What Is A Recession?

A recession is a significant decline in economic activity that lasts for months or even years. Experts declare a recession when a nation’s economy experiences negative gross domestic product (GDP), rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time. Recessions are considered an unavoidable part of the business cycle—or the regular cadence of expansion and contraction that occurs in a nation’s economy.

Official Recession Definition

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.

The Reserve Bank of India (RBI) is generally recognized as the authority that defines the starting and ending dates of Indian recessions. RBI has its own definition, “a recession is widely regarded as a period of prolonged decline in output experienced across much of the economy. To be more concrete, commentators often consider a recession to be in progress when total output (real gross domestic product) has declined for at least two consecutive quarters.” 

The National Bureau of Economic Research (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, the coronavirus could potentially create 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.

What Causes Recessions?

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 doubled the oil prices without warning in India, causing an economic crisis. 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 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.
• 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.
• 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.

Related: What Is Inflation And How To Beat It?

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 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.

What’s the Difference Between a Recession and a Depression?

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, India 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. During the Great Depression, unemployment rose to 24.9% in 1933 and the GDP growth by 10.8% in 1934. It was the most unprecedented economic collapse in modern Indian history.

By way of comparison, the Great Recession 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 fear that the coronavirus recession could morph into a depression, depending how long it lasts. Unemployment hit 14.7% in May 2020, which is the worst level seen since the depths of the Great Recession.

How Long Do Recessions Last?

The RBI tracks the average length of Indian recessions. According to RBI data, India has gone through four recessions in 1958, 1966, 1973 and 1980 and the most recent Covid 19 one is said to be the fifth one.  

• Trade Balance (1958). India faced its first recession in 1958 due to balance of payment problems. The primary sector of the economy, “agriculture” was facing its worst nightmare as its production was affected badly due to poor monsoon. Later India imported around 60 lakh tonnes of food, which led to a drop in economy and increase in prices. The GDP went into negative 1.2% and the country faced skyrocketing import bills. The consequences were that the foreign reserves of India dropped to half.
• Dreadful Drought (1966). India faced a recession post-China and Pakistan war in 1962 and 1965 respectively. The country later faced two terrible droughts that affected food grain production which dropped by around 20%. India depended on the foreign aid that came to rescue the starving populace. 1 crore tons of food aid was received by the country. The GDP growth was negative 3.66%. 
• Energy Emergency (1973). India went through an energy crisis due to the Organization of Arab Petroleum Exporting Countries (OAPEC) indicating an oil embargo which means a ban on oil trade. They attacked specially the countries that supported Israel during the ongoing war, “yom kippur”. The oil prices rose high by around 400% double the price of foreign exchange reserves present in India at that time. The GDP growth was negative 0.35%. 
• Oil breakdown (1980). The world faced oil shortage due to Iranian revolution. It shocked the world and led to an increase in oil prices. It continued even after the Iran-Iraq war which fueled the prices more. The GDP growth was negative 5.2% and created a balance of payment crisis for India. 

Can You Predict a Recession?

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 Indian economy had been all but closed down and millions of workers had lost their jobs. 

That being said, there are indicators of looming trouble. 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: The yield curve is a graph that plots the market value—or the yield—of a range of Indian 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 Indian 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. Sudden stock market declines: A large, sudden decline in stock markets 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.
4. 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, even if the RBI hasn’t officially declared a recession yet.

How Does a Recession Affect Me?

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 Emergency Credit Line Guarantee Scheme, 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 down payment to qualify for a 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 Indian history.