In economics, a recession is a business cycle contraction that occurs when there is a period of broad decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various events, such as a financial crisis, an external trade shock, an adverse supply shock, the bursting of an economic bubble, or a large-scale anthropogenic or natural disaster (e.g. a pandemic). There is no official definition of a recession, according to the International Monetary Fund.
In the United States, a recession is defined as "a significant decline in economic activity spread across the market, lasting more than a few months, normally visible in real gross domestic product (GDP), real income, employment, industrial production, and wholesale-retail sales". The European Union has adopted a similar definition. In the United Kingdom and Canada, a recession is defined as negative economic growth in GDP for two consecutive quarters.
Governments usually respond to recessions by adopting expansionary macroeconomic policies, such as increasing money supply and decreasing interest rates or increasing government spending and decreasing taxation.
Definitions
In a 1974 opinion article in The New York Times, Commissioner of the Bureau of Labor Statistics Julius Shiskin suggested that a rough translation of the bureau's qualitative definition of a recession into a quantitative one that almost anyone can use might run like this: In terms of duration – Declines in real gross national income (GNI) for two consecutive quarters; a decline in industrial production over a six-month period. In terms of depth – A 1.5% decline in real gross national income; a 15% decline in non-agricultural employment; a two-point rise in unemployment to a level of at least 6%. In terms of financial indicators - A significant increase in loan defaults or a tightening of credit conditions by financial institutions, leading to a decrease in business investment and consumer spending. In terms of diffusion – A decline in non-agricultural employment in more than 75% of industries, as measured over six-month spans, for six months or longer.
Over the years, some commentators dropped most of Shiskin's "recession-spotting" criteria for the simplistic rule-of-thumb of a decline in real GNI for two consecutive quarters.
In the United States, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) is generally seen as the authority for dating US recessions. The NBER, a private economic research organization, defines an economic recession as: "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales". The NBER also explains that: "a recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough." The NBER is considered the official arbiter of recession start and end dates for the United States. The Bureau of Economic Analysis, an independent federal agency that provides official macroeconomic and industry statistics, says "the often-cited identification of a recession with two consecutive quarters of negative GDP growth is not an official designation" and that instead, "The designation of a recession is the province of a committee of experts at the National Bureau of Economic Research".
The European Union, akin to the NBER's methodology, has embraced a definition of recession that integrates GDP alongside a spectrum of macroeconomic indicators, including employment and various other metrics. This approach allows for a comprehensive assessment of the depth and breadth of economic downturns, enabling policymakers to devise more effective strategies for economic stabilization and recovery.
Recessions in the United Kingdom are generally defined as two consecutive quarters of negative economic growth, as measured by the seasonally adjusted quarter-on-quarter figures for real GDP.
The Organisation for Economic Co-operation and Development (OECD), an intergovernmental organization, defines a recession as a period of at least two years during which the cumulative output gap reaches at least 2% of GDP, and the output gap is at least 1% for at least one year.
GDP per capita recession refers to the decline of GDP per capita instead of decline of total GDP.
Attributes
A recession encompasses multiple attributes that often occur simultaneously and encompasses declines in component measures of economic activity, such as GDP, including consumption, investment, government spending, and net export activity. These summary measures are indicative of underlying drivers such as employment levels and skills, household savings rates, corporate investment decisions, interest rates, demographics, and government policies (Smith, 2018; Johnson & Thompson, 2020). By examining these factors comprehensively, economists gain insights into the complex dynamics that contribute to economic downturns and can formulate effective strategies for mitigating their impact (Anderson, 2019; Patel, 2017).
Economist Richard C. Koo wrote that under ideal conditions, a country's economy should have the household sector as net savers and the corporate sector as net borrowers, with the government budget nearly balanced and net exports near zero.
A severe (GDP down by 10%) or prolonged (three or four years) recession is referred to as an economic depression, although some argue that their causes and cures can be different. As an informal shorthand, economists sometimes refer to different recession shapes, such as V-shaped, U-shaped, L-shaped and W-shaped recessions.
Type or shape
The type and shape of recessions are distinctive. In the US, v-shaped, or short-and-sharp contractions followed by rapid and sustained recovery, occurred in 1954 and 1990–1991; U-shaped (prolonged slump) in 1974–1975, and W-shaped, or double-dip recessions in 1949 and 1980–1982. Japan's 1993–1994 recession was U-shaped and its 8-out-of-9 quarters of contraction in 1997–1999 can be described as L-shaped. Korea, Hong Kong and South-east Asia experienced U-shaped recessions in 1997–1998, although Thailand's eight consecutive quarters of decline should be termed L-shaped.
Front end The front end refers to the early stages of an economic downturn with emerging negative trends across key economic sectors before a full-blown deepening recession is officially declared.
Indicators like GDP growth, employment rates, and consumer spending start to decline. A decline in overall demand causes a slowdown in economic activity. Falling consumer confidence, falling retail sales and reduced business investment are common signs that indicate the beginning of a recession. This phase of the economic cycle can also be marked by slowing economic growth, with factors like declining corporate profit margins (due to lower sales and increased costs), weakening business investment, falling industrial production (continued decline in overall manufacturing hours worked), and a deteriorating sluggish labor market (layoffs becoming more common, e.g. falling private payrolls, declining small business household employment), slower payroll growth, wage stagnation or decline, and a housing market slowdown as real estate buyers in the housing sector become more cautious (followed by declines in home sales, slowing building permits and falling home prices). In financial markets, some investors may become more risk-averse, and bond yields may rise, thereby making it more expensive for companies to borrow money, causing some businesses to struggle to meet their financial obligations.
The front end of a recession refers to the initial phase or onset of a recession. It typically is a period of increasing economic stress (job losses often appear early on) and significant uncertainty, and precedes the official recognition of a recession (the technical definition of a recession is two or more consecutive quarters of negative GDP growth), signaling that the economy is transitioning toward contraction, even before the full effects are felt or officially declared. Early warning indicators can be rising inflation (potential for tighter monetary policy), widening credit spreads (tightening lending standards, strained private sector lending), rising credit delinquencies, and an inverted yield curve (market expectation of much lower growth ahead, a historically reliable predictor of an approaching recession). Recessions especially in the U.S. are typically "preceded by a rising debt service ratio for the private sector".
Some economists also consider a rising 3-month average unemployment rate above the prior year's average as an early recession signal that can precede a formal recession declaration (this is often referred to as the Sahm rule). The Conference Board's Leading Economic Index (LEI) can also provide an early recession indication. Other "soft" consumer signals also tend to appear in everyday life before official statistics catch up, like slower travel (e.g. fewer flights). Identifying the front end of a recession gives policymakers more room to act early and allows for early intervention to potentially mitigate the impact of a recession before the downturn deepens.
The table below illustrates the progression toward recession. Each column represents a distinct phase in the economic cycle.
+Table: Stable economy → Front end of a recession (deterioration) → Critical point (strong recession) Conditions Normal economy Early warning signs / Front end indicators Recession threshold / Severe downturn Economic growth Average/strong Slowing None Confidence Average/high Declining Low Uncertainty Low Increased High Business investment Average/high Falling None Unemployment Low/average Growing High Home prices Stable/growing Falling Low Food prices Stable/low Growing High Corporate and household debt Low Growing High Consumer spending Stable/high Decreasing Low
Back end
Describes the latter part of an economic contraction, specifically the period after the trough (the lowest point of economic activity during a recession) when the economy begins to recover. Characteristics: Indicators like employment and consumer spending transition from decline to growth. Decreasing unemployment, stabilizing Gross Domestic Product (GDP), increased business investment are common signs. Summary: The back end of a recession is a period of gradual and sustained recovery where parts of the economy start to grow again. The recovery of median incomes to pre-recession levels took historically longer.
Psychological aspects
Recessions have psychological and confidence aspects. For example, if companies expect economic activity to slow, they may reduce employment levels and save money rather than invest. Such expectations can create a self-reinforcing downward cycle, bringing about or worsening a recession. Consumer confidence is one measure used to evaluate economic sentiment. The term animal spirits has been used to describe the psychological factors underlying economic activity. Keynes, in his The General Theory of Employment, Interest and Money, was the first economist to claim that such emotional mindsets significantly affect the economy. Economist Robert J. Shiller wrote that the term "refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people." Behavioral economics has also explained many psychological biases that may trigger a recession including the availability heuristic, the money illusion, and normalcy bias.
Balance sheet recession