Word of the Week 'Recession'



Updated Mar 6, 2019

What is a Recession

A recession is a significant decline in economic activity that goes on for more than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical defintion of a recession is two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP), although the National Bureau of Economic Research (NBER) does not necessarily need to see this occur to call a recession.

Causes of a Recession

Recession is a normal, albeit unpleasant, part of the business cycle. However, one-time crisis events can often trigger the onset of a recession. The global recession of 2009 brought a great amount of attention to the risky investment strategies used by large financial institutions, along with the global nature of the financial system. As a result of the wide-spread global recession, the economies of virtually all the world's developed and developing nations suffered significant setbacks. Numerous government policies were implemented to help prevent a similar future financial crisis as a result. Typically, a recession lasts from six to 18 months, and interest rates usually fall during these months to stimulate the economy.

Recession Predictors and Indicators

There is no reliable way to predict how and when a recession will occur. But, according to many economists, there are some generally accepted predictors that. when they occur together, may point to a possible recession. First, asset prices will begin to decline. This includes home prices and other financial assets like stocks. Another possible predictor is unemployment; generally speaking, a three-month change in the unemployment rate and initial jobless claims will point to a recession. An inverted yield curve is also another predictor. When long-term yields fall below the short term ones (the 10-year vs. the 3-month Treasury securities), a recession will occur. Conversely, a positively sloped curve (in the opposite direction) will signal inflationary growth. Since 1970, all the recessions that have taken place in the United States up through 2017 have followed an inverted yield curve.

Aside from two consecutive quarters of GDP decline, economists assess several metrics to determine whether a recession is imminent or already taking place. These indicators are divided into two categories: leading indicators and lagging indicators. Leading indicators materialize before a recession is officially declared. Perhaps the most common leading indicator is contraction in the stock market. Declines in broad stock indices, such as the Dow Jones Industrial Average (DJIA) and Standard & Poor's (S&P) 500 index, often appear several months before a recession takes shape. This was the case in 2007 in the United States, when the market began declining in August, four months ahead of the official recession in December 2007.

Lagging indicators of a recession include the unemployment rate. Though the Great Recession began in December 2007, the unemployment rate still indicated full employment — a rate of 5% or lower — four months later. The unemployment rate began declining in May 2008 and did not