What is a recession?

Many people feel that something is off in the economy or that it's about to be; there is a widespread feeling of precariousness. Even Elon Musk some weeks ago said that he has a "super bad feeling" about the economy and wants to pause hiring and cut his company's workforce; this probably means something, no? Experts wonder if all this fuss means we're actually going into recession. Let’s take a look at this scary economic term.

What is a recession?

Photo by Mikhail Nilov

Let's start simple: a recession is when the economy stops growing and starts shrinking. It can last for months or years and is somehow an unavoidable part of the business cycle. Experts usually declare a recession when a nation's economy experiences negative gross domestic product (GDP) growth, rising unemployment levels, falling retail sales and contracting measures of income and manufacturing for an extended period. Over the years, economists elaborated several theories to define when a country is heading into a recession. In 1975, Julius Shiskin published what is nowadays the most used system in an article from The New York Times. Shiskin suggested considering the trend in the gross domestic product (i.e. the value of all goods and financial services produced by a country) in two consecutive quarters: if the figure is negative in both, then the country is in recession. In the United States, that's the rule that gets officially applied to understand if the country is in recession. Specifically, the National Bureau of Economic Research checks all the parameters in the US. Still, every country has its own version of the same office. For example, the Istituto Nazionale di Statistica (ISTAT) has the same role in Italy. 

What causes a recession?

This question is not the easiest one to answer, and most people with a career in economics spend years researching and debating it. A country's economy is extremely complex; there's no unique answer. There is more than one way for a recession to start. Some common causes are a sudden economic shock (like the coronavirus outbreak), asset bubbles (like the real estate bubble from 2008), excessive debts, too much inflation (when prices for goods and services rise too fast) or too much deflation (when prices decline too quickly). For some economists, big changes and structural transformations in industries are the best way to explain when and how recessions happen. For example, a sudden, sustained spike in oil prices due to a geopolitical crisis (like the war in Ukraine) might simultaneously raise costs across many industries, or a revolutionary new technology might rapidly make entire industries obsolete. In both cases, these facts could trigger a widespread recession.

Stagflation vs recession vs depression

Photo by Sergei Starostin 

These three words often appear when talking about economic crises. But what are their differences and implications? Recessions and depressions usually have similar causes, but the impact of depression is usually much worse. Greater job losses, stronger declines in a country's GDP, and higher unemployment are all part of a depression's recipe. It also lasts longer. 

Stagflation, on the other hand, is a bit vaguer. Growth doesn't necessarily have to be negative, it can also just be stagnant, but when it comes with high inflation and high unemployment, that’s stagflation. Another thing to keep in mind when talking about stagflation, depression and a recession is that there are no clear guidelines when defining what is low and what is high. It highly depends on the country. 

How does a recession potentially affect me?

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The impact of a recession on your personal life could be pretty high. With a recession, there's usually an increase in unemployment. If you lose your job, finding another one could be more complicated than usual. If you manage to keep your job, you might have your hours reduced or face a substantial decrease in your company benefits. You'll probably have to take on more work responsibilities than usual or do two people's work. Prepare yourself mentally for a very exhausting time. 

This general pattern of uncertainty will lead you to spend less and cut back on the extras, such as holidays, or delay big purchases such as a new car. Things like streaming service subscriptions, cable TV or dinners out may also be reduced. Depending on the duration of this hypothetical recession, your family dynamics could change. You might have to postpone your marriage or delay a pregnancy. Some people may find themselves moving back home with their parents while getting their finances back on track. The value of investments, whether houses or shares, tends to plummet in times of recession. If you need cash and want to sell, you may lose out. In these times, banks also want more collateral to offer loans, so you may face difficulties in getting a mortgage or loan.

What can I do to prepare myself?

I know, the outlook doesn't look promising. But keep in mind that economic cycles historically come and go. You can start reorganising your finances now so that you won't find yourself stranded if things worsen. Try to save enough money to survive a minimum of three months without significant sacrifices; that would already be a good start. Remember that if we ever really face a recession, like everything in life, this one will also end. Usually after a period of economic crisis there are great moments of growth. Your sacrifices will fortify your spirit and make you appreciate your renewed stability.

The economy isn't in such a bad state, but a mixture of factors makes people think it is. It's still unclear where we're heading. Whether or not the recession will hit us, the economy seems to be in a moment of transition. We probably can't expect the same pace as the last years. But for now, all this talking of a recession is just that: talk.

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