What Is A Recession?

Accurate at the point of publication.

The UK has entered a ‘technical’ recession, according to figures from the Office for National Statistics (ONS), out today.

A recession is defined by the economy suffering two consecutive quarters of what is termed ‘negative growth’ in gross domestic product (GDP) – in other words, a decline in performance and output. In Q3 2023 – July to September – the ONS logged a fall of 0.1%, with the figure for Q4 (October to December) showing a 0.3% reduction.

The UK has teetered on the brink of recession in recent years but this is the first time the technical definition has been met since 2020, when large parts of the economy were effectively shut down during the Covid 19 pandemic.

The government has pledged to grow the economy. In response to the latest figures, it has suggested that the reduction in GDP is a consequence of a sustained period of high interest rates, which are being used to tame inflation.

Yesterday, the ONS revealed that the inflation figure for the year to January was 4%, unchanged on December. This is likely to delay any move by the Bank of England to bring rates down before the summer at the earliest.

Recessions are considered an unavoidable part of the expansion and contraction that occurs in a nation’s economy. Other advanced economies, notably Germany and Japan, have also seen reductions in GDP in recent months.

Recession: what’s the official 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 some 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.

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. 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.
  
• 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,” which 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.
  
• 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 labour-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.

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 UK, the Great Depression (also known as the Great Slump) was a period of national economic downturn in the 1930s, which resulted from the global Great Depression.

What UK recessions have there been?

As an unavoidable movement of any economy, people will typically experience several recessions within their lifetime.

In the UK, the most recent recession was during COVID-19 where, in Q1 and Q2 of 2020, GDP saw negative growth. GDP did not return to pre-pandemic levels until late 2021. Some economic effects of the virus – such as the limited availability of manufacturing goods – continue to impact rising inflation.

Before the pandemic-driven economic crisis, was the Great Recession of 2008 and 2009 resulting largely from the subprime mortgage crisis in the US impacting the British banking sector – and the subsequent ‘credit crunch’. Lasting for more than a year, this was the worst recession in the UK since the Second World War.

The 1990/1991 recession was caused by factors including a rapid economic expansion under Margaret Thatcher and Britain seeking to maintain membership of the Exchange Rate Mechanism. The Early 1990s Recession saw interest rates peak at 14.8% and inflation at 9.5%. Unemployment also reached 10.7% of the working population.

Can a recession be predicted?

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

That being said, there are indicators of looming trouble. Warning signs including a decline in consumer confidence, sudden stock market declines, rising unemployment and people not being able to afford their mortgages and household bills.

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, property 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, 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 one of the strongest period of economic growth in UK history.