What Is a Recession? Examples, Impact, Benefits
Do You Know Its Five Warning Signs?
A recession is when the economy declines significantly for at least six months. There's a drop in the following five economic indicators: real gross domestic product, income, employment, manufacturing, and retail sales.
People often say a recession is when the GDP growth rate is negative for two consecutive quarters or more. But a recession can quietly begin before the quarterly gross domestic product reports are out. That's why the National Bureau of Economic Research measures the other four factors. That data comes out monthly. When these economic indicators decline, so will GDP.
The National Bureau of Economic Research defines a recession as "a period of falling economic activity spread across the economy, lasting more than a few months." The NBER is the private non-profit that announces when recessions start and stop. It is the national source for measuring the stages of the business cycle.
The NBER uses the skill, judgment, and expertise of its commissioners to determine whether the country is in a recession. That way, it isn't boxed in by numbers. It can use monthly data to determine when a peak has occurred and when the economy has just started to decline. That allows it to be more precise and timely in its measurements.
Why trust the NBER? It's the official arbiter of economic expansions and contractions. National economics thought leaders, including Nobel Prize winners, make up its Board. It has more than 1,300 economics and business professors who do its research.
This textbook definition was first suggested by Julius Shisken, then-Commissioner of the Bureau of Labor Statistics, in 1974. He was a great deal more precise, though:
- Decline in real gross national product for two consecutive quarters.
- A 1.5% decline in real GNP.
- Decline in manufacturing over a six-month period.
- A 1.5% decline in non-farm payroll employment.
- A reduction in jobs in more than 75% of industries for six months or more.
- A two-point rise in unemployment to a level of at least 6%.
Commissioner Shisken suggested this quantitative definition because many people weren't sure if the country was in a recession in 1974.
That's because it was suffering from stagflation. Although GDP was negative, prices hadn't fallen. That was because of Nixon's economic policies, which mainly took the United States off of the gold standard. That, along with wage/price controls, created double-digit inflation. A clearer picture of these economic events over time may be seen by looking at the nation’s GDP by year.
Six Recession Indicators
The most important indicator is real GDP. That's everything produced by businesses and individuals in the United States. 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 then turn positive in the next quarter. Other times the Bureau of Economic Analysis might revise the GDP estimate in its next report. It's difficult to determine if you're in a recession based on GDP alone.
That's why the NBER measures the following five 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 when the economy is in a recession.
- Real income measures personal income adjusted for inflation. Transfer payments, such as Social Security and welfare payments, are also removed. When real income declines, that reduces consumer purchases and demand.
- Employment as measured by the monthly jobs report. Here's an analysis of the current jobs statistics.
- The health of the manufacturing sector, as measured by the Industrial Production Report.
- Manufacturing and wholesale-retail sales adjusted for inflation.
- The NBER also looks at monthly estimates of GDP provided by Macroeconomic Advisers.
Note that the stock market is NOT an indicator of a recession. Stock prices reflect anticipated earnings of public companies. Investors' expectations are sometimes too optimistic and sometimes too pessimistic. This makes the stock market more volatile than the economy.
When there is a recession, the stock market enters a bear market indicated by a 20% decline. A stock market crash can also cause a recession because a large number of investors lose confidence in the economy.
A recession is occurring when there are several quarters of slowing but still positive growth. Often a quarter of negative growth will occur, followed by positive growth for several quarters, and then another quarter of negative growth.
A recession is short, typically nine to 18 months. But its impact can be long-lasting.
The first sign of an impending recession occurs in one of the leading economic indicators such as manufacturing jobs. Manufacturers receive large orders months in advance. That's measured by the durable goods order report. If that declines over time, so will factory jobs. When manufacturers stop hiring, it means other sectors of the economy will slow.
A fall-off in consumer demand is normally the culprit behind slowing growth. As sales drop off, businesses stop expanding. Soon afterward they stop hiring new workers. By this time, the recession is underway.
How a Recession Affects You
A recession is destructive. It creates wide-spread unemployment, sometimes as high as 10%. That's when it affects most people. As the unemployment rate rises, consumer purchases fall off even more. Businesses go bankrupt.
In many recessions, people lose their homes when they can't afford the mortgage payments. Young people can't get a good job after school. That throws off their entire career.
The recession started in the first quarter of 2008 when GDP shrank 2.3%. The economy lost 16,000 jobs in January 2008, the first major job loss since 2003. That's another sign the recession was already underway.
Unlike most recessions, demand for housing slowed down first. As a result, most experts thought it was just the end of the housing bubble, not the start of a new recession. Here are the facts:
- In 2008, GDP contracted 2.1% in the third quarter and 8.4% in the fourth quarter. In 2009, it contracted 4.4% in the first quarter and 0.6% in the second quarter.
- Unemployment rose to 10% in October 2009.
- Employment fell by 33,000 jobs in July 2007. It rebounded, gaining 110,000 jobs in December. But by February 2008, it fell by 48,000 jobs. The losses continued to mount, with the year ending in a 704,000 job loss in December. The worst month was March 2009 when 803,000 jobs were lost. The economy didn’t gain jobs until November 2009, when 12,000 were added. The first significant job gain occurred in March 2010 when 180,000 jobs were added.
- Housing prices fell 10%.
The NBER declared the Great Recession over as of the third quarter of 2009. It was the worst recession since the Great Depression, with five quarters of economic contraction, four of them consecutive, in 2008 and 2009. It was also the longest, lasting for 18 months.
Another good example was the 2001 recession. It didn’t meet the textbook definition of recession because there were not two consecutive quarters of contraction. But the NBER said it lasted from March 2001 to November 2001. GDP contracted in the first and third quarters of 2001.
Recession Versus Depression
A recession can become a depression if it lasts long enough. In a recession, the economy contracts for two or more quarters. A depression will last several years. In a recession, unemployment can rise to 10%. During the Great Depression, which lasted from 1929 to 1939, the unemployment rate peaked at 25% in 1933.
One Benefit of a Recession
The only good thing about a recession is that it cures inflation. The Federal Reserve must always balance between slowing the economy enough to prevent inflation without triggering a recession. Usually, the Fed does this without the help of fiscal policy.
Politicians, who control the federal budget, try to stimulate the economy as much as possible through lowering taxes, spending on social programs, and ignoring the budget deficit. That's how the U.S. debt grew to $10.5 trillion before even a penny was spent on the 2009 Economic Stimulus Package, known formally as the American Recovery and Reinvestment Act.