What Is A Recession?

During a recession, the economy struggles, people lose work, companies make fewer sales and the country’s overall economic output declines. The point where the economy officially falls into a recession depends on a variety of factors.

In 1974, economist Julius Shiskin came up with a few rules of thumb to define a recession: The most popular was two consecutive quarters of declining GDP. A healthy economy expands over time, so two quarters in a row of contracting output suggests there are serious underlying problems, according to Shiskin. This definition of a recession became a common standard over the years. Australia was one of the few developed countries that did not go into a technical recession during the GFC, for example, as we did not experience two consecutive quarters of negative growth— largely owing to China’s appetite for our raw materials and our minimal exposure to the US subprime market.

In the US, the National Bureau of Economic Research (NBER) is generally recognized as the authority that defines the starting and ending dates of US recessions. NBER has its own definition of what constitutes a recession, namely “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

The NBER’s definition is more flexible than Shiskin’s rule for determining what is a recession. For example, some countries may experience a W-shaped recession, where the economy falls one quarter, starts to grow, then drops again in the future. This would not be a recession by Shiskin’s rules but could be under the NBER’s definition.

There is more than one way for a recession to get started, from a sudden economic shock to fallout from uncontrolled inflation. These phenomena are some of the main drivers of a recession:

• A sudden economic shock: An economic shock is a surprise problem that creates serious financial damage. In the 1970s, OPEC cut off the supply of oil to the US without warning, causing a recession, not to mention endless lines at gas stations. The coronavirus outbreak, which shut down economies worldwide, is a more recent example of a sudden economic shock.
• Excessive debt: When individuals or businesses take on too much debt, the cost of servicing the debt can grow to the point where they can’t pay their bills. Growing debt defaults and bankruptcies then capsize the economy. The US housing bubble in the mid-aughts that led to the Great Recession is a prime example of excessive debt causing a recession.
• Asset bubbles: When investing decisions are driven by emotion, bad economic outcomes aren’t far behind. Investors can become too optimistic during a strong economy. Former Fed Chair Alan Greenspan famously referred to this tendency as “irrational exuberance,” in describing the outsized gains in the stock market in the late 1990s. Irrational exuberance inflates stock market or real estate bubbles—and when the bubbles pop, panic selling can crash the market, causing a recession. Some pundits in Australia view our highly leveraged property market as a bubble waiting to pop.
• Too much inflation: Inflation is the steady, upward trend in prices over time. Inflation isn’t a bad thing per se, but excessive inflation is a dangerous phenomenon. Central banks control inflation by raising interest rates, and higher interest rates depress economic activity. Out-of-control inflation was an ongoing problem in the U.S. in the 1970s. To break the cycle, the Federal Reserve rapidly raised interest rates, which caused a recession. Closer to home, Australia is attempting to bring down inflation by raising interest rates: a trend repeated across the globe.
• Too much deflation: While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and business stop spending, which undermines the economy. Central banks and economists have few tools to fix the underlying problems that cause deflation. Japan’s struggles with deflation throughout most of the 1990s caused a severe recession.
• Technological change: New inventions increase productivity and help the economy over the long term, but there can be short-term periods of adjustment to technological breakthroughs. In the 19th century, there were waves of labor-saving technological improvements. The Industrial Revolution made entire professions obsolete, sparking recessions and hard times. Today, some economists worry that AI and robots could cause recessions by eliminating whole categories of jobs.

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Recessions and the Business Cycle

The business cycle describes the way an economy alternates between periods of expansion and recessions. As an economic expansion begins, the economy sees healthy, sustainable growth. Over time, lenders make it easier and less expensive to borrow money, encouraging consumers and businesses to load up on debt. Irrational exuberance starts to overtake asset prices.

As the economic expansion ages, asset values rise more rapidly and debt loads become larger. At a certain point in the cycle, one of the phenomena from the list above derails the economic expansion. The shock bursts asset bubbles, crashes the stock market, and makes those large debt loads too expensive to maintain. As a result, growth contracts and the economy enters recession.

Recessions and depressions have similar causes, but the overall impact of a depression is much, much worse. There are greater job losses, higher unemployment and steeper declines in GDP. Most of all, a depression lasts longer—years, not months—and it takes more time for the economy to recover.

Economists do not have a set definition or fixed measurements to show what counts as a depression. Suffice to say, all the impacts of a depression are deeper and last longer. In the past century, Australia has faced just one depression: The Great Depression.

The Great Depression

The Great Depression started in 1929 and lasted through 1933, although the economy didn’t really recover until World War II, nearly a decade later. The 1929 crash on Wall Street hit Australia hard, with jobs thin on the ground and living standards curtailed. A five-year unemployment average for 1930-34 was 23.4%, however it peaked at a staggering  30%—almost one in three—in 1932.

During the Great Depression in the US, unemployment rose to 25% and the GDP fell by 30%. It was the most unprecedented economic collapse in modern U.S. history.

By way of comparison, the Great Recession in the US was the worst recession since the Great Depression. During the Great Recession, unemployment peaked around 10% and the recession officially lasted from December 2007 to June 2009, about a year and a half.

Some economists feared that the coronavirus recession could morph into a depression, with unemployment hitting 14.7% in May 2020, which is the worst level seen since the depths of the Great Recession.

In Australia, the RBA concludes that we have been through three recessions:

• The mid ’70s recession (1974–1975): When the price of global oil quadrupled in the mid 70s and wage pressures mounted, it caused inflation to soar. Due to the increase in the costs of production, and lower global demand for our exports, our economy contracted and unemployment rose sharply. During this recession, inflation peaked at 18%t.
• The follow-on recession 1982–1983): As the RBA explains, the “high rates of inflation that emerged during the 1970s had become entrenched, with the inflationary effects of higher oil prices reinforced by excessive growth of the money supply and expansionary fiscal policies”. Central banks tried to reduce inflation through tighter monetary policy (sound familiar?) that caused a recession in a number of economies. In Australia, the recessionary pain was compounded by a period of drought
• The recession we had to have (1991–1992): Famously billed by then-PM Paul Keating as the ‘recession we had to have’, the early 1990s recession was a result of Australia’s efforts to limit speculative behaviour in commercial property markets, soften domestic demand and reduce inflation. Interest rates were also increased to put downward pressure on demand and inflation, while the unemployment rate peaked at just over 11%.

Over the past 30 years, the US has gone through four recessions:

• The Covid-19 Recession. The most recent recession began in February 2020 and lasted only two months, making it the shortest U.S. recession in history.
• The Great Recession (December 2007 to June 2009). As mentioned, the Great Recession was caused in part by a bubble in the real estate market. The Great Recession wasn’t as severe as the Great Depression, its long duration and severe effects earned it a similar moniker. Lasting 18 months, the Great Recession was almost double the length of recent U.S. recessions.
• The Dot Com Recession (March 2001 to November 2001). At the turn of the millennium, the U.S. was facing several major economic problems, including fallout from the tech bubble crash and accounting scandals at companies like Enron, capped off by the 9/11 terrorist attacks. Together these troubles drove a brief recession, from which the economy quickly bounced back.
• The Gulf War Recession (July 1990 to March 1991). At the start of the 1990s, the U.S. went through a short, eight-month recession, partly caused by spiking oil prices during the First Gulf War.

Given that economic forecasting is uncertain, predicting future recessions is far from easy. For example, COVID-19 appeared seemingly out of nowhere in early 2020, and within a few months the US economy had been all but closed down and millions of workers had lost their jobs. The NBER has officially declared a U.S. recession due to coronavirus, noting that the US economy fell into contraction starting in February 2020. It was a similar story in Australia, with many workers sacked as the cornovirus took hold. Within two years, Australia would experience record low levels of unemployment—highlighting how quickly things can change.

That being said, there are indicators of looming trouble, especially if the trouble originates in the US. The following warning signs can give you more time to figure out how to prepare for a recession before it happens:

1. An inverted yield curve in the US: The yield curve is a graph that plots the market value—or the yield—of a range of US government bonds, from notes with a term of four months to 30-year bonds. When the economy is functioning normally, yields should be higher on longer-term bonds. But when long-term yields are lower than short-term yields, it shows that investors are worried about a recession. This phenomenon is known as a yield curve inversion, and it has predicted past recessions.
2. Declines in consumer confidence: Consumer spending is the main driver of the Australian economy. If surveys show a sustained drop in consumer confidence, it could be a sign of impending trouble for the economy. When consumer confidence declines, that means people are telling survey takers they don’t feel confident spending money; if they follow through on their fears, lower spending slows down the economy.
3. A drop in the US Leading Economic Index (LEI): Published monthly by the Conference Board, the LEI strives to predict future economic trends in the US. It looks at factors like applications for unemployment insurance, new orders for manufacturing and stock market performance. If the LEI declines, trouble may be brewing in the economy.
4. Sudden stock market declines: A large, sudden decline in stock markets, both here and in the US, could be a sign of a recession coming on, since investors sell off parts and sometimes all of their holdings in anticipation of an economic slowdown.
5. Rising unemployment: It goes without saying that if people are losing their jobs, it’s a bad sign for the economy. Just a few months of steep job losses is a big warning of an imminent recession.

You may lose your job during a recession, as unemployment levels rise. Not only are you more likely to lose your current job, it becomes much harder to find a job replacement since more people are out of work. People who keep their jobs may see cuts to pay and benefits, and struggle to negotiate future pay raises.

Investments in stocks, bonds, real estate and other assets can lose money in a recession, reducing your savings and upsetting your plans for retirement. Even worse, if you can’t pay your bills due to job loss, you may face the prospect of losing your home and other property.

Business owners make fewer sales during a recession, and may even be forced into bankruptcy. The government tries to support businesses during these tough times, like with the JobKeeper scheme during the coronavirus crisis, but it’s hard to keep everyone afloat during a severe downturn.

With more people unable to pay their bills during a recession, lenders tighten standards for mortgages, car loans and other types of financing. You need a better credit score or a larger deposit to qualify for a home loan that would be the case during more normal economic times.

Even if you plan ahead to prepare for a recession, it can be a frightening experience. If there’s any silver lining, it’s that recessions do not last forever. Even the Great Depression eventually ended, and when it did, it was followed by the arguably the strongest period of economic growth in history.

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