What Is a Double Dip Recession?
Double Dip Recessions Explained
A double dip recession occurs when an economy enters recovery from a recession, but then is derailed and slides back into a recession. They are rare, but can happen. There have only been two of them since the Great Depression of 1929-1933.
Learn what defines a double dip recession, what causes and happens during one, and how one might impact your finances. Will there be a double dip recession in 2020 or 2021? We don't have a crystal ball, but we can look at some possibilities.
What Is a Double Dip Recession?
Double dip recessions occur when there is an economic shock, like more COVID-19 lockdowns, during the early stages of a recovery that follows a recession. The economy is already weakened, leaving it vulnerable to the cycle of reduced spending, rising unemployment, and reduced credit, and it falls back into recession.
- Alternate name: W-shaped recession
Double dip recessions can also be called W-shaped recessions. Think of it as in the economy being high, then low, then on the rise again before dipping a second time before an official recovery.
How Do Recessions and Recoveries Work?
According to the National Bureau of Economic Research, recessions are a "decline in economic activity spread across the economy that lasts more than a few months." Recessions can be triggered by any number of events or economic shocks, including:
- Runaway inflation, as in the late 1970s in excess of 10%
- Monetary policy change, such as increasing interest rates and reducing available credit
- Crisis in the financial system, such as the subprime mortgage crisis of 2008-2009
Whatever the reason, consumers lose confidence and reduce spending. Businesses falter, and jobs are lost. Banks extend less credit to businesses and consumers, which further reduces spending and employment, and the misery continues to spread across the economy.
Most recently, the COVID-19 pandemic has set off a recessionary chain of events, with the economic and social impact of nationwide lockdowns pushing consumer spending down 33.2% in the second quarter of 2020.
A recovery is the process of returning from a recession to previous levels of economic activity and growth. Conditions become favorable for businesses to begin hiring. Unemployment declines, consumers gain confidence and begin spending, banks resume extending credit, and the recovery, ideally, takes off leading to an economic expansion.
Recoveries can be slow and gradual. Graphically they look like a U. Recoveries can also be rapid, looking more like a V. Double dip recessions are recoveries that look like a W. The return to pre-recession economic activity is interrupted leading to a decline, and then eventually a new recovery.
Double Dip Recessions Throughout U.S. History
There have only been two double dip recessions in the last 90 years, the first in 1937, and the last one in 1982. Both of them were triggered by changes in monetary policy.
The Double Dip of 1937
The U.S. economy began to recover from the Great Depression in 1933. From 1933 to 1936 unemployment fell from 25% to 14%, and the economy grew at an annual rate of 9%.
But in 1936, the Federal Reserve became concerned about potential runaway inflation and systematically reduced the capacity of the banks to provide credit to business and consumers. At the same time, tax increases from the Revenue Act of 1935 and the social security payroll tax took effect. Plus, the veterans bonus of 1936 (a spending stimulus) was removed. Higher taxes, reduced credit, and reduced spending were enough to interrupt the recovery from the Great Depression.
The end result was a double dip recession lasting from May of 1937 until June of 1938. Unemployment rose to 19%, industrial production fell by 32%, and personal income fell by 11%. The subsequent recovery took another two years.
The downturn of 1937 is considered to be the third worst of the 20th century.
The Double Dip of 1982
The short recession of January 1980 through July 1980 was brought on by the sharply increased price of oil, as a result of the OPEC embargo, and prolonged high inflation, which peaked at 14.6% in the spring of that year. As the economy began to recover, the Fed dramatically increased interest rates in an effort to bring inflation under control.
Skyrocketing interest rates, peaking at a prime rate of 21.5% in December of 1980, pulled the economy back into a recession which lasted through most of 1982. Mortgage rates were over 18% in October of 1981, making home ownership virtually impossible for most first-time buyers.
Will We See a Double Dip Recession in 2020 or 2021?
A recession that began in February, the ongoing social and economic impact of COVID-19, a volatile stock market, massive economic intervention by Congress and the Fed, and a contentious political environment have made for a turbulent 2020. Are we headed for a double dip recession?
According to the National Association of Business Economists August 2020 survey, 80% of its members believe there is a one in four chance of a double dip recession. The NY Fed puts the probability of a recession by August of 2021 at almost 19%.
Dr. Chris Westley, Dean of the Lutgert College of Business at Florida Gulf Coast University, told The Balance via email that Covid-related financial aid has helped the economy recover from a strong downturn earlier in the year. But he expects the economy to revert back once much of the spending ends.
"This year, we had a severe contraction brought on by the lockdowns in April and May,” Westley said. He added that forgivable loans from the Paycheck Protection Program has kept some businesses afloat, and that money disbursed to individuals through the CARES Act (such as expanded federal unemployment benefits and one-time $1,200 checks) helped buoy consumer spending.
But that money will run out. "When the spending ends, the economy can revert back to its previous (recessionary) state," he said. "I’d expect that reversion to happen eventually, either late this year or early next year."
What Does a Double Dip Recession Mean for Investors?
During both double dip recessions, the stock market pulled back, dropping 35.34% in 1937, and 4.7% in 1981, both recovering sharply in the following year.
Double dip recessions, however, have only happened twice in the last 90 years, so it's difficult to draw any conclusions about how the markets might respond based on the past.
The possible triggers of a double dip recession seem likely to be an additional stimulus package from Congress that falls short of expectations, a tightening in the Fed’s monetary policy, extended delays of a vaccine, or new lockdowns. While a change in monetary policy seems unlikely based on Fed Chairman Jerome Powell’s statements, the stimulus package, and the path of the pandemic and vaccine are unknown.
In the past, stocks have done well during periods of expansionary monetary policy when the Fed uses interest rates, open market operations, and reserve requirements to increase economic activity. It’s unclear though how any additional stimulus will ultimately aid recovery.
Steps to Take Before a Double Dip Recession
The possibility of a double dip recession is a good reason to review your investment plan if you haven’t already done so. Make sure you are comfortable with your risk levels and allocations to stocks, bonds, and other assets. Are you financially positioned to withstand a market downturn, should one occur?
Examine the companies in your stock, mutual fund, and exchange-traded fund (ETF) portfolio. Are they financially strong? Do your mutual fund and ETF strategies need to be adjusted to accommodate a possible downturn?
If you don’t have an investment plan, now is a good time to build one. Consider getting help from a financial professional to balance the uncertainty of the future with your overall investment goals.
- Double dip recessions occur when an economy’s recovery from a recession takes a negative turn.
- Because of the highs and lows, it’s also known as a W-shaped recession.
- There have only been two double dip recessions in the last 90 years, but uncertainty about the pandemic, and the response to it, have the potential to derail the recovery.
- A double dip recession could be triggered by an additional economic shock such as new lockdowns, a lack of any additional stimulus from Congress, or a change in the Fed’s monetary policy.
- Review your investment portfolio to better weather a potential double dip recession and market downturn.