What Does Recession Mean for You?

Key Takeaways

While economic downturns are a natural part of the business cycle, you may find it helpful to understand the difference between a recession and a more or less severe slowdown. Some important things to know are:

• The National Bureau of Economic Research (NBER) employs a specific methodology, known as business cycle dating, to identify recessions. They analyze various economic indicators to pinpoint the peaks and troughs of economic activity, with a recession marking the period between a peak and a trough.

• By understanding what a recession means, you can navigate economic cycles with more confidence and make informed decisions for your financial well-being.

• When economic activity slows down, it impacts employment, spending, the stock market, and other aspects of the economy.

Read on to explore the key indicators that signal a downturn, the underlying causes that trigger them, and how to prepare for a recessionary period.

What does recession mean?

According to the National Bureau of Economic Research (NBER), a recession is a significant economic activity decline "that is spread across the economy and that lasts more than a few months” [1]. The shortest recession in US history was two months, starting in February 2020 and lasting until April [2]. The longest economic downturn was the Great Depression, which lasted from 1929 to 1941 [3].

When economic activity slows down, it affects employment, spending, the stock market, and more. In some cases, the government intervenes by providing economic support for families, adjusting interest rates, and approving infrastructure projects to stimulate economic activity.

Signs of a recession

A commonly held belief is that a recession happens when the nation's gross domestic product (GDP) falls for two consecutive quarters. Still, the analysts who determine when the economy enters a recession look at more than this single indicator. They also consider nonfarm payroll employment, real personal income less transfers, wholesale retail sales adjusted for changes,  and industrial production, among other factors. 

1. Nonfarm payroll employment (NFP)

The total nonfarm payroll (NFP) helps indicate how healthy the overall economy and workforce are. It represents the number of all paid US workers except farmworkers, military personnel, and self-employed individuals (both sole proprietors and unincorporated self-employed). Domestic workers and employees of select government agencies do not count in this data.

Unemployment numbers can help identify the start of a recession because researchers have noticed an uptick in layoffs and unemployment claims around the time past recessions began. According to economist Claudia Sahm, a recession may be in the works when the unemployment rate's three-month average increases by 50 basis points or more compared to its low last year [4].

2. Real personal income less transfers

Personal income (PI) includes employee compensation, bonuses, proprietors’ income, income from rental persons, personal income receipts, and personal current transfer receipts. Transfer payments refer to payments, donations, fines, and fees paid to a government agency (including taxes).

When people lose jobs, they also lose income. This is one reason real personal income less transfers can help identify when the economy slides into a recession. High inflation also erodes earnings and can contribute to an economic downturn if the Federal Reserve Bank raises interest rates, leading to a decrease in spending.

3. Gross domestic product

Gross domestic product (GDP) is a key indicator of the economy's health. This is the market value of goods and services produced by the government and private companies in the US. It does not include the value of services and goods these organizations use during the production process.

According to the International Monetary Fund, the nation's GDP typically falls between two and five percent during a recession [5]. Since trends in employment often parallel GDP, unemployment may rise when production declines. However, keep in mind that production rises, falls in a cyclical pattern, and can fall without signaling a recession.

What causes a recession?

Common causes of a recession include supply shocks, monetary policies, financial crises, and market crashes. You often won't find a single event leading to a recession. The economy operates in a cycle of peaks and troughs, and a dip in the process is normal. However, an external shock like the spike in oil prices in the 1970s or the effects of the supply chain disruptions during the COVID-19 pandemic in 2020 can push a downturn into a recession. Consider the following historical examples of recession causes.

Overheating economy

Inflation sometimes signals an overheating economy that could precede a recession. In this economy, with rising inflation and an unnaturally low unemployment rate, demand can exceed supply. Eventually, resources become scarce, and the economy starts to contract. A classic example of overheating is the recession of 1969 when unemployment dropped to 3.5 percent, and inflation steadily increased in response to a number of policy initiatives and spending for the Vietnam War [6]. This mild recession started in December of 1969 and ended 11 months later [7].

Asset bubbles

An asset bubble appears when the market value of an asset (stocks, bonds, real estate) quickly increases, typically over a short period of time. Bubbles usually start when a group of people cash in on a particular investment and inspire other investors to join in. The increased demand raises prices until the money supply dwindles, leading to a dramatic fall in demand.

For example, the housing market experienced significant growth, peaking in 2006, which resulted in an uptick in foreclosures. This helped trigger the Great Recession. From December 2007 until June 2009, the US economy limped through a downturn that was longer than any other one experienced after World War II.

Economic shocks

An economic shock occurs when an unforeseen event happens, such as the oil shocks of the 1970s or the 2020 COVID-19 pandemic. These events occur with no advanced warning and often create high inflation and unemployment. The COVID-19 pandemic was a massive shock to the US economy in recent years, triggering a minor recession in April 2020.

Recession vs. depression

A depression differs from a recession in a few ways, notably in severity and depth. Recessions are shorter than depressions (often lasting around a year) and more common. You have to go back to the 1930s to find a depression, and it lasted for more than a decade. In many ways, you can think of a depression as a heightened recession with a greater drop in GDP and higher unemployment rates.

How long do recessions last?

Based on data collected by NBER, recessions typically last between 10 and 18 months [10]. However, depending on several factors, a recession can end quicker or last longer. The number of jobs lost, the depth of the drop in GDP, and government intervention have a significant effect on the trajectory of a downturn. 

How to prepare for a recession

To prepare for and protect yourself from the effects of a recession, assess your job skills, income, and assets. Review your budget and create a plan to lower your debt and increase your savings to maintain your lifestyle. Jobs in healthcare, education, and trades tend to remain steady during an economic downturn, and developing skills that can help you get a job in one of these fields could be helpful in the future.

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