What is a recession?


(The Washington Post) The U.S. economy is back in the headlines, with more economists and financial experts warning of an impending downturn at some point in the next year. But what is a recession – and what happens during one?

The answers can be complicated and vague.

“Recessions are notoriously hard to predict in advance,” said Tara Sinclair, an economics professor at George Washington University. “It’s pretty easy to say a recession is coming at some point in the future. . . . It’s much harder to quantify exactly when, how long and how deep.”

For nearly two years, the U.S. economy has notched blockbuster gains, with millions of new jobs and wage hikes adding to the streak of good news. Families and businesses were flush with cash, which they used to buy houses, cars, electronics and other big-ticket items. That extra spending – combined with lingering supply chain shortages and delays from the pandemic – helped drive up prices and contributed to the highest inflation in 40 years.

Now policymakers are trying to tackle some of those skyrocketing prices with higher interest rates. They’re hoping that by making it more expensive for families and businesses to borrow – for investments, homes and cars, for example – that demand for those things will go down. The question is whether they will be able to slow things down just enough, without sending the country into a recession.

Here, we answer some common questions on economic downturns and how they affect Americans.

What is a recession?

Technically, a recession is six months of negative growth in the U.S. economy. The National Bureau of Economic Research (NBER), which is the official arbiter of U.S. recessions, looks for a few other bad signs. It requires “significant” and widespread declines across the economy in measures such as the employment rate, consumer spending and all the things factories make. There are no hard and fast rules on exactly which measures are factored in or how they are weighted, though the NBER notes that it pays close attention to jobs numbers and personal income levels, which measure wages, benefits and investments heading into people’s bank accounts.

How do we know if we’re in a recession?

An official recession often isn’t called until things get pretty bad. During the Great Recession, for example, the NBER didn’t announce until December 2008 that a recession had begun a full year earlier.

But even before it is official, there are plenty of warning signs that can point to a souring economy: Job losses typically rise, wages stall, and families and businesses stop spending so much.

The job market in particular can hold many clues. The economist Claudia Sahm, for example, has come up with a way to recognize recessions in the early stages based on changes in the unemployment rate.

“Unemployment rises in recessions, which is why they’re so bad and broad-based,” Sahm said. “The unemployment rate usually isn’t the first thing to go bad, but once it starts rising in a recession, it tends to keep going.”

By her measure, which is called the “Sahm rule,” we’re nowhere near a recession: The unemployment rate is at a pandemic low of 3.6%, down from 5.8% a year ago.

But, she added, the coronavirus crisis has blown many economic conventions out of the water, so it’s anybody’s guess whether past trends will hold true the next time around.

“It is a pattern we’ve seen over time, but it does not mean it is a rule of nature,” she said. “There is no crystal ball.”

Is a recession coming? How soon?

That’s the big question of the moment. At this point, many economists say they expect a downturn next year, although the outlook is changing by the week.

Deutsche Bank, the first major bank to predict a 2023 recession, is now forecasting an even “earlier and somewhat more severe recession.” The bank’s chief economist now expects the U.S. economy to shrink by about 0.5% next year and the unemployment rate to peak near 5.5% in 2024.

“Our current forecast has the economy skirting close to recession in the first half of [2023],” Deutsche Bank economists wrote in a research note this month. “A more severe tightening of financial conditions could, therefore, easily pull forward recession risks to around the turn of the year.”

Meanwhile, another large bank, Goldman Sachs, is also upping the odds of a 2023 recession, from 15% to 30%.

Here’s what we know: Unemployment is at historical lows. Savings accounts are still flush, thanks in part to government stimulus at the height of the pandemic. And families and businesses are continuing to spend more than they were a year ago.

At the same time, inflation is at 40-year highs. Americans are buying fewer cars, appliances and other goods. Trillions of dollars in stock market wealth have been wiped out in recent months. And families, many of whom are working through their savings, are starting to rethink vacations, haircuts, restaurant visits and other types of service spending.

In addition, the U.S. economy unexpectedly shrank in the first three months of the year, although we won’t know until late July whether that trend continued for another quarter.

“We are not in a recession, nor is one inevitable,” Sahm said. “There are actions that could be taken over the next six months to the next year that will be decisive in whether we go into a recession or don’t – or whether we go into a mild recession or a severe one.”

How long does a typical recession last?

The average modern-day recession has been 11 months long, according to NBER data.

That said, time frames can vary. The pandemic recession in early 2020, for example, lasted just two months – the shortest on record – while the Great Recession of 2007 to 2009 dragged on for 18 months.

How does a recession affect the average person?

Far-reaching job losses are one of the biggest ways recessions hit home – and they can quickly snowball into even more dire problems, such as eviction or foreclosure.

But even those who stay employed can be hurt: It can be harder to switch jobs or get a raise. Small businesses are more likely to fold. And for young adults entering the labor force during a downturn, it can take years to make up for spotty employment options and low starting pay.

“At the end of the day, recessions are bad because people suffer financially,” Sahm said. “They’re a big hit, and they touch everyone.”

What should I do to protect my finances before a recession?

This can be tricky, economists and financial advisers say: The right decision for individuals is generally to put off spending and save for a rainy day. But that’s often not what’s best for the economy.

“When people cut back on spending in a recession, that makes the recession even worse because when they’re not spending then they’re not creating income for others,” said Sinclair of GWU.

In general, though, she said households and businesses should make sure their money isn’t all in one place. Keeping investments spread out across a range of stocks and bonds can protect from huge swings in any one market. And it’s important to stay patient. Long-run trends are more important than short-term changes in value.

Michelle Singletary, The Washington Post’s personal finance columnist, agrees: “Feel what you feel, but don’t make irrational moves based on your fear,” she recently told readers.

Singletary advised against making major stock portfolio changes and said individuals should instead focus on paying down credit card debt, particularly as interest rates rise, and rebuilding savings.

Recessions can also be a good time to go back to school. “The unemployment rate is consistently lower for people with a college degree, so this can be a way to insulate yourself a bit from the business cycle,” she said.

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