What is Recession?

A recession is a period when an economy shrinks instead of growing. Businesses produce and sell less, households spend less, companies slow their hiring and unemployment rises. Economists track this mainly through gross domestic product, or GDP, which is the total value of all goods and services an economy produces. A common rule of thumb calls it a recession when GDP falls for two quarters in a row, a quarter being a three-month period. In the US the official call is made by a committee of economists who look at a wider set of data, including jobs, incomes and industrial production. They often announce a recession months after it has begun.

Say a hypothetical economy produces $1,000 billion of goods and services in one quarter. The next quarter output falls to $990 billion, a decline of $10 billion, or 1%. In the quarter after that it falls to $980 billion, another drop of $10 billion, which is about 1.01% of $990 billion. Two consecutive quarters of shrinking output meet the rule of thumb, and output now sits 2% below where it started. To get back to $1,000 billion, the economy needs to grow by $20 billion, which is about 2.04% from $980 billion.

A common misunderstanding is that a recession and a stock market fall are the same thing. Share prices reflect expectations about future company profits, so markets often fall before a recession is recognised and frequently recover while economic data still looks weak. Some recessions come with deep losses. The S&P 500 fell 54.6% from peak to low, with dividends, between 2007 and 2009, a period of severe economic contraction. Other market declines happen with no recession at all, and some recessions bring only modest falls. Because official dates arrive late, the label mostly describes the past rather than acting as a signal.

For a private investor building a long-term portfolio, recessions are a normal part of the economic cycle rather than rare events. They tend to bring falling company earnings, rising unemployment and often lower interest rates from the central bank, the institution that sets a country's short-term interest rates. These changes can affect shares, bonds and cash in different ways. Investors who understand that markets and the economy move on different timetables are less likely to sell at a low point in reaction to bad headlines. Many investors spread their money across several asset classes, meaning broad groups of investments such as shares and bonds. Many also keep enough cash for living costs, so that a recession does not force them to sell investments when prices are down.

By Dr. Harry Hamann

What is the definition of a recession?
A recession is a significant, widespread decline in economic activity lasting more than a few months. A popular rule of thumb is two consecutive quarters of falling GDP. Official bodies also look at jobs, incomes, spending and industrial production before declaring one.

Do stocks always fall during a recession?
No. Stock markets often fall before a recession is officially recognised and can start recovering while the economy is still weak. Some recessions coincide with deep market losses, others with modest ones, and some market declines happen without any recession.

What is the difference between a recession and a depression?
A depression is an unusually deep and long-lasting recession, with very large falls in output and very high unemployment. There is no single official threshold. The term is generally reserved for the most severe and prolonged economic downturns.

How long does a recession last?
There is no fixed length. Some recessions last only a few months, while others stretch over a year or more. Because official start and end dates are usually announced with a delay, a recession is often over by the time its end is confirmed.