What Is a Recession?

Table of Contents

1. What Is a Recession?

2. What Is the Difference Between a Recession and a Depression?

3. How Long Do Recessions Last?

4. Can Economists Predict Recessions?

5. The Causes of Recession

6. Why Are There So Many Recessions?

7. How Do Governments Respond to Recessions?

During periods of economic change, there is always talk about whether or not we are entering a recession. Then there are the financial advisors who are always saying that we are about to enter a recession. It can be impossible to know what’s real and what is just speculation. Here is how experts determine whether or not the economy is experiencing a recession.

What Is a Recession?

A recession is the term for a significant decrease in economic activity that affects multiple industries and lasts for a significant period of time.

The following things will happen during a recession:

Economic output will reduce.
Consumer spending will decrease.
Unemployment rates will rise.
Interest rates will decline.
Tax revenue will decline.
The government will increase spending on social programs and unemployment insurance.

There is no standardized formula for a recession, as different economists classify recessions in different ways. However, it is widely agreed that there must be negative GDP growth for at least 6 months in a row.

Due to the classification needing at least 6 months of economic downturn, a recession will often not be declared until after the effects have been felt. Discussions of a recession when economic downtown has only lasted for a few months are simply speculation due to the 6-month requirement.

The 2020 recession due to the pandemic was an exception to the 6-month rule. It only lasted 2 months, but due to the widespread impact and severity of the downturn, it was classified as a recession. During the recent recession, many companies sought the expertise of a business dispute attorney to navigate the complex legal challenges arising from contract issues and financial strains.

What Is the Difference Between a Recession and a Depression?

Both terms don’t have exact criteria, but a recession is a significant decrease in economic activity that affects multiple industries and lasts for at least 6 months. A depression is a recession that lasts for a long time and has a significant economic decline. Another key difference between recessions and economic depressions is that recessions can affect the economy of just one country (though in our global economy, they often affect multiple), whereas depressions are global events.

Aspect	Recession	Depression
Definition	A recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.	A depression is a more severe and prolonged downturn in economic activity, typically characterized by a severe decline in GDP lasting more than three years.
Duration	Recessions typically last for a few months to up to two years.	Depressions last several years; historically, they have ranged from three years to a decade or more.
Decline in GDP	In a recession, GDP declines but typically not more than 10%.	In a depression, GDP can fall significantly, often more than 10%.
Unemployment Rate	Unemployment increases but is typically not higher than 10%.	Unemployment is usually much higher, often exceeding 15% or more.
Common Causes	Recessions can be caused by various factors including high interest rates, reduced consumer confidence, and decreased investment.	Depressions are usually caused by a combination of severe factors including a collapse in the banking system, prolonged reduction in consumption and investment, and high unemployment.
Government Response	Typically involves reducing interest rates, increasing government spending, and enacting policies to boost economic growth.	Often requires more extensive and long-term government interventions, including major policy reforms, large-scale fiscal stimulus, and sometimes restructuring of national economies.
Market Impact	Stock markets may decline, but the decrease is usually temporary and recovers as the economy rebounds.	Stock markets can crash significantly, and recovery may take a much longer time, reflecting the prolonged nature of economic depression.
Consumer Confidence	Generally reduced, leading to decreased spending and investment, but can rebound relatively quickly once the recession ends.	Severely damaged, resulting in a prolonged period of reduced spending and investment, contributing to the length and severity of a depression.

The Great Depression is the most well-known example of a depression. Construction, farming, and manufacturing slowed dramatically, which resulted in job losses. The impact of the Great Depression was felt globally for 10 years.

The Global Financial Crisis of 2008 was the worst recession since the Great Depression, but it is classed as a recession, not a depression, due to swift responses by governments around the world.

How Long Do Recessions Last?

The duration of recessions can vary significantly based on the circumstances of the recession and the government response. In the last few decades, recessions have lasted for 10 months on average. It is worth noting that it may take some time for the symptoms of recession (like high unemployment rates) to correct during economic recovery. For that reason, it may feel like the recession has lasted longer than its official duration.

Can Economists Predict Recessions?

There are often predictors that economists can point to, but they are not always accurate. Economists will look at the following recession indicators:

An inverted yield curve
Conference Board Leading Economic Index
ISM Purchasing Managers Index
OECD Composite Leading Indicator

The presence of these indicators does not always mean there will be a recession.

The inverted yield curve is the most commonly used recession predictor because it shows investor’s perception of the risk of interest rate decreases.

A yield curve is the relationship between the yields on short-term investments and long-term investments. Long-term investments carry more risk because there is more scope for the value to decrease during the term. This could be due to a large number of factors, but the primary among them are interest rate increases or inflation. So, in a normal yield curve, the yield for a short-term investment is lower than a long-term investment because of the perception of risk.

Investment yields are based on the perception of risk (by the market and investors), so when short-term yields are higher than long-term yields, that shows that the market believes there will be an event in the short term that will decrease the value of the investment. When the short-term yields are higher than long-term yields, this is called an inverted yield curve.

An inverted yield curve does not mean there will be a recession. It has predicted the last 10 recessions in the US, but there have also been inverted yield curves that were not followed by a recession. It is simply a prediction of whether the market believes there is a risk of inflation or interest rate increases in the short term.

The Causes of Recession

Recessions can be caused by widespread changes in supply (production of goods and services) or demand (consumer behavior.) There can be a number of causes of recession because a lot of factors may impact supply or demand in the economy.

The three main categories of recession causes are:

Financial: credit growth, reduction in the supply of money or credit, or high financial risk burden.
Economic: structural industry shifts or scarcity of raw materials.
Psychological: consumer pessimism in economic downturns.

Often, the cause of a recession may be a combination of those categories.

Why Are There So Many Recessions?

It can feel like we have experienced constant recessions in the last few years because the word is thrown around a lot in the news. However, recessions have become less frequent in the last few decades, and our recession recovery times have improved considerably. In fact, aside from a few exceptions, the economy has grown steadily.

The reason why it feels like there have been so many recessions in the last few years is because symptoms of economic decline and recessions worsen each other. For example, inflation and increased unemployment will cause consumers to reduce spending, which may result in companies laying off staff in response to reduced demand. This will then reduce consumer spending even more, and so on.

When the economy recovers, unemployment rates, hiring freezes, and reduced consumer spending can take months or even years to recover. Because individuals and businesses are affected by those symptoms of recession, it may feel like the recession lasts longer than the official recession duration.

It is also worth noting that recessions refer to economic downturns that affect multiple industries. In between recessions, industries may face economic downturns due to changes in the industry or consumer behavior. For example, new laws may pass that impact one industry, or consumer trends may reduce the demand for certain types of products or services. Because it only impacts one industry, this economic downturn is not considered a recession.

How Do Governments Respond to Recessions?

Each country’s government has financial policies for recessions. Because recessions aren’t declared until after the fact, many of these policies and measures are in place automatically to reduce the economic impact on individuals and businesses during times of economic decline. For example, unemployment insurance treats one of the symptoms of recessions, increasing unemployment rates.

Governments will seek to stimulate investment and consumer spending during times of recession. During the Covid-19 pandemic, we saw the government create temporary economic event-specific schemes and laws to mitigate the impact of economic events. Some examples of government responses to the 2020 recession include stimulus checks to encourage consumer spending and business loans aimed at helping businesses retain their staff and pay for their expenses to decrease unemployment.

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