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What is a recession?

 

Summary: A recession is period of negative economic growth over the period of at least two quarters. This is measured in a country’s Gross Domestic Product (GDP), although this isn’t always necessary to declare that a country is in a recession.

What is a Recession?

Since the Articles of Confederation – the first US constitution signed in the 18th century – there have been almost 50 recessions in the United States. Through the last 80 years alone, there have been a total of 15 official recessions, including the latest financial crisis which started in 2007 and ended in 2009, as some of you may be familiar with. However, what is an official recession, what are the causes of it and should you invest during a recession period? This and more will be covered in the following lines.

For an economic decline to be identified as a recession, there has to be a significant downturn in economic activity spread across the economy, lasting more than two quarters, i.e. 6 months. This definition of a recession by the US National Bureau of Economic Research also states that a recession usually implies negative economic growth, lower employment rates caused by a stop in hiring, lower personal demand, personal spending, company earnings, industrial production and retail sales.

US GDP Growth from 1950 to 2010

Major US Recessions in the 20th and 21st Century

The absence of economic statistics makes it more difficult to determine the occurrence of economic downturns prior the 20th century, so economists and researchers have to use various unofficial sources to identify those recessions, such as newspapers and business ledgers.  It was not until after the Second World War that countries, including the US, started to adopt modern economic statistics that include the unemployment rate and GDP, which makes it significantly easier to spot the early stages of a recession and its effects on economic activity.

 Duration of Recessions including Average Time Before Recessions

The following list shows some of the most important recessions in the United States during the 20th and 21st century. However, bear in mind that no recession after World War II has come anywhere near the depth of the Great Depression of 1929, which lasted 3 years and 7 months. The average duration of recessions after 1945 is around 10 months.

  • Great Depression of 1929

The Great Depression started with the collapse of the stock market in 1929 and was by far the most devastating recession of US history. The economic downturn rapidly spread across the whole country and was followed by a banking panic and a collapse in the money supply, partly because of the commitment to the Gold Standard. Many companies went bankrupt and unemployment rates skyrocketed as manufacturers had to lay off workers. While fresh gold inflow led to larger money supply and slight economic recovery in the mid-30s, the recession double dipped in 1937. Looser monetary policy and the consecutive increase in money supply ultimately led to a recovery in the early 1940s. During the Great Depression, the unemployment rate peaked at 24.9 percent, while the economic decline reached 26.7 percent in GDP terms.

  • Recession of 1973-1975

In October 1973, OPEC countries proclaimed an oil embargo which was targeted at countries that were supporting Israel during the Yom Kippur War. The United States was one of the targeted countries, along with Canada, Japan, the Netherlands and the United Kingdom. The oil embargo caused oil prices to quadruple from $3 to $12 globally, which led to a growth recession and stagflation in the US. Stagflation refers to a combination of a contraction in economic activity coupled with high inflation.

  • Early 1990s Recession

The early 1990s recession was a brief economic downturn caused by a number of factors, including a rate hike cycle by the Federal Reserve from 1986 to 1989, the 1990 oil price shock, growing pessimism among US consumers and accumulating debt. The 1990s recession lasted 8 months, with the unemployment rate peaking at 7.8% and the GDP declining 1.4%.

  • Early 2000s Recession

Another shallow recession happened in the early 2000s. After a long period of growth in the United States during the 1990s, the 2000s recession emerged with the collapse of the dot-com bubble, falling investments and the September 11th attacks, which led to a fall in the GDP of 0.3%.

  • Great Recession of 2007-2009

The great recession of 2007-2009 was a widespread global financial crisis which began with the subprime mortgage crisis in the United States and spread soon across the world. Many housing-related assets experienced a free-fall, which led to major problems and bankruptcies in some of the most important financial institutions in the United States, such as Fannie Mae, Freddie Mac, Citi Bank, AIG, Lehman Brothers and Bear Stearns. To stabilise the US financial market, the government injected a breathtaking $700 billion bank bailout and a $787 billion fiscal stimulus package. The increase in government spending is a typical Keynesian solution to a recession, which – according to the theory – should stimulate aggregate demand and cause the GDP to rise.

FAQ about recessions

What are the causes of a recession?

  • There can be many factors contributing to the formation of a recession. Rate hikes, high inflation, soaring oil prices, growing consumer pessimism and lower business investments can all work together and lead to an economic decline. A country is in a recession when its economy posts a negative growth for two consecutive quarters.

What are the benefits of a recession?

  • One of the most important benefits of a recession is that it helps control inflation. The Federal Reserve, for example, has to balance its monetary policy in order to cool down the economy just enough to prevent higher inflation rates, without triggering a recession. Recessions are usually a sign of misbalance in key economic factors, which needs to be resolved in order for the economy to function properly.

What are double dip and triple dip recessions?

  • A double dip recession refers to a situation in which a country’s GDP growth falls to negative territory after a quarter or two of positive growth. In other words, a double dip recession happens when an economy falls into recession, followed by a short-term growth, followed by a second recession. Similar to double dip recessions, a triple dip recession refers to a new, third recession after a double dip recession.

What is a good investment during a recession?

  • A recession is usually followed by a significant fall in equity prices. Many popular investors, including Warren Buffet, perceive a recession as an opportunity to get into the stock market at relatively low prices. As the saying goes, buy low – sell high. During the great recession of 2007-2009, the S&P 500 reached its lowest point of 666.3 in March 2009, only to grow and reach its pre-crisis high of 1,578 points in March 2013. As of October 2018, the index stands around 2,800 points.

Read: What are Economic Indicators?

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