What Happens in a Recession?

A recession is a widespread, significant decline in economic activity that lasts for multiple months. Many consider the economy to be in recession when a country’s gross domestic product (GDP), when adjusted for inflation, falls more than two quarters in a row. However, this method fails to consider the holistic state of the economy. 

Instead, the National Bureau of Economic Research examines a multitude of factors and data in order to identify whether or not the economy is in a recession, such as industrial production, consumer and business spending, income, and the labor market. Properly examining this data can take time as data and details typically become available at varying times. As a result, the National Bureau of Economic Research is often only able to officially designate or announce the current state of the economy being in a recession after it has already started.

In this article, we explore some of the indicators of a recession, as well as how to prepare should one arise. 

Indications of a recession

The severity and length of a recession can range, often lasting anywhere from two months to a year and a half, with the average recession lasting approximately 10 months [1].  When a recession hits, various aspects of the economy are negatively impacted. Below are some common indicators that happen during a recession, which allow experts to determine whether or not a recession has hit.

GDP

GDP measures the production value of goods and services throughout a country, as well as the income gained as a result of this production over a period of time in some cases. To calculate GDP, you would consider factors such as consumption by citizens, investments, government spending, and exports minus imports. During a recession, GDP can fall anywhere from 2 to 5 percent in more extreme cases. For example, the GDP during the Great Recession of 2007 to 2009 fell 4.3 percent [2].

Unemployment

As spending slows during a recession, companies will need to look for ways to cut costs, often resulting in layoffs and a reduction in hiring. It can become a cyclical process since people who experience layoffs will typically spend less money, causing businesses to take further losses. Unfortunately, unemployment can take a long time to rebound, and its lasting effects can linger into the recovery period following a recession. For example, during the 2020 recession, unemployment increased drastically from 3.6 percent to 13 percent in the initial wake of the COVID-19 pandemic [3].

Read more: What to Do When You're Laid Off

Income inequality

Not everyone suffers the same during a recession. According to data from the Pew Research Center, from the beginning of the Great Recession in 2007 and through 2016, the wealthiest 20 percent of American households still experienced an increase of 13 percent in their net worth [4]. On the other hand, families in the 20 to 40 percent range experienced a 20 percent loss of net worth, a significantly different outcome than those in the top tier [4]. 

Manufacturing activity

Manufacturing tends to suffer as a result of recessions, often due to an increase in production costs and shortages in supply and labor. The fact that consumers limit spending during recessions only worsens the impact of a receding economy on manufacturing. Downturns in manufacturing will also be reflected by the lowering of GDP. 

However, one positive note about the manufacturing industry is that it will usually recover faster after the initial decrease than other parts of the economy. In this case, an upswing in manufacturing can be a potential sign that the recession may be ending.

Retail sales

During a recession, many retailers have to employ cost-saving measures to mitigate the losses caused by reduced sales. These cost-saving measures can include layoffs, suspended hiring efforts, limited raises, and lower overall spending. 

Surviving a reduction in sales during a recession can be especially challenging for small businesses that don’t have the same ability to apply cost-cutting measures. During the 2020 recession, retailers implemented strategies such as online ordering and curbside delivery to make shopping easier for consumers. 

Stock market

The stock market also can suffer due to the effects of a recession. The market can become highly volatile, dropping significantly. It is especially prone to occur in the early stages of a recession. 

Certain industries, such as those selling consumer necessities, are more likely to successfully limit the damage of a recession. However, not all recessions are the same. With numerous factors potentially impacting stock prices, such as lower consumer spending causing lower profits for businesses, it is challenging to predict the performance of stocks during a recession. 

Interest rate

During a recession, interest rates are likely to decline. For example, the Federal Open Market Committee within the Federal Reserve lowered the target interest rate from 4.5 percent in 2007 to just 2 percent by September 2008 [5]. 

Low interest rates can boost the economy through increased spending, and the ability to borrow money at a lower rate can make it more affordable to take out loans for individuals and businesses. Some people choose to use low interest rates as an opportunity to make a big purchase, such as buying a house. As a result, inflation can then rise in response to the increased spending. 

How to prepare for a recession

In order to prepare for a recession, it's important to keep some tips and practices in mind. One way to prepare is to build some savings, as experts recommend having at least three months of expenses saved. Additionally, setting a budget to keep track of your spending can be helpful. Budgeting can be an especially great option for those who have limited finances to add to savings. You may also consider taking on a side hustle to increase your income. 

Learn more: Cyclical Unemployment: How to Stay Relevant During an Economic Downturn

Next steps

Online courses offer an accessible way to learn more about financial markets and banking. For example, consider taking Economics of Money and Banking, offered by Columbia University on Coursera, to explore the innovation attempts banks used in response to the financial collapse from 2007 to 2009. Another option is the University of Pennsylvania’s Microeconomics: The Power of Markets course, which can teach you why markets exist and the impact government intervention can make. 

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