Over the last few months, the words “recession,” “depression,” and even “economic collapse” have been bandied about a lot. These words can spark a lot of fear and anxiety. In fact, after seeing them you may be tempted to stop reading right now. Don’t.
That’s because knowing the facts can help you be better prepared for whatever might come. This week, I want to dive into what the word “recession” means, what it might look like, and how it might impact you. Remember, I’m a financial educator, not an economist. These aren’t predictions of what may or may not lie ahead. But hopefully a better understanding of the basics can give you some peace amidst the worry.
What is a recession? According to the National Bureau of Economic Research (NBER) — the organization that officially declares recessions — America has entered recession territory when it experiences a “significant decline in economic activity spread across the economy, lasting more than a few months.” If you think of the normal business or economic cycle as a roller coaster ride, the recession is that steep drop. It’s not an anomaly; in fact, it’s a part of the cycle, generally following a period of economic expansion — like what we’ve had since the last recession ended in 2009.
Tip: While the recession begins just after the economy reaches a peak of activity — the highest point in the roller coaster ride — the NBER won’t officially announce that there is a recession until we experience two consecutive quarters of economic decline.
What are the indicators? While the most important indicator is Gross Domestic Product (GDP). Investopedia defines GDP as the “total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period.” The NBER generally declares a recession after two consecutive quarters of negative growth in GDP. A recession can show up in a few different ways: a decrease in personal income, a rise in unemployment, and fluctuations in the overall health and sales of the manufacturing sector.
Tip: Despite what you may hear, declines in the stock market are not an indicator of a recession. They reflect investor confidence in the economy, not the health of the economy itself. However, a steep decline in the stock market can be a contributor to or an effect of a recession.
How long might it last? Every recession is different so it’s tough to say. The Great Recession in 2008-2009 lasted a year and a half, but the effects were felt for much longer. The 2001 recession, while it didn’t match the textbook definition, lasted from March to November 2001.
Tip: A recession lasts two or more quarters; a depression lasts two or more years. By some measures, the Great Depression in the 1930s lasted an entire decade. The Great Recession in 2008 did not enter depression territory because the economy began to turn around in the third quarter of 2009.
How might it impact me? We’ve already seen some of the most detrimental impacts of a recession: rises in unemployment, corporate cutbacks, businesses going bankrupt, stock market drops, and a decrease in consumer purchases. But as you might remember from the Great Recession, there are also longer lasting effects: people losing their homes, a fall in housing prices, growth in government debt, and young people having a tough time getting a good job after graduation.
Tip: There are a few positive impacts of a recession. One is that it curbs inflation — in other words, it staves off the slow rise of the cost of goods and services. Another potential positive is a drop in interest rates. While this means you may earn less on any interest bearing savings accounts, it also means that businesses and consumers can borrow more easily. This may be a better time to buy/refinance a home or make large purchases like a car or appliance.
What can I do now? There’s nothing you can do personally to stave off a recession, but you can prepare for it. This is a great time to do a financial audit to get a clearer picture of your financial life. What financial obligations (bills, household expenses, and debt payments) do you have to meet each month? What discretionary spending (entertainment, online shopping, subscriptions) could you reduce or eliminate if you had to? What savings do you have in place to help you meet your obligations, if needed?
Tip: Still feeling anxious? This may be a good time to walk through the specifics of your worst-case scenario. What’s the worst impact the recession might bring to you and your family? How would you handle it? Don’t let your imagination run wild; instead, be methodical. Name the worst-case scenario and ask yourself (and your partner): “What would you do next?” Then, “What would you do after that?” Work out the situation step-by-step until you reach a likely resolution. Remember, there may be resources available to you (like unemployment or government support) that can be tough to predict right now.