What Happens in a Recession?

Key takeaways

A recession is a widespread, significant decline in economic activity that lasts for multiple months.

• 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 17 months [1].

• The National Bureau of Economic Research examines a multitude of factors and data, including industrial production, consumer and business spending, income, and the labor market, to determine whether the economy is in a recession.

• You can prepare for a recession by meeting with your financial advisor to gain a better understanding of your financial situation. 

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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), 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, such as industrial production, consumer and business spending, income, and the labor market, in order to identify whether or not the economy is in a recession. 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 as being in a recession after it has already started.

Key indicators: What happens during a recession in the US?

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 17 months [1]. When a recession hits, various aspects of the economy are negatively impacted. Below are some common indicators that occur during a recession, which allow experts to determine whether or not a recession has hit.

What does a recession do to the average person?

During a recession, you may experience job loss, lower wages, and fewer growth opportunities. Losing your job can also mean losing benefits like health insurance and retirement savings. While this extreme will not happen to everyone, it is a time of financial strain.

GDP

Gross domestic product (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 recover from, 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].

Income inequality

Not everyone suffers the same during a recession. Prior to the COVID-19 pandemic, in 2019, upper-income households had 58 times as much wealth as lower-income households [4]. However, the wealth of lower-income households grew by 101 percent during the pandemic, compared with 15 percent for upper-income households [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 recessionary economy on manufacturing. Downturns in manufacturing will also be reflected in 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.

Learn more: What Is Production Management? Definition, Careers, and More

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. 

What happens to stocks in a recession? 

The stock market can also 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, such as lower consumer spending causing lower profits for businesses, potentially impacting stock prices, it is challenging to predict the performance of stocks during a recession. 

What happens to interest rates in a recession?

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 for individuals and businesses to take out loans. 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 what happens in a “recession economy”

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. 

Explore free resources to build your financial literacy

If you’re interested in building financial literacy, subscribe to our LinkedIn newsletter, Career Chat, to learn more about trending topics in finance. Or, explore free digital resources to guide you.

• Hear from an expert: 8 Questions with an Expert: Google Financial Data Analyst

• Build a budget: Google Sheets Dynamic Charts: How to Build Visuals That Update Automatically

• Watch on YouTube: Financial Markets with Robert Shiller by Yale University

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