What is a Recession and is One Coming?

Speculation about another recession is growing. But is it coming? And what would that entail? Here, we examine what a recession is, whether one is on the way and how to prepare.

By Lora Korpar

What do you think of when hearing the word “recession”? You might visualize the 2008 housing crisis or maybe the Dust Bowl of the American plains during the 1930s Great Depression.

The New York Times defines a recession as “when the economy stops growing and starts shrinking.” This economic decline can lead to other issues like unemployment, dips in prices and less spending. Investopedia says other recession characteristics include business and bank failures and a “negative growth in production.”

The most recent recession in the U.S. took place from February to April 2020, when the COVID-19 pandemic began, according to the National Bureau of Economic Research (NBER). Some experts theorize another could be coming.

But how can we tell, and can a recession even be predicted? I spoke with Stanford University economics professor Nick Bloom, Ph.D ., and Northwestern University economics professor Mark Witte, Ph.D ., about how recessions work, whether we can determine if one is coming and how to prepare.

What Happens In a Recession

The NBER says a recession is the period of decline between a peak in economic activity and its subsequent trough, or lowest point. The recession ends when economic activity increases again, though the aftereffects can remain.

Most recessions don’t last long because “expansion is the normal state of the economy,” according to the NBER. Bloom added that recessions tend to last two or more quarters, but exceptions exist, like the brief recession at the pandemic’s onset.?

If a recession becomes severe enough, it is considered a depression. The Federal Reserve Bank of San Francisco says no concrete criteria exist for identifying when a recession becomes a depression. However, the degree of severity must be high. For example, during the Great Depression, the real output of the U.S. decreased by almost 30% and unemployment rose by 22%. In comparison, during the worst World War II-era recession, the country’s real output fell by 3.4% and unemployment underwent a 5% increase.

The NBER formally declares recessions. The agency says recessions impact multiple sectors, so it takes a broad view. These include declines in real GDP, real personal income, employment, consumer expenditures, industrial production, and wholesale-retail sales.

The NBER often doesn’t declare a recession until the country is well into one. Bloom and Witte say this is because it takes time for economic data to be compiled, especially in a country as big as the U.S.

“The economy is the most complex thing ever built by humans,” Witte said.

Misconceptions About Recessions

Bloom says a common misconception about recessions is that the economy will provide an immediate bounceback. The truth is recessions are binary – you either are in one or not. And not being in one does not mean the economy is thriving.

“A recession is defined as a contraction, so when you’ve hit bottom and start to recover, that's no longer a recession, but you can still be wavy on the trend, and employment can still be very high, but coming down,” Bloom said. “That means you're still in a bad economic situation, but it's not a recession.”?

Bloom also said not all recessions look the same. He said the “Anna Karenina” quote “all happy families are alike; each unhappy family is unhappy in its own way,” applies to the economy too.

“Economists often call this the ‘Anna Karenina’ theory of recessions, which is basically recessions are all different,” Bloom said. “Expansions tend to be similar – unemployment is low and falling, employment is rising, the economy tends to grow 2-3% a year. The expansion in 2018 and 2019 was very stable and had predictable, steady growth. Recessions are totally different. The 2008-2009 recession is completely different from the 2020 recession.”

Witte says another misconception is that recessions are inevitable.

“If you throw a ball in the air, it's going to fall down. That's inevitable,” Witte said. “But if you're playing cards, you might have a run where you win all your hands. It's not inevitable that you'd lose. It's very likely that at some point, things go wrong for you, but it need not happen.”

Can You Predict a Recession?

Bloom compared predicting recessions to predicting the weather. You can anticipate economic hardship the same way you can observe a storm cloud and predict rain. It is not a perfect system. If it was, governments could stop recessions before they begin.

“I think a better thing rather than saying if there is or is not a recession would be predicting what growth rates are going to be,” Bloom said. “[It is] like predicting the temperature. You don't need to perfectly predict whether it will go below zero or not. You can say ‘Look, I'm pretty sure it's going to be cold.’”

Bloom says factors you should consider to predict the economy's direction include unemployment, inflation, and the rate of consumer spending. Warning signs exist that could indicate a recession, according to Witte. One is a concept called “yield curve inversion.”

When a person or government borrows money, interest rates tend to be higher for long-term bonds because lenders want their money’s worth. So a visual plot of the yields would curve upward because the interest rates increase with time. However, when interest rates for short-term bonds are higher than the rates for long-term ones, the yield curve is inverted.

“This is often seen as one of the best warning signs of recession,” Witte said. “And the joke is that it has predicted 15 of the last nine recessions. We almost never have a recession without yield curves inverting.”

Another indicator could be a decline in housing prices, car sales and purchases of other “durable goods.” This shows people are decreasing their spending. However, Witte added that these indicators should not be an immediate cause for worry.

“You can get all these warning signs [and think] ‘Oh, a recession is coming,’ but sometimes it doesn't,” Witte said. “Sometimes we dodge the bullet.”

Is a Recession Coming?

No expert can make a 100% accurate prediction about the economy’s direction, but Witte and Bloom said a recession in the U.S. is likely. Witte added that the Federal Reserve would be “perfectly happy to have a recession” because it would bring inflation down.

Witte said the U.S. dollar becoming on par with the euro could also indicate a recession risk. Though the two currencies matching in value shows a decrease in inflation and import costs, it also means U.S. exports will be harder to sell abroad.?

The euro and the dollar reached parity for the first time since 2002 on Wednesday, CNBC reported. Also, the U.S. Treasury’s yield curve inverted to its deepest point since before the 2008 recession on Tuesday, according to Markets Insider.

Bloom thinks the chance of the U.S. entering another recession soon is about 50-60%.?

“What is likely to happen is we're going to have very low growth, close to zero,” Bloom said. “Whether that's formally a recession or not, I don't think it’s even that important a measure. Most people really only care about the level of growth. 0.1% is not a recession, if it's -0.1%, it is, but they look almost identical.”

Preparing for Recession

Though you can’t always predict a recession, you can change your habits to better prepare for one.?

Bloom recommends cutting spending until a recession hits if you are planning for major expenses like a renovation or a vacation. This way, purchase prices will be lower.

Witte also suggests being mindful of your spending and paying off credit card debt to have an extra balance to access if necessary.?

“Plan your spending patterns in a way that is prudent so you can build up some cushion for if you're laid off or you get fewer hours,” Witte said.

Top takeaways

What to know about recessions

• A recession is a period of economic decline, including decreases in GDP, employment, income and spending.
• A period of economic hardship can continue even if the recession is over.
• No one can perfectly predict a recession, but you can follow trends in the yield curve and the housing market to make an educated guess.
• If you are concerned about a future recession, be mindful of spending.