- A recession is a decline in economic activity lasting over a few months.
- A depression is a more severe recession, but there has only been one major economic depression in the US.
- Consequences of recession include job losses, reduced income, and declining investments.
Economic downturns are a lousy time for everyone. You may be worried about losing your job and being able to pay your bills — or you may be alarmed at just how abruptly that little red line that represents your investment portfolio has dropped.
An economic depression is a more severe, long-lasting recession that extends beyond the confines of a single country's border and into the economies of other nations.
Here's how to protect your investment portfolio during economic downturns to help you better understand the business cycle and prepare for the twists and turns of a possible recession.
What is a recession?
A recession can be a precursor to a depression if the US economy continues to be unstable and underlying issues are not addressed. But in most cases, a recession doesn't lead to an economic depression.
Since the Great Depression, the US has experienced 14 recessions, the last of which occurred in 2020 due to the COVID-19 pandemic.
Defining a recession
A recession is defined as two consecutive quarters — or six months —of negative Gross Domestic Product (GDP), which measures the total value of goods and services in a country over a certain period.
According to the National Bureau of Economic Research (NBER), a nonprofit organization that officially declares US recessions and expansions, the technical definition of a recession is "a significant decline in economic activity that is spread across the economy and that lasts more than a few months."
Over the course of a business cycle, GDP might contract for a period of time, but that doesn't necessarily mean that there's a recession.
Recessions impact almost every aspect of the economy, including consumer spending, mortgage interest rates, unemployment, and stock performance. Luckily, these downturns tend to be short-lived.
Recession indicators
The NBER defines the following recession indicators:
- Decline in real GDP
- Decline in real income
- Rise in unemployment
- Slowed industrial production and retail sales
- Lack of consumer spending
The NBER's view of recessions takes a more holistic outlook on the economy, meaning recessions are not necessarily defined by one single factor. Instead, factors are intertwined. A significant drop in GDP could rattle consumer spending or unemployment.
Bear markets tend to be close behind, indicating low investor confidence. That said, bear markets can offer buying opportunities.
How long recessions last
According to figures provided by the International Monetary Fund (IMF), recessions aren't actually that long, averaging around a year (2-18 months). However, recessions may be getting shorter, with the last six since 1980 averaging around 10 months.
The COVID-19 recession lasted only two months. Before that was the Great Recession, starting in 2007 and lasting roughly 18 months.
That said, the IMF finds expansions typically last longer, as the economy is usually growing.
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Recession vs. depression
A depression is a more severe recession. However, it's a little tricky to concretely and quantifiably describe the difference between a recession and a depression, mainly because there's only been one.
What is a depression?
An economic depression is typically understood as an extreme downturn in economic activity lasting several years, but the exact definition and specifications of a depression are less clear.
"The way people think about it is a depression is a more widespread and severe recession," Laura Ullrich, senior regional economist with the Federal Reserve Bank of Richmond, says, "but there is no clear-cut moment where we can say 'we hit X unemployment rate or Y GDP growth — we're now officially in a depression.'"
The NBER notes that economists differ on the period of time that designates a depression. Some experts believe a depression lasts only when economic activity is declining, while the more common understanding is that a depression extends until economic activity has returned to close to normal levels.
The difference between a recession and a depression
Because economists do not have a set definition for what constitutes a depression, the general public sometimes uses it interchangeably with the term recession. However, the difference makes itself evident when you compare the Great Recession to the Great Depression.
Generally speaking, a depression lasts years rather than months and typically causes higher unemployment rates and a sharper decline in GDP. While a recession is often limited to a single country, a depression is usually severe enough to have global impacts.
What causes a recession?
Generally speaking, expansion and growth in an economy cannot last forever. A significant decline in economic activity is usually triggered by a complex, interconnected combination of factors, including:
Economic shocks
An economic shock is an unpredictable event that causes widespread economic disruption, such as a natural disaster or a terrorist attack. One example of such a shock was the COVID-19 outbreak, which triggered a brief recession.
Another event that served as a shock to the economy was Hurricane Katrina. One estimate found this natural disaster caused $200 billion worth of damage, according to figures from the US Bureau of Labor Statistics.
High interest rates
High interest rates make it more expensive for consumers to borrow money, meaning people are less likely to spend on major purchases like houses or cars. Companies will probably reduce their spending and growth plans as well because the cost of financing is too high.
Asset bubbles
During an asset bubble, the prices of investments like tech stocks in the dot-com era or real estate before the Great Recession (housing bubble) rise rapidly. Artificially inflated demand drives prices stemming from overly optimistic expectations of future asset values. Eventually, the bubble bursts.
At this point, people lose money, and confidence collapses. Both consumers and businesses cut down on spending, and the economy goes into recession.
Loss of confidence
Consumer sentiment substantially impacts the economy, accounting for nearly 70% of US GDP. When consumers tighten their purse strings, it can tip the economy into recession.
Even if this change in mindset is not enough to trigger a recession, a drop in consumer demand gives companies less incentive to produce goods and services, which can, in turn, motivate them to lay off employees to maintain profitability.
The confidence of business executives and other key decision-makers in corporations substantially impacts the health of the economy. If these decision-makers become less confident, they could cut budgets, lay off workers, and potentially reduce expenditures on capital equipment to bolster profitability.
Recessions and the business cycle
To understand the macroeconomic variables that constitute recessions, Giacomo Santalego, PhD, a senior economics lecturer at Fordham University, says it's important to acknowledge the relationship between recessions and the business cycle.
The economy naturally fluctuates, called the business cycle. Governments try to smooth these ups and downs with money and spending policies.
Phases of the business cycle
Business cycles are understood as having four distinct phases:
- Expansion: A period of economic growth, also considered the "normal" phase of the business cycle. It is often characterized by an increase in employment and a swelling of consumer spending and demand, which leads to an increase in the production and cost of goods and services.
- Peak: The highest point of a business cycle that signifies when an economy has reached its output crest. Here, there's nowhere to go but down, sending the economy into a contraction phase. This can happen for many reasons: Investors get too speculative and create an asset bubble, or industrial production starts outpacing demand. This is commonly seen as the turning point into the contraction phase.
- Contraction: A period marked by a decline in economic activity, often identified by a rise in unemployment and a bear market. Additionally, GDP growth falls under 2%. As growth contracts, the economy enters a recession.
- Trough: A peak is an expansion, and a trough is a contraction. A trough marks the bottom of a business cycle's economic activity and the start of a new wave of expansion and a new business cycle. A new wave of expansion follows this turning point.
Business cycles do not occur at predictable intervals. They are irregular in length, and their severity is reflected by the economic variables of the time. The average post-World War II business cycle lasted 65 months, according to the Congressional Research Service.
What to expect from a recession
Here's how a recession affects the average person.
Job losses
One major consequence of economic downturns is job losses. When the economy starts to contract, revenues decline, which gives companies substantial incentive to lay off employees to turn a profit.
A perfect example is the recession that coincided with the COVID-19 pandemic. The global pandemic began in early 2020, and during March, April, and May of that year, the nation's employers shed 1.5 million jobs, according to figures from the Bureau of Labor Statistics.
Economic downturns result in reduced tax revenue, prompting governments to lay off workers. Many state governments, in particular, must balance their budgets each year, which can cause them to slash jobs.
Reduced income
Economic downturns can lower residents' incomes by eliminating jobs and lowering wages. In addition, companies reduce capital equipment investment during recessions, decreasing productivity, which can, in turn, adversely impact salaries.
Lowered incomes can significantly impact the economy in the long term, for example, undermining nutrition and making it more difficult for people to pursue a college education. Both of these adverse effects can impact productivity in the long run.
Difficulty finding work
One very noticeable impact of an economic downturn is a tighter labor market. When the economy goes into recession, many jobs will be eliminated, both in the public and private sectors. This can increase the number of applicants for every available position, resulting in a highly competitive labor market.
This increased competition for jobs can undermine employees' power to demand adequate compensation and, in turn, place downward pressure on salaries and wages.
Declining investments
One common challenge investors encounter during economic downturns is the impact of falling asset values on their net worth. When the economy goes into recession, the value of assets held by everyday investors, like stocks and real estate, can decline substantially.
This can undermine the value of their retirement accounts and wealth outside these accounts, like in brokerage accounts. When investors feel less wealthy, they are less likely to spend, a phenomenon known as the wealth effect. This can, in turn, contribute to further economic contraction.
Get debt relief
The effects of recessions can stress a household's budget. Debt relief companies may be an option to help with out-of-control debt.
Recession FAQs
Is a recession good or bad?
A recession is typically considered bad for the economy, individuals, and businesses. Although a recession is a normal part of the business cycle, economic downturns result in job losses, decreased consumer spending, reduced income, and declining investments.
What is a recession?
A recession is a significant period of economic decline, typically when the economy shrinks. A recession is also defined as two consecutive quarters of negative GDP, but many economists view a recession as more widespread and requiring a significant rise in unemployment.
What would a recession look like?
A recession looks like a slowing economy with pessimistic investor sentiment and two-quarters of negative GDP growth. Key indicators of a recession include a decline in stocks, large-scale layoffs, an uptick in bankruptcies, and reduced consumer spending.
When was the last recession?
The last recession occurred in 2020 during the COVID-19 pandemic. Unemployment skyrocketed to 14.7% in April 2020 due to quarantine, business closures, and in-person restrictions. However, the recession only lasted two months.
