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What Is a Recession?

Here’s all the information you need to understand recessions—and what they mean for your money.

Written by Jacqui Kenyon / August 25, 2022

Quick Bites

  • Economists say that there’s about a 50% chance that the U.S. falls into a recession in 2023.
  • “Recession” doesn’t have a standard definition, and there are many factors, like real income, employment, stock prices and more that can indicate that a recession is coming.
  • If you’re investing for long-term goals like retirement, don’t sell your investments because of fear—stay the course.

Economists, investment bankers and other experts have, of late, been throwing around a scary word: recession.

A recent Bloomberg survey of economists puts the risk of a recession in 2023 close to 50%.[1]

When you think about recessions, you might fear losing a job or income, watching the value of your investment portfolio plummet or losing equity or value in your home. If so, you have not yet forgotten the 2008 Great Recession.

But there’s a lot of confusion and misinformation around recessions, how they’re defined and what they mean for your wallet.

Inside this article

  1. Recessions explained
  2. What causes recessions?
  3. The business cycle
  4. How long do recessions last?
  5. Recession vs. depression
  6. Examples of recessions
  7. What a recession means for you

Recessions explained

The word “recession” doesn’t actually have an official definition or diagnostic criteria.[2]

One common rule of thumb that, experts say, denotes a recession is two consecutive quarters where gross domestic product (GDP) is in decline. But other experts have said that this rule is far too simplistic and that it fails to acknowledge a wealth of other indicators that could point to a recession.[3]

According to the National Bureau of Economic Research (NBER), a recession “involves a significant decline in economic activity that is spread across the economy and lasts more than a few months.”[4]

The NBER, in fact, is the body that officially decides whether we’re in a recession or not. It’s a nonpartisan organization with over 1,700 member economists.[4]

But the operative group when it comes to declaring recessions is the Business Cycle Dating Committee, a group of eight economists that is hand-selected by NBER’s president. [5]

Economic indicators of a recession

Although each recession tends to have different characteristics—and there aren’t super-specific notes that need to be hit in order to declare one—there are certain circumstances that point to a possible recession.

A recession tends to comprise declines in production, employment and real income (what someone earns after accounting for inflation).[6] A recessionary period may also be characterized by decreases in equity prices and real exports.[7] Finally, decreases in consumer confidence and business confidence—perhaps due to inflation, for example—can signal a recession.[8]

Any of these factors on their own doesn’t mean much, but in concert can mean that a recession is coming.

What causes recessions?

It can be challenging to identify the exact cause of a recession, regardless of how much data and how many brilliant economic minds you have at your fingertips. There are so many factors involved, and hardly ever a singular cause.

International turmoil, rapid technological innovation, shocks in the cost of energy and monetary policy by governing bodies are a few of the factors that can contribute to the start of a recession.[7]

Economic overheating can also help trigger a recession. An economy that’s overheated experiences demand so high that it outstrips supply—of labor and resources, for instance. High inflation and very low unemployment are signs of an overheated economy.[10]

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Finally, the rapid growth and subsequent “popping” of asset bubbles—when the price of an asset increases rapidly without enough real value to justify it, resulting in an eventual crash in price—can cause overheating and a subsequent recession. [9]

The U.S. experienced this with the 2001 recession following a dot-com bubble, and again in 2008 with the housing bubble.[10]

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Recessions and the business cycle

A recession doesn’t necessarily mean that a country or sector has done something wrong. Recessions are just part of doing business in the modern economic system.

Economists dubbed these ebbs and flows of economic growth “business cycles.”

Each business cycle has two distinct phases: a decrease in economic activity across sectors— a.k.a. a recession—and a period of economic growth, or expansion.[12]

Economists describe the different phases of the business cycle similarly to the way scientists describe waves. The highest point of economic activity is known as a peak. The peak indicates the highest point of an expansion before a recession begins. The lowest point of economic activity is known as a trough. The trough indicates the lowest point of a recession before an expansion begins.[4]

For instance, a typical recession sees a 2.75% fall in GDP, while a typical expansion sees a nearly 20% increase in GDP.[12]

Generally speaking, the expansion that follows a recession tends to mirror the recession’s intensity—the deeper the recession, the stronger the recovery.[7]

How long do recessions last?

Typically, one of the defining features of a recession is that it takes place over an extended period.

However, we were just in a recession that only lasted two months—at the beginning of the COVID-19 pandemic in 2020.[13] (That period qualified as a recession because, despite the fact that it was so short-lived, the decline was so steep and spread so evenly across the entire economy that experts still felt it right to classify it that way.[4])

Historically, however, recessions last significantly longer than that—about 11 months, on average.[14]

Recessions are by and large shorter and less frequent than expansions, and they have become more so over time. The average length of an expansion is about five years.[12]

Recession vs. depression

The biggest household name among recessions is likely the Great Depression, which followed the market crash of 1929. It was the deepest decline in U.S. history and it lasted longer than any other recession to date.[15]

But what makes a recession a depression?

When a recession is a particularly steep decline, with a peak-to-trough decline of 10% or more, it can be classified as a depression.[12]

Examples of recessions

1928

The Great Depression likely had the largest, most lasting impact on Americans of any recession in history, largely because of how long it was (10 years) and the steepness of the decline.[15]

Stocks lost 50% of their value in about two and a half months. People began to lose their jobs—two years in, 25% of American workers were unemployed. Businesses went under.[16]

And banks failed, setting off panic across parts of the U.S. and deepening the recession.[17]

The economic decline spread across the world, and many economies didn’t fully recover until the beginning of World War II.[15]

2001

The 2001 recession followed a record-breaking expansion—the expansion of March 1991 to March 2001. It lasted less than a year, a shorter period than the average recession. It came to a close in November 2001, which was an impressive feat considering the global turmoil that followed the September 11, 2001, terrorist attacks.[7]

The 2001 recession was also of relatively modest severity. GDP increased about 0.2% from the peak to the trough.[7]

Though it’s hard to isolate a single variable to have caused a recession, a significant contributing factor of the 2001 recession was the bursting of the so-called dot-com bubble. The stock prices of internet companies skyrocketed without sufficient underlying justification and eventually crashed.[10]

2008

The recession of 2008, which is now also known as The Great Recession, began with a crash—the housing market crash. What followed would be, in many ways, the worst recession since the Great Depression.[11]

The peak-to-trough decline in economic activity was 3.7% and it lasted 18 months—significantly longer than average.[11]

About 1 in 5 working Americans lost their jobs at the beginning of the recession, and it took nearly 10 years for the unemployment rate to reach pre-recession levels.[18]

What a recession means for your money

You may be less concerned about the macro effects of recessions than about the impact they could have on your bottom line.

R.J. Weiss, a Certified Financial Planner and founder of The Ways to Wealth, says that despite the fact that you might feel like you should do something in response to the news that a recession may be looming, it doesn’t necessarily mean that you should change your financial plan.

“If we look at history, it's fair to say recessions are inevitable,” Weiss said. “So the possibility of a recession shouldn't change your plan. What can and should change your plan is if thinking about a recession keeps you up at night. This stress indicates that your long-term financial plan wasn't a good match and signifies that change is needed.”

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In short, if your portfolio losing value is causing you to lose sleep, your asset allocation might be a bit too risky for your taste. Making some adjustments so that more of your money is in more stable investments, like bonds, could be a good bet.

But during a recession isn’t necessarily the best time to make a big change to your financial strategy, regardless—especially when it comes to saving for retirement.

“The biggest mistake is to stop investing or selling investments at a loss—this behavior is driven by fear, which can quickly take over during a recession when everyone is fixated on short-term events,” says Weiss. “Recessions are temporary economic downturns, whereas retirement is a long-term goal. As long as you have a long-term time horizon, you should maintain your investment strategy and focus on your goals.”

As far as what you should do with your investments as a recession looms, Weiss recommended living below your means and…not much else.

“My recommendation is to delete the stock apps off your phone and don't bother with the news,” he says.

Article Sources
  1. “Odds of US Recession Within Next Year Near 50%, Survey Shows,” Bloomberg, July 15, 2022, https://www.bloomberg.com/news/articles/2022-07-15/odds-of-us-recession-within-next-year-near-50-survey-shows.
  2. “Back to Basics: What Is A Recession?” IMF, March 2009, https://www.imf.org/external/pubs/ft/fandd/2009/03/pdf/basics.pdf.
  3. "The Risk of Redefining Recession,” CNN, May 7, 2008, https://money.cnn.com/2008/05/05/news/economy/recession/.
  4. “Business Cycle Dating,” NBER, https://www.nber.org/research/business-cycle-dating.
  5. “Who Decides If We’re in a Recession?” CBS, June 30, 2022, https://www.cbsnews.com/baltimore/news/who-decides-if-were-in-a-recession-8-economists-youve-likely-never-heard-of/.
  6. “Recession: When Bad Times Prevail,” IMF, https://www.imf.org/external/pubs/ft/fandd/basics/34-recession.htm.
  7. “The 2001 Recession: How Was It Different and What Developments May Have Caused It?” St. Louis Fed, September 2003, https://files.stlouisfed.org/files/htdocs/publications/review/03/09/Kliesen.pdf.
  8. “Financial and Macroeconomic Indicators of Recession Risk,” The Federal Reserve, June 21, 2022, https://www.federalreserve.gov/econres/notes/feds-notes/financial-and-macroeconomic-indicators-of-recession-risk-20220621.htm.
  9. “Asset Bubbles and Where to Find Them,” Vanguard, March 8, 2021, https://advisors.vanguard.com/insights/article/assetbubblesandwheretofindthem.
  10. “What Causes a Recession?” The Congressional Research Service, June 3, 2019, crsreports.congress.gov/product/pdf/IN/IN10853.
  11. “Chart Book: The Legacy of the Great Recession,” Center on Budget and Policy Priorities, May 27, 2022, https://www.cbpp.org/research/economy/the-legacy-of-the-great-recession.
  12. “From Recession to Recovery: How Soon and How Strong?” MIT/IMF, January 2009, https://www.researchgate.net/publication/265479929_From_Recession_to_Recovery_How_Soon_and_How_Strong.
  13. “What Is a Recession and When Is the Next One Going to Begin?” The New York Times, June 24, 2022, https://www.nytimes.com/2022/06/24/business/what-is-a-recession.html.
  14. “Recessions,” Econlib, https://www.econlib.org/library/Enc/Recessions.html.
  15. “The Great Depression,” Federal Reserve History, https://www.federalreservehistory.org/essays/great-depression.
  16. “Americans React to the Great Depression,” Library of Congress, https://www.loc.gov/classroom-materials/united-states-history-primary-source-timeline/great-depression-and-world-war-ii-1929-1945/americans-react-to-great-depression/.
  17. “Banking Panics of 1930-31,” Federal Reserve History, https://www.federalreservehistory.org/essays/banking-panics-1930-31.
  18. “How the Great Recession Changed American Workers,” Knowledge at Wharton, Sep. 10, 2018, https://knowledge.wharton.upenn.edu/article/great-recession-american-dream/.

About the Author

Jacqui Kenyon

Jacqui Kenyon

Jacqui Kenyon is a writer and editor, ghostwriter, editorial consultant and media coach based in Brooklyn, NY. Her work has appeared in Business Insider, Forbes, The Daily Beast, Rate.com, Fabric, and more.

Full bio

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