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Recessions Explained

A recession is a significant decline in economic activity, lasting more than a few months. There's a drop in the following five economic indicators: real gross domestic product, income, employment, manufacturing, and retail sales.

A recession is a decline in an economy that is significant enough to affect employment, manufacturing, retail sales, gross domestic product, and consumer income. The drops are monitored by economists, and a recession is only declared by the National Bureau of Economic Research's Business Cycle Dating Committee after a recession has ended.

Learn more about recessions, the indicators, and what it means for an economy.

The Balance

Definition and Examples of a Recession

A recession is a decline in the economic output of an economy accompanied by a decrease in income and employment. You may hear that a recession occurs when the GDP growth rate is negative for two consecutive quarters or more, but a recession can quietly begin before quarterly gross domestic product reports are out. That's why the National Bureau of Economic Research (NBER) measures the other four factors using monthly data. When these economic indicators decline, so will GDP.

The Great Recession of 2008 started in 2006 when housing prices began to fall. Bad lending practices, securitized derivatives of bad loans, deregulation, and an interconnected global financial system all played a part in creating the financial crisis and the recession years before the economy crashed.

How Recessions Work

The NBER is the national source for measuring the stages of the business cycle. The bureau defines a recession as "...a significant decline in economic activity that is spread across the economy and lasts more than a few months…"

The NBER does not officially declare recessions until after they are over. This is because the data must be analyzed, and the Business Cycle Dating Committee must agree that it indicates a recession.

The NBER uses the expertise of its commissioners to determine whether the country is in a recession. That way, it isn't boxed in by set numbers. The Bureau can use monthly data to determine when a peak or trough has occurred.

Most recessions are short, averaging 11 months since 1945, but their impact can be long-lasting. A recession is a contraction in the economy; after a recession, the economy enters the expansionary phase where it must return to the level it was before the recession and continue expanding.

Because expansion is the normal state of the economy, this phase tends to run longer than the contractionary phase. For example, the longest expansionary phase in U.S. history ran from 2009 to 2020, a total of 128 months.

Economic Indicators of a Recession

The most important indicator of a recession is real GDP. Real GDP is a measurement of everything businesses and individuals in the United States produce. It's called "real" because the effects of inflation are stripped out.

When the real GDP growth rate first turns negative, it could signal a recession, but sometimes growth will be negative and then turn positive in the next quarter. Additionally, the Bureau of Economic Analysis might revise the GDP estimate in its following report, so it's difficult to determine if you're in a recession based on GDP alone.

Note that the stock market is NOT an indicator of a recession. However, a stock market crash can cause a recession because many investors lose confidence in the economy.

That's why the NBER measures the following monthly statistics. These give a timelier estimate of economic growth. When these economic indicators decline, so will GDP. These are the indicators to watch if you want to know whether the economy is in a recession:

• Real income: Measures personal income adjusted for inflation. Transfer payments, such as Social Security and welfare payments, are removed. When real income declines, so do consumer purchases and demand.
• Employment: The employment rate and real income together tell the commissioners about the overall health of the economy.
• Manufacturing: The commissioners look at the manufacturing sector's health, as measured by the Industrial Production Report.
• Retail sales, adjusted for inflation: Tells commissioners how firms are responding to consumer demand.
• Real Gross Domestic Product: The NBER also looks at monthly estimates of GDP provided by economists such as Macroeconomic Advisers.

Manufacturing jobs are generally regarded as one of the first signs that a recession might be starting. This is because manufacturers receive large orders months in advance, communicated by the durable goods order report. If that declines over time, so will employment at factories. When manufacturers stop hiring, other sectors of the economy tend to slow as well.

A fall-off in consumer demand is usually the culprit behind slowing growth. As sales drop, businesses cease expanding. Soon afterward, they stop hiring new workers. By that time, the recession is underway.

Recession vs. Depression

In a recession, the economy contracts for two or more quarters. A depression will last for several years. In the last recession, unemployment rose to 10.0% in October 2009. In the short recession during the Covid-19 pandemic, unemployment rose to 14.7% in April 2020. During the Great Depression, which lasted from 1929 to 1939, the unemployment rate peaked at 25.59% in 1933.

A recession can become a depression if it lasts long enough. However, there is no set period a recession must last or conditions that must be met for a depression to be recognized. Instead, it is a greatly exaggerated and lengthy contraction of one or more economies—you'll also know that you're in a depression because you'll have been enduring a recession for a long time.

Key Takeaways

• A recession is a significant decline in economic activity, lasting more than a few months.
• In the business cycle, a recession occurs between the peak and the trough.
• The National Bureau of Economic Research analyzes the United States economy to determine where it is in the business cycle.
• The NBER uses many economic indicators other than real GDP to determine when a recession began.
• The 2008 recession was the most significant United States economic downturn since the Great Depression.

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Source: https://www.thebalance.com/what-is-a-recession-3306019

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