A recession refers to a decline in economic growth and activity within a country. This macroeconomic term, based on the GDP, consists of two back to back quarters where the economic growth is declining and unemployment is rising.
When a nation starts to experience negative gross domestic product (GDP) that would be considered the start of a recession. In a recession, there will be a consistent decline in economic activity for months or even years. During this time retail sales for businesses will be down and unemployment will rise.
What Happens During a Recession?
During this time period, many people will lose their jobs, the economy will suffer, and economic activity within the country will be down. Additionally, businesses will generate less money which forces them to lay off large amounts of workers. Stores will produce and sell less merchandise since consumers won’t have money available to spend.
When there’s two consecutive quarters of declining economic productivity, it is not good for the economy’s health (GDP). Economic output is extremely low during a recession and many families will experience serious financial hardships.
Example of Recession
An example of a recession would be in 2008 when the United States had the housing crisis. Housing prices increased and fell from the subprime mortgage crisis. This caused banks to go into bankruptcy since these mortgage-backed securities were defaulting. The stock market plummeted and crashed in 2008 causing many American families to lose a significant amount of their wealth.
America right now is experiencing the global pandemic which forced the country into another recession. For months many businesses had to shut down for long periods of time to prevent the spread of COVID-19. In addition, companies permanently closed due to the lack of business, making them unable to be able to pay for their operating functions.
How Long Does a Recession Last?
A recession can last for a couple of months or for a number of years. The average time that a recession lasts would be around 11 months, or just short of a full year. These financial crises can wreak havoc on the economy, for investors, consumers, and families.
Can You Predict a Recession?
A recession can be very difficult to predict in many cases. You can pay close attention to economic trends sometimes and predict that a recession may be brewing up in the near future.
However, some leading indicators can warn investors that an economic recession is approaching. The most notorious one is the yield curve being inverted. A yield curve is the relationship between short-term and long-term government bonds. In a healthy economy, the long-term bonds are at a higher rate, but when it is at a lower rate, it shows that people are losing faith in the economy and that a recession is coming.
What Is Stagflation?
Stagflation is consist of three unwanted economic situations. This includes high inflation, high unemployment, and extremely slow economic growth. How stagflation occurs is when central banks try to simultaneously expand and constrain the country’s money supply.
What Causes a Recession?
A recession is caused by a number of different factors such as economic shocks, a loss of consumer confidence, high interest rates, deflation, and asset bubbles.
Economic Shocks
Economic shocks are variables that have an effect on macroeconomic outcomes. In addition, they can be utilized to measure economic performance and growth. These shocks can affect unemployment, inflation, and consumer spending within a country.
Loss of Consumer Confidence
Loss of consumer confidence refers to consumer optimism. This is based on how they feel about the current economic conditions and how it is affecting them financially. Consumers will be more likely to spend when their confidence is high and aren’t as worried about saving money for the future.
High Interest Rates
High interest rates will lead to more borrowing within an economy. This causes people to spend less and the demands for goods and services will decrease at this time. Interest rates will decrease at the start of a recession. Additionally, when these rates start to decrease it can help end a recession in a country.
Deflation
Deflation is when prices of goods and services are rapidly decreasing. The purchasing power of currency during this time typically is rising. Deflation prices can fall due to increased productivity, and deflation is often associated with the contraction of the country’s money supply and credit.
Asset Bubbles
An asset bubbles is created when money is constantly entering a specific market market sector. Since investors have such confidence in this asset it brings these assets to an artificially inflated price. Once the money being pumped into this asset stops, the bubble bursts causing investors to lose a substantial amount of their investment.
What Are the Stages of the Business Cycle?
There are 4 main stages of the business cycle. Let’s review what they are and how they impact the economy.
Expansion
The expansion phase is when the economy is rapidly growing and consumer confidence is at a high. During this time production in the economy is increasing, inflation is going up, and interest rates are usually on the lower side.
Peak
The highest point of the business cycle would be called the peak stage. The economy is producing its maximum possible amount of output at this time. Employment is high which is great for the economy. Many people are not looking for jobs and companies have many workers. Also, there are very noticeable inflationary pressures on prices that are noticeable.
Contraction
The contraction stage is when the economy starts to contract and company production is starting to slow down. The economy is declining at this time. The recession would start until an economy has experienced two consecutive quarters of declining economic activity. During a contraction unemployment is increasing and it can be difficult to predict how long the contraction will last.
Trough
The trough is when economic activity is bottoming and the prices are dropping. After these drops a trough will lead to an economic rise. During the trough unemployment is very high, business sales are down, and there is lower credit availability for consumers.
Preparing for a Recession
A financial advisor can help you plan for a recession and help you manage your money. Financial advisors are experienced in dealing with any economic conditions and can help you with financial planning strategies. You should think about contacting a financial advisor today to help you improve your financial situation and build your wealth.