What Is a Recession?

What Is a Recession?

One popular definition of a recession is two consecutive quarters of negative gross domestic product (GDP) growth. While that's commonly the case, it's not a hard and fast rule.

More specifically, the National Bureau of Economic Research's (NBER) Business Cycle Dating Committee—the go-to source that declares when there's a recession—considers various economic indicators. According to NBER's stated definition, a recession is "a significant decline in economic activity that is spread across the economy and that lasts more than a few months."

What Are the Signs of a Recession?

The NBER economists generally look for three signs to determine whether we're in a recession:

• Depth: How severe is the economic fall?
• Diffusion: How many sectors of the economy are affected?
• Duration: How long has the economy been in a downturn?

The NBER's panel of eight research economists look at all three of these factors to determine whether an economic downturn should be defined as a period of recession. In some cases, however, extreme conditions in one area can outweigh the others.

One example is the pandemic-related recession in early 2020. Although the decline in economic activity lasted only two months, the committee determined that the drop was so severe and widespread that it still met the definition of a recession.

What Can Cause a Recession?

Normally, the economy expands and grows when times are good. These periods can last several years. But what causes an expanding economy to reverse direction? Historically, three types of events trigger recessions:

• Asset bubbles: A recession can occur when one type of asset—such as stocks or real estate—collapses and its fallout causes an economic downturn. Such was the case in the early 2000s with the dot-com bubble and again in 2007, when the housing market crashed and set off the Great Recession.
• Economic shocks: Sometimes, an event or disruption can be so impactful it causes severe harm to the economy. For example, a financial crisis in another country, a sharp spike in oil prices or a global pandemic can have far-reaching effects.
• Overheating: High inflation and low unemployment can cause an economy to grow too fast, or overheat. When prices rise too fast, the Federal Reserve may raise interest rates to curb spending and borrowing, which can shrink the economy.

When Was the Last Recession?

The last recession began in February 2020 and lasted until April 2020, according to the NBER, as the COVID-19 pandemic brought the global economy to a halt. It was the shortest U.S. recession on record, but the economic damage was severe, with over 20 million jobs lost in April 2020 alone, according to the Center on Budget and Policy Priorities.

Although the declared recession period was short, recovery continued for several years, as is often the case with recessions. Getting back to pre-recession levels can take much longer than the downturn itself lasts.

How Long Does a Recession Last?

The last 10 recessions each lasted about 10 months, on average, but their actual length can vary significantly. The NBER's chart of business cycle expansions and contractions shows that recessions have ranged from just a couple of months to more than a year. The two most recent recessions illustrate this point. The recession that began in February 2020 lasted just two months. Meanwhile, the Great Recession, which started in December 2007, lingered for 18 months.

According to the NBER, a recession is measured as the period between a peak in economic activity and a trough—the drop from a high point to the lowest point. Conversely, the normal or expansionary period occurs from the trough to the next peak. Sometimes it can take a while to determine when those peaks and troughs occurred, and it's not uncommon for the NBER committee to take several months (sometimes over a year) to declare that there was a recession. That's why it's possible to be in a recession without it being confirmed until later.

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

Unlike with a recession, there's no formal definition or committee that declares a depression. However, the general understanding is that a depression is a more extreme or long-lasting recession. There's also only been one depression in the modern U.S., the Great Depression, which lasted from 1929 into World War II.

During the Great Depression, production, employment, construction and trade nearly came to a halt, and unemployment reached historic highs. In a depression, the financial strain is so severe, most people won't be able to manage it without going through major hardship.

Learn more: What Is the Difference Between a Recession and a Depression?

How Can a Recession Affect You?

How a recession may impact you likely depends on what causes the recession and what parts of the economy get hit the hardest.

Layoffs and Hiring Pauses

Companies generally pause hiring and may lay people off as the economy shrinks and their profits decline or disappear. Even if you still have your job, fear of losing your employment and limited opportunities could keep you from asking for a raise or looking for a better job elsewhere.

Rising Prices

At the same time, inflation may lead to rising prices during a recession and in its recovery. That's what happened with auto prices and many foreign goods in recent years, as renewed demand, supply shortages and rising production costs pushed prices higher.

Declining Stock Values

The value of your stock portfolio and retirement account may also drop during a recession. Unfortunately, if you've lost your job or need extra money, this also means that you may be forced to sell investments when they're down in order to free up cash.

Learn more: How to Avoid Emotional Investing

Changes to Credit Offerings

You may find fewer borrowing options and more stringent eligibility requirements, as lenders become more cautious about lending money. You might need a higher credit score or larger down payment to qualify for new credit, and some creditors may discontinue some products altogether. They may also be more likely to offer hardship plans, however, which can help account holders avoid missing payments.

Interest Rate Fluctuations

The Federal Reserve also tends to lower interest rates during a recession to try and spur growth. In March 2020, for example, the Fed slashed its benchmark rate to near zero in response to the economic fallout from the coronavirus outbreak—weeks before a recession was officially declared. While rate cuts can make borrowing more affordable, they can also lower returns on savings accounts and CDs.

But the Fed could also raise rates to fight inflation. In that case, you might pay more interest on credit cards and loans, but you could also earn higher yields on deposit accounts.

Is My Money Safe During a Recession?

Your money may be safe during a recession, but you might want to be more cautious with it. Even if you haven't lost your job, you may want to hold off on large purchases and build up your emergency fund, especially if businesses in your area or industry are cutting back or closing.

While bank failures happen, they're rare, and your cash is generally protected—especially if you deposit it in an account insured by the Federal Deposit Insurance Corp. (FDIC).

These accounts are protected up to $250,000 per depositor, account type and financial institution. Even if your bank fails during a recession, your money is still safe up to the limit. Credit unions offer similar protection through the National Credit Union Administration (NCUA).

Learn more: Financial Do's and Don'ts to Follow During a Recession

How to Prepare for a Recession

A recession can take a real toll on your finances, so it's a good idea to prepare ahead of time. Here are a few important actions you might take to shore up your finances and get through a recession with less stress.

• Avoid unnecessary purchases. Try to limit extra spending, especially large purchases, so you have more money on hand for essential costs like food, utilities and your rent or mortgage. You'll also be in a better position to handle an unexpected expense, like a car repair or medical bill, without having to rely on credit.
• Pay down debt. If inflation rates are rising, it could be more expensive to keep up with your credit cards and loans. Consider following a repayment strategy—such as the debt snowball or debt avalanche method—to systematically eliminate what you owe. Balance transfer credit cards with 0% introductory periods for up to 21 months may give you enough time to pay off debt interest-free.
• Fortify your emergency fund. Even if you already have an emergency fund, you may want to reassess your income and financial situation to make sure you have enough saved. Having a flush emergency fund, and increasing your balance if possible, could give you more options if you lose a job or need extra cash fast.
• Negotiate your bills. Lowering your bills is often just a phone call away. For example, you might contact your auto insurance provider and ask for a policy review to see if you qualify for any discounts you're not currently receiving. You can also compare rates from other car insurers to see if switching saves you money. Similarly, some credit card companies may lower your interest rate if you ask. You can also negotiate your utility bill to free up more room in your budget.
• Look for ways to cut expenses. Another way to give yourself more financial breathing room is to cut back on expenses you don't necessarily need. Canceling little-used subscriptions and memberships can be a quick win. Limiting entertainment and dining costs can also give you more financial flexibility. Review your budget to spot expenses you can cut with little impact on your lifestyle but help you reach your goals.

Learn more: How to Prepare Your Finances for a Recession

Good Credit May Give You Added Flexibility During a Recession

While taking on new debt during a recession isn't ideal, maintaining good credit still matters because it gives you more flexibility if you truly need to borrow. This can be especially helpful when interest rates are high and lenders are tightening their eligibility requirements.

See where your credit stands by checking your FICO^® Score^☉ for free and reviewing your credit report for any issues that may be affecting your score. If necessary, take steps to improve your score and credit profile to put you in the best shape if a recession is on the horizon.