Recession

A recession is a term from microeconomics that describes a situation of a critical decline in all economic activity across the given area. It is declared by the National Bureau of Economic Research (NBER) whenever recognized. Previously, the NBER needed two-quarter GDP decline data to call it a recession, plus a few monthly indicators reflecting the overall downtrend in economics. According to current definitions, recession lasts anywhere from several months and affects income, employment rate, industrial development, production and sales volumes.

Recessions are officially announced after a sequence of two quarters of negative GDP growth. In the U.S., where those decisions are taken by the members of the NBER committee, the economic growth is measured by a wide range of factors. The NBER considers more frequent performance reports from plants and wholesale suppliers, as well as employment rate and real incomes of the population. For this reason, recessions declared do not match the quarterly GDP falls.

What is a Recession

The Industrial revolution of the XVIII-XIX centuries led to the global rise in national economies. Since then, most countries have been developing steadily. Despite the general upward trend, economies faced some fairly short periods of slowdowns and declines. The periods of 6-month and up to several-year negative trends are natural and fall under the definition of economic recession.

Recessions are the times of numerous business and bank failures all over the affected region, reduced production, elevated unemployment and lower wages. For the national economy, a recession is a hard-to-get-through period that leaves its printmark even in the short-term presence. It happens because the economic structure is reshaped: weak and obsolete players are swept away from the market, whole industries become vulnerable, technologies slow down. The government is certain to respond by the total reconsideration of policy regulations for businesses and monetary institutions. This is not to speak about the reaction of mass to downsizings, shortages and currency devaluation. 

Signs of Recessions

There are no tools to predict the beginning of a recession, though there are several underlying metrics that determine the beginning or a prospect of a downturn. The majority of economic analysts name a few commonly accepted predictors of a recession all business decision makers should look at.

1. Leading indicators start to display changes before the corresponding moves are shown by microeconomic trends. Such indicators include ISM Purchasing Managers Index, Conference Board Leading Economic Index, OECD Composite Leading Indicator, and Treasury yield curve. 
2. Government-published data reflecting the situation in key economic sectors. Reported by agencies, such data changes happen simultaneously with microeconomic variables or slightly earlier, partially because these are components of GDP calculations. These include housing starts, new orders for capital goods and other economic statistics brought to the general public by the U.S. Census. 
3. Lagging indicators confirm the ongoing recession after it has begun. These depict the apparent shifts in economics, such as households income and spending, or interest rate. 

Causes of Recessions

Researchers have long attempted to explain why economies reverse their long-term upward trend to a down movement and stay in recession before they recover. The economic theories that evolved from those analyses are focused on either economic, financial or psychological factors or try to combine them all. Let us look at the underlying ideas of each of them.

Economists who share a microeconomic approach believe that recessions are caused by economic shocks - substantial changes in industries and domestic markets. For example, gas price spikes during a global political crisis raise prices for all goods and businesses. Or else, revolutionary innovations in technology make firms and - sometimes - whole industries go obsolete because there’s no demand for their products. Both situations inevitably lay grounds for economic distress.

The most recent example of an economic shock that led toward an economic downturn was the 2020 COVID-19 pandemic. The beginning of widespread lock-downs and production stoppages was the turning point of all major trends.

The monetary theories based on financial factors analyze the number of credits, financial environment and money supply. These put emphasis on either high volume of credits and rising financial risks or, oppositely, decrease in money circulation prior to a recession. Such findings derive from Monetarism or Austrian Business Cycle theory, for example.

Economists studying behavioral patterns also blame the periods of economic boom for the occurrence of recessions and go further in their thinking to explain why recessions persist. The theories in this category basically suggest that the economic environment of market optimism and pessimism drives people’s behavior. Financial bubbles make a good example. The followers of Minskyite theories prove that recessions happen when undue euphoria becomes the foundation for a credit bubble that will eventually burst because of its speculative nature. When recessions hit, investors hold on to the pessimistic forecasts about the market and critically reduce their investment spendings, according to Keynesians. This hurts people’s income, affecting consumption spending altogether. 

Recessions on record

As reported by NBER, the number of recessions has shrunk from the 1850-s, when economic declines were most frequent. They published the numbers showing that only 5 of the 34 recessions dated anywhere from 1854 to 2020 took place after 1980.

There have been two recessions in world history that stood out from the rest: the Great Depression of the 1930-s and the Great Recession precipitating the global financial crisis of 2008. When speaking about a deep and prolonged recession, it is usually called a depression. There is no fine line between a recession and depression, but the damage experienced by economy is seen in numbers. During the Great Depression, the real GDP in the U.S. showed a 33% decline, stock market prices plunged by 80%, and 25% of the population were affected by unemployment.

Investing during a Recession

Despite the negative economic background, investors can still continue to monetize their capital. The economic volatility requires extra cautiousness, so close investigation into the company’s performance is vital. A suitable option would be a stable, low-debt business, showing a sustainable stream of revenue and healthy balance sheets. In contrast, cyclical businesses like restaurants and fashion retail, or leveraged companies with debt exceeding revenue  won’t do well in a crisis. In the same way, small speculative firms should be avoided.