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What is a recession? Here are the basics

People walk past a convenience store where the latest cover of a magazine is stuck on a pillar outside of it on Sunday, March 15, 2020, in New York City. (AP Photo/Wong Maye-E)
People walk past a convenience store where the latest cover of a magazine is stuck on a pillar outside of it on Sunday, March 15, 2020, in New York City. (AP Photo/Wong Maye-E)

Responding to the global outbreak of coronavirus, federal, state, and local governments are taking unprecedented measures to mitigate the spread of contagion, shutting down restaurants, cafes, movie theaters, schools, offices, and large social gatherings around the U.S.

As Americans hunker down, telltale recession markers are starting to emerge: a massive stock market sell-off, coronavirus-related layoffs, and reduced consumer spending outside of stocking up on food and supplies.

A recession is loosely defined as a period when the gross domestic product (GDP) — or total dollar value of all goods and services produced in a given country — falls for two consecutive quarters.

A commuter wears a face mask while riding a nearly empty subway car on March 12, 2020, in New York City. (AP Photo/John Minchillo)
A commuter wears a face mask while riding a nearly empty subway car on March 12, 2020, in New York City. (AP Photo/John Minchillo)

But the official determination comes from the National Bureau of Economic Research (NBER), a private nonprofit of economists. The NBER charts both economic expansions and recessions, and uses more measures than just GDP to define a recession. Here’s its explanation:

A recession is 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. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.

In simplest terms, a recession is an ongoing economic slump that includes flatlining incomes, employment, industrial production and retail sales, too. Often, the NBER retroactively declares a recession as it did with the Great Recession. It deemed it a recession in November 2008, 11 months after it started.

What causes a recession?

A food truck vendor pushes his cart down an empty street near Times Square in New York, on March 15, 2020. (AP Photo/Wong Maye-E)
A food truck vendor pushes his cart down an empty street near Times Square in New York, on March 15, 2020. (AP Photo/Wong Maye-E)

Typically when consumer spending, real estate and manufacturing slows during a high-interest period, that’s considered a recipe for a recession.

The last two recessions in 2001 and 2007 started after asset bubbles burst in technology stocks and housing, respectively. But the Great Recession spiraled even further, becoming a financial crisis when the supply of credit was choked off.

The economy also runs in cycles, according to Allen Katz, a New York-based certified financial planner

“There are ups and downs that for the most part can't be controlled,” said Allen Katz. “Government policies can change the magnitude, but can't stop the cycles.”

The economy now faces the consequences of a global health crisis that requires consumers to stay home — thus limiting their spending — and businesses to close down temporarily to stem the spread of the disease.

What happens during a recession?

An employee at Dunkin' rests his eyes for a moment as he awaits to-go orders at the empty food court in Bridgewater, MA at 4:30 p.m. on March 16, 2020. Orders in the fast-food restaurants are take-out only as Governor Charlie Baker ordered all sit-down restaurants and bars to close their doors to prevent the spread of coronavirus. (Photo by Stan Grossfeld/The Boston Globe via Getty Images)
An employee at Dunkin' rests his eyes for a moment as he awaits to-go orders at the empty food court in Bridgewater, MA at 4:30 p.m. on March 16, 2020. Orders in the fast-food restaurants are take-out only as Governor Charlie Baker ordered all sit-down restaurants and bars to close their doors to prevent the spread of coronavirus. (Photo by Stan Grossfeld/The Boston Globe via Getty Images)

Recessions are so routine that since 1920, Americans have weathered 17, each lasting anywhere from six to 42 months, according to data from the National Bureau of Economic Research.

That gives us enough historical data to spot recession trends and hallmarks. Recessions usually share certain characteristics, and many have a domino effect as the economy contracts:

  • Unemployment spikes

  • Capital expenditures — the buildings, equipment or land purchased by a business or corporation — sink

  • Consumer spending tightens

  • Business activity tanks

  • Bank credit and loans are harder to come by, particularly for small business owners and entrepreneurs

  • Real estate values and sales fall

  • Interest rates fall

How should I prepare my finances for a recession?

During a time of economic contraction, layoffs are common across industries and sectors. You can recession-proof your finances by spending less on luxuries and only on essentials. (Photo: Getty)
During a time of economic contraction, layoffs are common across industries and sectors. You can recession-proof your finances by spending less on luxuries and only on essentials. (Photo: Getty)

There’s nothing you can do to prevent an economic contraction, but you can recession-proof your finances by paying down any credit card balances, socking away money, and evaluating the essentials (rent, utilities, groceries) from the nice-to-haves (dining out, concerts, new clothing.)

Should you or a member of your household get laid off or have your pay or hours scaled back, that’s when it’s time to dip into your emergency savings account to cover necessary expenses. Conventional wisdom dictates to have three to six months' worth of money to cover living expenses while you’re looking for work.

If you don’t have an emergency fund, building one is a good place to start before a potential recession. If you can avoid it, try not to rely on high-interest credit cards to carry you during your temporary unemployment.

“If you have trouble saving, then automate as much as possible,” said Aaron Clarke, a Virginia-based financial advisor “Remove the temptation to spend money you should be saving for a rainy day. Set up auto transfers so that you have no choice but to spend less by deferring your income to savings before you even get a chance to spend it.”

How should I prepare my career for a recession?

If an economic slowdown appears in the offing, it may make sense to put any job changes on hold, if you’re employed.

“Try not to make a career move right before an economic slowdown,” Clarke said. “It’s never good to be the new kid on the block when your employer may become financially strained.”

Take the time to shadow and learn from your colleagues. When budgets get slashed, duplicative or overlapping roles will be eliminated and those still employed will have to carry a heavier load. Amass all the knowledge and information you can about your industry or company and complementary jobs to show your employer that you’re a valuable asset.

If you are laid off, it’s important to apply for unemployment benefits, understand your health insurance options, negotiate severance pay if possible, among other considerations. Cashay offers a guide on what to do when you lose your job.

How is a recession different from depression?

Specialist Meric Greenbaum works at his post on the floor of the New York Stock Exchange, Monday, March 9, 2020. The Dow Jones Industrial Average sank 7.8% as a free-fall in oil prices and worsening fears of fallout from the spreading coronavirus outbreak seize markets. (AP Photo/Richard Drew)
Specialist Meric Greenbaum works at his post on the floor of the New York Stock Exchange, Monday, March 9, 2020. The Dow Jones Industrial Average sank 7.8% as a free-fall in oil prices and worsening fears of fallout from the spreading coronavirus outbreak seize markets. (AP Photo/Richard Drew)

President Harry Truman, President Franklin Roosevelt’s vice president and eventual successor, deftly distinguished the two, “It's a recession when your neighbor loses his job; it's a depression when you lose yours.”

While there’s no standard definition for a depression, economists generally agree that a depression is considered a more severe and extended recession.

For instance, during the Great Depression which lasted from 1929 to 1939, the unemployment rate peaked at 24.9% in 1933. During the Great Recession, which lasted from 2007 to 2009, the unemployment rate topped at 9.3% in 2009, according to the Bureau of Labor Statistics.

Fortunately, American economists have learned from the past and regulations have been enacted to avoid all future depressions. Katz points out, “there were less checks and balances” in the 1920s and since then, “many laws were enacted to try to avoid this.”

“Each downturn since, in comparison, has been less damaging and has taken less time to recover from,” he said.

What goes down, must go up

A recession is not permanent. Markets and the economy do rebound, sometimes to pre-recession highs. (Photo: AP)
A recession is not permanent. Markets and the economy do rebound, sometimes to pre-recession highs. (Photo: AP)

Although its effects can be long-lasting, a recession doesn’t have to be a financial death sentence and a silver lining does exist.

Americans learn to live with less in leaner times and personal savings generally rise. Tougher economic times mean weakened stock and housing markets but can create windows of buying opportunities for first-time investors or homebuyers, if you have the money to invest. Markets not only rebound, but they can reach pre-recession highs.

Depending on your distance to retirement, it’s important to not get skittish by the market’s volatility.

“If you invested in the S&P 500 in October of 2007 (a pretty bad time to invest), as long as you remained invested, your money would have grown over 160% or over 8% per year,” said Mark Beaver, an Ohio-based certified financial planner.

Stephanie is a reporter for Yahoo Money and Cashay, a new personal finance website. She can be reached at stephanie.asymkos@yahoofinance.com. Follow her on Twitter @SJAsymkos.

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