What Is a Recession?
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Key takeaways:
A recession is a prolonged and widespread decline in economic activity.
The length and severity of each recession varies.
You can’t predict exactly when a recession will hit, but you can take measures to prepare your finances.
For many, waiting for a recession feels like waiting for the inevitable major storm or earthquake to hit. But it doesn’t have to be a cause for panic.
Understanding what a recession is can help you remain calm and brace your finances.
What is a recession?
A recession is when the economy stops growing and economic activity shrinks. The National Bureau of Economic Research, a nonprofit organization, tracks the business cycle (including both economic expansion and contraction periods) in the U.S. to determine when a recession begins and ends.
The NBER traditionally defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” However, it notes that all three conditions don’t need to be fully met in every case, as the extent of one factor can outweigh the others.
What causes a recession?
Recessions follow periods of economic expansion, or growth. At times, the Federal Reserve has let the economy grow at an unsustainable rate and then hiked interest rates aggressively in an attempt to correct this, according to Lynn Reaser, chief economist at Point Loma Nazarene University in San Diego. But many factors can lead to a recession. Past causes include inflation, trade conflicts, reduced spending and unexpected economic shocks, such as the coronavirus pandemic.
“The 9/11 attack thrust the economy into recession, oil price jumps pushed the economy downward in the 1970s and the housing market's collapse triggered the severe decline in 2007-2009,” Reaser said in an email.
What happens during a recession?
No two recessions are exactly alike. Some are far more devastating than others. But often, job losses occur, unemployment rates rise, consumer and business sales fall and production drops across most industries, Reaser says. For many people, this creates financial challenges.
“It’s going to affect those at the lower end of the spectrum the most,” says Lamar Watson, a certified financial planner and founder of Dream Financial Planning in Reston, Virginia. “Think about those that are hourly workers, that work in the hospitality industry and things like that.”
People in these situations typically have higher debt balances and will be susceptible to layoffs, Watson says. Lenders may also be less likely to extend credit during a recession. This can make it difficult for some to afford necessary expenses. But for others, downturns present opportunities to refinance or invest when mortgage rates and stock prices drop, for example. (Learn more about what to invest in during a recession.)
What was the Great Recession of 2008?
The Great Recession was an 18-month-long economic downturn sparked by predatory lending and a bursting housing bubble. This period is sometimes referred to as the “2008 recession,” but the recession actually began at the tail end of 2007 and ended in 2009.
The Great Recession is notable, not just because it’s a not-too-distant memory for many. It’s also the most severe recession the U.S. has experienced since the Great Depression. Millions of people lost homes and jobs; The unemployment rate reached 9.5% during the Great Recession (it hovered around 5% before it started). Gross domestic product fell, and interest rates dropped.
The circumstances surrounding the recession led to new regulations aimed at increasing transparency and accountability around financial products and services, as well as the creation of the Consumer Financial Protection Bureau.
How long do recessions last?
It varies. The U.S. has gone through 34 recessions since 1857, which have lasted between two months and several years, according to the NBER. The most recent recession, which occurred between February 2020 and April 2020, is the shortest on record. The Great Recession before that spanned 18 months, lasting from December 2007 to June 2009. No one can say for certain how long the next recession will last.
How do recession differ from depressions?
The NBER doesn’t define the term “depression.” But most experts agree that a depression is a longer, more severe period of economic decline. One rule of thumb is that a downturn is considered a depression when the decline in gross domestic product is greater than 10%. Recession can lead to depression, but not always. Read more about recession versus depression.
How to prepare for a recession
The earlier you can start readying your finances, the better you’ll fare. Be proactive and create a plan of attack now. Here are a few ways to begin preparing for a recession:
Build up an emergency fund
Ideally, you should save between three and six months worth of expenses to help you stay afloat during a job loss or other hardship. But any amount you can contribute is better than nothing. Setting up automatic transfers to a savings account is a smart way to stockpile funds.
Make a budget
It’s important to know how much you’re spending, how much you can really afford to spend and what exactly you’re spending on. The 50/30/20 budget is a good guideline for splitting your money between needs, wants and savings.
Rein in your spending
Look for expenses you can cut or reduce from your budget. Start with nonessential purchases — think downsizing your cable package or dialing down your online shopping habit.
Pay down debt
Go after high interest debt such as credit cards first. Toxic debt can become much more difficult to manage during a serious recession. Consider options like debt consolidation and make extra payments, when you can.
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