Recession: what is it and how to protect against it?

A large, pervasive, and protracted decline in economic activity is referred to as a recession. A common rule of thumb is that a recession is defined as two consecutive quarters of a country’s Gross Domestic Product (GDP) declining. This is because recessions can last six months or more.

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A recession is defined by economists as an economic contraction that begins at the peak of the expansion that came before it and ends at the lowest point of the subsequent downturn. This definition is shared by economists at the National Bureau of Economic Research (NBER), which dates US business cycles.

What causes a recession?

The majority of recessions have the following traits:

• Rising inflation or interest rates, or both – High interest rates restrict the amount of money that can be borrowed and may be an indicator that a recession is about to start. The term “inflation” describes an increase in the cost of the things and services we buy on a daily basis, such as food, petrol, and consumer goods.
• “Real salaries” don’t purchase as much – Real wages are used to describe how far our incomes go. In one location, for instance, if you make 60,000€ a year, you could be able to purchase a house and lead a reasonably good life. However, in a more pricey region, that same 60,000€ will not go as far. Real wages start to decline all throughout the nation as a recession gets underway.
• Consumers lose faith as actual earnings start to decline – They cut down on their spending as a result of realizing that their income is not keeping up with inflation, which adds to a slowdown in the economy as a whole. In fact, one of the goals of the $2 trillion stimulus plan the US government approved in 2020 was to keep people spending money and the economy growing until the new coronavirus danger has subsided.

Signs and indicators of recession

Despite the fact that there isn’t a single reliable recession signal, an inverted yield curve has been right about each of the ten US recessions since 1955 (while also setting off a few false alarms).

To predict when the economy will turn, investors often look to leading indications. The Conference Board Leading Economic Index, the OECD Composite Leading Indicator, and the ISM Purchasing Managers Index are a few examples.

What happens in a recession?

Economic production, consumer demand and employment all often experience reductions during recessions. The NBER determines the beginning and conclusion of US recessions, often months after the peak and trough of the business cycle, by taking into account a variety of indicators, including nonfarm payrolls, industrial output, and retail sales, among others.

Even while not all families and companies actually see a drop in income, a recession makes people’s expectations about the future less definite, which makes them put off making significant purchases or investments.

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The decrease in output during recessions can be attributed to fewer corporate and consumer purchases of machinery and equipment as well as fewer additions of items to stocks or inventories. Inventory likely experiences the most impact; firms avoid adding to their inventories and are more inclined to use them to fulfil manufacturing orders. Decreases in inventory, therefore, have two effects on production volume.

Several factors determine whether a recession turns into a serious and protracted depression. They include the volume of credit provided during the preceding era of prosperity, the level of speculation authorized, the potential for fiscal and monetary policy to halt the downward trend, and the quantity of unutilized productive capacity.

Since the Industrial Revolution, most nations have seen economic expansion, with the periodic recession being the exception. Recessions are the relatively brief corrective stage of the business cycle; they frequently deal with the imbalances in the economy brought on by the boom that came before them, paving the way for growth to pick up again.

Even though they are a regular occurrence in the economic landscape, recessions have become less frequent and shorter over time. The International Monetary Fund estimates that between 1960 and 2007, 122 recessions impacting 21 advanced economies occurred (IMF).

Investing in firms with minimal debt, robust balance sheets, and positive cash flow is one of the finest methods for investors to employ during a recession. In contrast, it is better to stay away from shares of cyclical, speculative, or highly indebted firms until the recession is over since the survivors among them frequently start outperforming.

Severity of recessions

Since 1854, there have been 34 recessions in the United States, according to the NBER. Since 1980, there have been only five.

The double-dip recessions in the early 1980s and the global financial crisis of 2008 led to a downturn that was far worse than either the Great Depression or the depression of 1937–1938.

According to the IMF, mild recessions may knock an economy back by 2%, while severe ones can knock an economy by 5%. There is no agreed numerical formula for defining a depression; it is a particularly severe and protracted recession.

US economic production decreased by 33% during the Great Depression, while equities fell by 80%, and the jobless rate rose to 25%. Real GDP fell 10% during the depression of 1937–1938, while the unemployment rate increased to 20%.

Since 1857, the typical U.S. recession has lasted 17 months, but the six that have occurred since 1980 have averaged less than 10 months.

How to survive a recession?

There are steps you may do to stay afloat and weather the economic downturn without suffering too much. They consist of:

• Cut back on wasteful spending – For instance, if you already pay for the most costly streaming service, switch to a more affordable one. Increase the number of meals you prepare at home, combine high-interest debt into a reduced-interest personal loan, give up smoking, look for lower insurance rates, plant a garden, use less energy, and come up with additional temporary spending cuts.
• Reduce your debt – If you still have a job and an emergency fund, start paying off your debt. At the very least, try to transfer your credit card debt to a card with a 0% balance transfer rate if you are unable to pay off your debt.
• Spread out your revenue – If you are unemployed, take advantage of the opportunity to study or look for internships to get you ready for a new profession.
• Invest – Investing in stocks (or other assets) and holding them through good and bad times is the greatest strategy for profiting from them. People often fear as the stock market starts to decline, making buying seem counterintuitive. However, if you plan to invest for the long term, you should continue doing so even during a possible recession.