What does the term “recession” actually mean?

Unemployment skyrocketed, entire industries ground to a halt, businesses shuttered. It came as no surprise when the National Bureau of Economic Research (NBER)—the governing body that declares recessions—made the formal declaration in 2020 as the U.S. and much of the world felt the harsh effects of COVID-19. 

Conversations soon turned to, “Will this turn into a depression?” Luckily, that was not the case. Just as quickly as the pandemic had emerged, the U.S. economy rebounded at an unprecedented rate—so quickly, in fact, that the NBER was forced to reconsider the definition of the word “recession” itself. 

By conventional rules, the 2020 recession was a near miss, though millions of people around the country may not be able to say the same. Unconventionally speaking, the 2020 pandemic was one of the worst in modern U.S. history. As we grapple with this new concept of what a recession can be, it’s important to understand the basics, and just as importantly, how recessions are an integral part of the economic cycle.

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Table of contents

What is a recession?Recession vs. depressionCommon causes of a recessionCan we predict recessions?Recent recessions in the U.S.

What is a recession?

A recession is a period of significant decline in economic activity in a certain region or across an entire country that lasts several months. This could look like:

  • High unemployment rates

  • Lower production of goods and services

  • Bank failures

  • Businesses shutting down

To be considered a recession, these effects must be spread across the economy, rather than a single sector. Even sectors that are considered to be somewhat “recession-proof” will be impacted.

The economic indicator that most clearly signals a recession is real gross domestic product (GDP), or the goods produced minus the effects of inflation. Other key indicators include income, employment, manufacturing, and wholesale retail sales. During a recession, each of these areas experiences a decline. 

Formerly, a recession was characterized by two or more consecutive quarters of negative GDP growth; however, given the severity of the 2020 recession in such a short time frame, the NBER decided to loosen the rules. The NBER now says that a recession is a downturn in economic activity spread across a large and various sectors, and it should last more than a few months; while the depth, diffusion, and duration of the downturn have to be experienced to some degree, the severity of each can vary. 

For instance, with the onset of the COVID-19 pandemic, the U.S. GDP decreased 31.4% in Q2 of 2020 before increasing 33.4% in Q3 and 4.3% in Q4. There was technically only one quarter of loss, but because so many other areas of the economy, including employment and sales, took a hit, it was still declared a recession, albeit a brief one.

Recession vs. depression

A depression is also a period of significant decline in economic activity, but it is much more severe and lasts longer than a recession. A long-term recession may turn into a depression if it lasts several years. 

The last depression in the United States was the Great Depression, and it eventually spread worldwide. At its height (1929–1933), U.S. unemployment hit 24.9%; 9,000 banks failed; housing prices dropped; and international trade collapsed. The U.S. felt the effects of the Great Depression for a decade, before the economy began to recover around 1939.

Common causes of a recession

There are many theories as to how and why a recession begins, but these three are the most widely accepted: 

  1. Economic influence: Some economists believe that recessions are a result of massive changes within industries or geopolitical events. This could look like trade disputes, an international conflict, or a global pandemic that forces a national lockdown. 

  2. Financial influence: Financial factors could include the liberal issuing of credit by lenders pre-recession that results in unsustainable repayment plans for borrowers. A sudden or severe downtick in issued credit could also signal a recession. If credit is initially overextended and subsequently underextended, this could result in a recession. 

  3. Psychological influence: This belief system places a great deal of pressure on the citizens of a certain place to influence the severity of a recession. With psychology-based factors, people are expected to have over-indulged for some period of time ahead of the downturn, resulting in a drastic conservatism that spurs the recession. 

Much of Keynesian economics is psychology-based; under this theory, people get spooked by the onset of a recession, so they hoard their cash, which prolongs and even worsens its effects. In turn, production by businesses also decreases.

Two signs point in different directions reading "recession" and "prosperity".

Can we predict recessions?

Unfortunately, there is no way to predict a recession. Recessions are declared based on reports of previous unemployment, production, sales, and income. Therefore, economists, businesses, investors, and governmental agencies are usually only able to assess whether or not they are currently going through a recession on a regional, national, or global scale. 

However, there are some indicators that could signal an imminent or nascent recession.

Several macroeconomic indicators, such as the Treasury yield curve, show shifts in trends or growth rates. These indicators are typically used by investors because they help them understand how they will be compensated for their investment in risk over time. 

Governmental reports on various sectors across the economy can also illuminate the possibility of a recession. For instance, if fewer homes are being built, or new orders on capital goods are down, this could signal a downturn. Since these things filter into a country’s GDP, a decrease could be a telling indicator. 

Although not ideal for predicting a recession well in advance, lagging indicators can be effective in foreshadowing a recession. Lagging indicators are financial signs that indicate changes in trends or behaviors over time. Changes in unemployment and GDP are common lagging indicators used to track recessions.

Recent recessions in the U.S.

There have been a number of recessions over the past 20 years, some more detrimental than others. 

2020: Prompted by the COVID-19 pandemic, the recession in 2020 was short-lived but ended the longest period of economic growth in U.S. history. Economic decline only lasted one quarter; however, NBER did not hesitate to declare it a recession as unemployment skyrocketed, businesses and entire industries were subject to government-ordered shutdown, people went into lockdown, retail sales plummeted, the stock market crashed, and so on. Many people argue that 2020 was the worst recession in modern U.S. history because it caused such a great amount of damage in such a short amount of time. For the U.S., the initial recovery was much sooner than expected, with several industries already achieving or surpassing their pre-pandemic activity. 

2007–2009: At the time, the Great Recession was the worst economic downturn that the U.S. had seen since the Great Depression of the 1930s. In the mid-2000s, low mortgage interest rates meant to encourage homeownership created a housing bubble, or extreme seller’s market. When the bubble burst, people defaulted on their loans en masse, triggering a recession and nationwide financial crisis. Real GDP dropped 4.3%; unemployment peaked at 10.0%. 

2001: The new millennium brought with it a wave of uncertainty for Americans and businesses. Dot com businesses had already boomed then busted—a situation not improved by the Y2K scare, which created panic as to how technology would transition from 1999 to 2000. The terrorist attacks of 9/11 also created widespread panic, creating initial shocks in the stock market and rippling through major sectors, such as the airline and insurance industries. Compared to the recessions of 2020 and 2007–2009, the 2001 recession was mild, with U.S. unemployment peaking at 6.3% and GDP dipping for only three quarters with a cumulative decline of less than 1%. 

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