What Is a Recession?

Recessions Explained

DEFINITION
A recession is a significant decline in economic activity, lasting more than a few months. There's a drop in the following five economic indicators: real gross domestic product, income, employment, manufacturing, and retail sales.

Definition and Examples of a Recession

People often say that a recession occurs 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.

One of the most famous examples of a recession was the Great Recession of 2008.

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The Balance

How Recessions Work

The National Bureau of Economic Research (NBER) defines a recession as "...a significant decline in economic activity spread across the economy, lasting more than a few months…” The NBER is a 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. 

The textbook definition of a recession was first suggested by Julius Shiskin, 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 whether the country was in a recession in 1974. That's because it was suffering from stagflation. Although GDP was negative, prices hadn't fallen.

Stagflation was caused by several interlocking factors seldom seen before, including coordinated efforts from OPEC Nations to push up the price of oil by 1200% and some of President Nixon's economic policies—one of which took the United States off of the gold standard.

Soft monetary policy directives from the Federal Reserve also contributed as interest rates began to rise. These factors, 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.

Economic Indicators of a Recession

The most important indicator is real GDP. That comprises 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 and 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 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 whether the economy is in a recession. 

1. Real Income

Real income measures personal income adjusted for inflation. Transfer payments, such as Social Security and welfare payments, are removed. When real income declines, so do consumer purchases and demand.

2. Employment

Employment and real income together tell the commissioners about the overall health of the economy.

3. Manufacturing

The commissioners look at the health of the manufacturing sector, as measured by the Industrial Production Report.

4. Wholesale-Retail Sales

Manufacturing and wholesale-retail sales, adjusted for inflation, tell commissioners how firms are responding to consumer demand. 

5. Monthly GDP Estimates

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 the anticipated earnings of public companies. Investors' expectations are sometimes too optimistic or too pessimistic, making the stock market more volatile than the economy.

When there is a recession, the stock market could enter a bear market indicated by a decline of 20% or more over at least a two-month period. A stock market crash can also cause a recession because a large number of investors lose confidence in the economy.

What Are the Warning Signs of a Recession?

During a recession, a quarter of negative growth could 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 which is measured by the durable goods order report. If that declines over time, so will factory jobs. When manufacturers stop hiring, 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 that time, the recession is underway.

How a Recession Affects You

Recessions are destructive in that they typically create widespread unemployment, which is why so many are typically impacted when they occur. As the unemployment rate rises, consumer purchases fall off even more. Businesses can go bankrupt.

In many recessions, people lose their homes when they can't afford their mortgage payments. Young people can't get a good job after they graduation from school, which can throw off their entire career.

Historical Recessions

The Great Recession began in December 2007 and ended in June 2009. Real GDP declined in the first, third, and fourth quarters of 2008 and in the first quarter of 2009. The recession started when GDP shrank 2.3%. The economy lost 17,000 non-farm jobs in January 2008.

When measured by duration, only the 30-month employment downturn from February 2001 to August 2003 was longer than the most recent downturn. That's another sign that the recession was already underway.

Unlike most recessions, demand for housing slowed first. As a result, most experts thought it was just the end of the housing bubble, not the start of a new recession.

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 since the Great Depression, 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 reported that it lasted from March 2001 to November 2001. GDP contracted in the first and third quarters of 2001.

Recession vs. 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 for several years. In the last recession, unemployment rose to 10.8% in October 2009. During the Great Depression, which lasted from 1929 to 1939, the unemployment rate peaked at 25.59% in 1933.

Benefits of Recessions

The only good thing about a recession is that it cures inflation. The Federal Reserve must always try to slow the economy enough to prevent inflation without triggering a recession. Usually, the Fed does that 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.

Key Takeaways

  • A recession is a significant decline in economic activity, lasting more than a few months. 
  • In the business cycle, a recession is occurs at some point between the peak and the trough. 
  • The National Bureau of Economic Research analyzes the United States economy to determine where it is in the business cycle.
  • The NBER uses many different economic indicators other than real GDP to determine when a recession has begun. 
  • The 2008 recession was the biggest United States economic downturn since the Great Depression.

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