What is a recession?

Recessions are a normal part of the economic cycle, but there’s some disagreement on what constitutes a recession and what it means for you. Find out what a recession is, how one starts, how it can affect your finances, and how you’ll know when an economy in recession has started to recover.

Generally, a recession is defined as two consecutive quarters of negative growth, which is determined by monitoring a country’s inflation-adjusted gross domestic product (GDP). GDP measures a nation’s economic output, so a decline indicates that economic activity has slowed.

Recessions hit key economic metrics, including gross domestic product (GDP), employment, consumer spending, industrial production, and business investments.

In the United States, the Business Cycle Dating Committee, part of the National Bureau of Economic Research, is the only body with the authority to declare a recession. However, the committee only announces a recession once it’s already happening, making it difficult for the average consumer to prepare.

The Great Recession, which took place between 2007 and 2009, caused a prolonged period of global economic instability. Several factors contributed to the decline in economic activity, but the housing market crash accelerated the problem in the United States.

A recession also occurred during the COVID-19 pandemic. Governments around the world issued lockdown orders to prevent SARS-CoV-2 from spreading, leaving many businesses struggling to survive. Consumers couldn’t dine in restaurants, browse clothing boutiques, or enjoy Broadway performances.

Early recessions typically occurred due to banking panics, which prompted Americans to withdraw their funds en masse. After World War II, recessions began to occur in response to supply and demand shocks.

A supply shock causes a sudden drop in the amount of resources available to support critical production processes. In response, suppliers raise their prices. Demand shocks occur when consumers and business owners aren’t willing to spend as much money. Supply and demand shocks occur for many reasons, such as financial crises, trade wars, sudden policy changes, or housing market crashes.

The Great Recession occurred, in part, because of a housing market crash. Due to looser credit requirements, many high-risk borrowers were able to get home loans that they wouldn’t have qualified for in the past.

If a borrower couldn’t afford their mortgage payments, they simply refinanced the original loan. This worked well while property values were rising, but it wasn’t a viable option when prices started to fall.

Eventually, many borrowers defaulted on their loans, prompting banks to foreclose. At the same time, investors were buying mortgage-backed securities, or bonds secured by mortgages. When property values dropped, the value of these securities also declined significantly, leaving investors with substantial losses.

During the COVID-19 recession, the federal government issued a series of stimulus payments to help Americans cope with the pandemic. Although these payments made it easier to afford food and other necessities, they also increased the money supply, contributing at least somewhat to the inflation that followed the pandemic. There is debate among economists as to how much stimulus spending contributed to inflation.

To qualify as a recession, the decline in economic activity must last for at least two months. However, some recessions last longer than others. Recovery depends on several factors, including policy changes and variations in supply and demand.

For example, the Great Recession lasted from December 2007 to June 2009. In contrast, the COVID-19 recession was significantly shorter, lasting just two months. The U.S. economy recovered quickly due to a combination of structural resilience, rapid vaccine development, and fiscal support programs. That said, the economic effects of the pandemic lasted far longer.

A recession doesn’t affect everyone the same way. The impact depends on your household income and overall financial stability, among other factors. Some families can flourish while others struggle under the same economic conditions.

If you operate a business, a recession may have the following effects:

Recessions may affect consumers in the following ways:

Recessions are difficult for the vast majority of families, but some people benefit from periods of economic downturn. For example, if you have a significant amount of money saved, you may be able to invest in stocks and other securities when their prices are low.

Businesses with plenty of cash on hand may also have an easier time negotiating with vendors who’ve been hurt by the decline in economic activity. A recession is also a good time to look for bargains on furniture, electronics, and other goods.

There are some economic indicators that may signal a coming transition in the economic cycle:

All recessions eventually come to an end. The economy may be improving if you notice that companies are hiring workers again or that the government has made policy changes designed to stimulate economic activity.

For example, the IRS issued 476 million economic impact payments to eligible American taxpayers, increasing the amount of money available to spend. These payments were part of the relief measures included in the Coronavirus Aid, Relief, and Economic Security Act of 2020 and the American Rescue Plan of 2021.

The CARES Act also allocated additional funds to help the economy recover from the lingering effects of the COVID-19 pandemic. In 2009, Congress passed the American Recovery and Reinvestment Act (ARRA), which helped the United States recover from the Great Recession much faster than other developed nations. For example, ARRA resulted in a rapid decrease in the unemployment rate and a $500 billion increase in the U.S. GDP within a single year.

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