is a normal part of the economic life cycle. Recessions are usually characterised by two consecutive quarters of negative gross domestic product (GDP) growth.
Indicators of a recession include a decline in industrial production, a rise in unemployment, a fall in consumer spending, and a decrease in business investment.
Recessions typically last about a year. The average US recession since 1857 lasted 17 months, while the six recessions since 1980 averaged less than 10 months.
