Recessions occur typically when the demand for goods and services starts declining rapidly and steadily.
A recession is a significant decline in economic activity that lasts for months or even years. Experts declare a recession when a nation’s economy experiences negative gross domestic product (GDP), rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time.
The National Bureau of Economic Research (NBER) is generally defines the starting and ending dates of U.S. recessions. NBER’s definition of a recession is when “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
Unemployment rate. NBER-dated recessions in gray. (Cart below)
Source: Bureau of Labor Statistics via the Federal Reserve Bank of St. Louis.
There is more than one cause for a recession to get started, from a sudden economic shock to fallout from uncontrolled inflation. According to Forbes Advisors, some of the main drivers of a recession are:
- A sudden economic shock: An economic shock is a surprise problem that creates serious financial damage. In the 1970s, OPEC cut off the supply of oil to the U.S. without warning, causing a recession. The coronavirus outbreak, which shut down economies worldwide, is a more recent example of a sudden economic shock.
- Excessive debt: When individuals or businesses take on too much debt, the cost of servicing the debt can grow to the point where they can’t pay their bills. Growing debt defaults and bankruptcies then capsize the economy. The housing bubble in 2007-8 that led to the Great Recession is a prime example of excessive debt causing a recession.
- Asset bubbles: When investing decisions are driven by emotion, bad economic outcomes aren’t far behind. Investors can become too optimistic during a strong economy. Former Fed Chair Alan Greenspan famously referred to this tendency as “irrational exuberance”. Irrational exuberance inflates stock market or real estate bubbles—and when the bubbles pop, panic selling can crash the market, causing a recession.
- Too much inflation: Inflation is the steady, upward trend in prices over time. Inflation isn’t a bad thing per se, but excessive inflation is a dangerous phenomenon. Central banks, such as the Federal Reserve, control inflation by raising interest rates, and higher interest rates depress economic activity. Out-of-control inflation was an ongoing problem in the U.S. in the 1970s. To break the cycle, the Federal Reserve rapidly raised interest rates, which caused a recession.
- Too much deflation: While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and business stop spending, which undermines the economy. Central banks and economists have few tools to fix the underlying problems that cause deflation.
- Technological change: New inventions increase productivity and help the economy over the long term, but there can be short-term periods of adjustment to technological breakthroughs. In the 19th century, there were waves of labor-saving technological improvements. The Industrial Revolution made entire professions obsolete, sparking recessions and hard times.
According to NBER data, from 1945 to 2009, the average recession lasted 11 months. Over the past 22 years, the U.S. has gone through three recessions:
- The Covid-19 Recession. The most recent recession began in February 2020 and lasted only two months, making it the shortest U.S. recession in history.
- The Great Recession (December 2007 to June 2009). The Great Recession was caused in part by a bubble in the real estate market. It lasted 18 months, almost double the length of recent U.S. recessions.
- The Dot Com Recession (March 2001 to November 2001). At the turn of the millennium, the U.S. was facing several major economic problems, including fallout from the tech bubble crash and accounting scandals at companies like Enron, capped off by the 9/11 terrorist attacks. Together these troubles drove a brief recession, from which the economy quickly bounced back.
If there’s a silver lining, it’s that recessions do not last forever.
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