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What Is a Recession?

Dana George
By: Dana George

Our Personal Finance Expert

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There's a lot going on in the world. In addition to the coronavirus pandemic, we are currently in a recession. But what is a recession? Whether you have experienced several recessions in your life or this is your first, here's what to expect -- and how to get through it.

If you are already facing financial difficulties, there's help available. Maybe your job or health has been impacted by COVID-19, or maybe you're struggling to make ends meet. Whatever your situation, check our coronavirus support resources for guides to applying for unemployment, asking creditors for payment leniency, and more.

Definition of an economic recession

A recession is a period of economic decline, signaled by an increase in unemployment, a drop in the stock market, and a dip in the housing market. An official recession is not declared until the total value of goods and services in the U.S. (called the Gross Domestic Product or GDP) has been in decline for two or more quarters (six months or more).

What causes a recession?

Depending upon which economist you ask, the United States is currently suffering through either its 45th or 47th recession. What's remarkable is that no two have been exactly alike. There are, however, characteristics that most recessions have in common:

  • High interest rates, high inflation, or both. High interest rates limit the amount of money available to borrow and can signal the beginning of a recession. Inflation refers to a rise in prices of everyday goods and services we purchase, like groceries, gasoline, and consumer items.
  • "Real wages" don't buy as much. The term real wages refers to how far our incomes stretch. For example, if you earn $60,000 in one city, you might be able to buy a home and live a fairly comfortable life. That same $60,000 is not going to stretch nearly as far in a more expensive area, though. As a recession begins, real wages across the country begin to shrink.
  • Once real wages begin to shrink, consumers lose confidence. As they realize that their income is not keeping pace with inflation, they stop spending as much, which contributes to an overall slowdown. In fact, one of the reasons the U.S. government passed a $2 trillion stimulus package in March was to keep Americans spending money and the economy chugging along until the novel coronavirus threat has passed.

What happens during a recession?

Like a snowball growing larger as it rolls down a hill, a recession gathers power as one economic indicator after another gets caught up. Here's how that happens:

  • GDP falls.
  • Economic activity becomes shaky and companies cut back in an attempt to survive.
  • These corporate cutbacks lead to layoffs and unemployment.
  • Watching other people get laid off causes those who are still employed to worry that they are going to lose their jobs, which leads to less consumer spending.
  • Government debt rises as it attempts to stabilize the economy.
  • The Federal Reserve cuts interest rates in an attempt to stimulate growth.
  • Stocks and other assets -- like homes -- lose value, and a full-fledged financial crisis is underway.

How long does a recession last?

Although the Great Recession lasted for 18 months, it was unusual. If you take it out of the equation, the other 10 recessions since World War II have lasted between six and 16 months, or an average of 10.4 months. It's important to note that the U.S. economy falls apart and rebuilds itself quite regularly. What set the Great Recession apart from other recessions was how long it took to rebuild. The same may be true of the current recession.

What's the difference between a recession and depression?

For those asking, "what is a recession?," it's important to know that a recession is not as severe as a depression. A recession marks the contraction phase of a business cycle, when everything slows down for at least two quarters. In contrast, as the Great Depression showed, depression is a prolonged period of economic downturn during which a significant decline in economic indicators occurs. In short, these two factors set a depression apart from a recession:

  • Severity: When economic indicators contract (or weaken) for two quarters, it is considered a recession. A depression causes economic indicators to decline more significantly.
  • Length: A depression is deeper and lasts longer than a recession. For example, the Great Depression of 1929 lasted 43 months, whereas the Great Recession lasted 18 months.

What was the worst recession in history?

Prior to the current recession, the Great Recession of 2007-2009 was considered the most severe. The IMF ranks it as the second-worst downturn of all time, behind only the Great Depression. The Great Recession was fueled by the collapse of the U.S. real estate market, which was caused by a subprime mortgage crisis (banks giving mortgages to people who were clearly unable to repay the debt).

Like the current financial crisis, the Great Recession was the "perfect storm" for a downturn. Subprime mortgages were the first snowball at the top of the hill. Homeowners who had gotten in over their heads began to default on their loans. As defaults dotted the real estate market, home values plummeted. Even those who did keep up on their mortgages suddenly lost equity. The stock market quickly followed: Worried investors sold their stocks quickly. Next, banks collapsed. Much of the world economy was sucked down with ours.

Part of the recovery process included new legislation designed to prevent the same kind of financial crisis from taking place again. While some experts warn that the Trump administration has rolled back or watered down some of these protective measures, a number of protections still stand.

It is safe to assume that once the final numbers are tallied, our current coronavirus-fed recession will take the place of the Great Recession as the worst recession of all time. There are several reasons for this, including:

  • We've seen greatest number of unemployment claims since the Great Depression.
  • It took only four weeks for COVID-19 to wipe out the total number of jobs created since 2009 and to send the unemployment rate soaring.
  • There's still a lot of uncertainty. We don't know when there will be a vaccine, how many people will take advantage of it, whether millions of small businesses will reopen, or how long it will take for the majority of the unemployed to get back to work.

Economic research may try to predict how long the current economic recession will linger, and the central bank may try to stimulate the economy with changes to the federal funds rate. Nevertheless, economic downturns are felt at ground level by everyday people. It's tough to renew consumer confidence and return to normal, pre-recession spending levels.

The COVID-19 recession

While there are certainly lessons to be learned from previous recessions, there's also a big and obvious difference: None of those economic downturns were tied to a worldwide pandemic. So, what is a recession when it's tied to a once-in-a-lifetime medical emergency?

One important thing to understand about recessions is that they are a normal part of the economic cycle. The last major recession ended in 2009 and recovery began to take hold in mid-2011. According to the National Bureau of Economic Research, the average expansion period lasts around 59 months, or just shy of five years. This is why economists proclaimed we were overdue for a recession, even before the novel coronavirus hit.

In other words, we knew that the cyclical nature of business and economic growth would lead us into another recession. What we had no way of knowing was that it would coincide with a once-in-a-lifetime pandemic. That unfortunate combination has led to economic declines of near-historic proportions, including:

  • Unemployment: More than 38 million Americans filed jobless claims during the nine-week period beginning March 12. That figure does not include many freelance and gig workers, who were unable to register unemployment claims, nor those whose income was reduced.
  • Stock market: Dow Jones experienced a 2,997 point drop -- the largest in its 123-year-old history -- on March 16.
  • GDP: On March 31, as businesses shuttered and millions of Americans were sheltering in place, economists from Goldman Sachs forecasted a 34% drop in GDP in the coming months.
  • Consumer confidence: The Global Consumer Confidence Index surveys more than 17,500 adults under the age of 75 in 24 countries. The Global Consumer Confidence Index for June is 40.0, 8.7 points lower than it was in January, which is problematic. Consumer insecurity leads to less spending and slows the economy as a whole.

How a recession might affect you

What is a recession? It's a downturn in economic activity that impacts us all to some degree. Even if our jobs are secure, it is likely that our retirement accounts will lose value and many of our homes will be worth less than they were prior to the recession. As more people lose their jobs and unemployment grows, the number of bankruptcies and foreclosures will go up, meaning some of the homes around ours will stand empty.

One of the longest-lasting impacts of a recession may be emotional. A study published in Clinical Psychological Science found that people who suffered a job-related, housing-related, or financial hardship during the last recession were more likely to show signs of depression, anxiety, and drug use -- years after the recession ended. Those without a safety net are particularly impacted.

Do house prices drop during a recession?

The short answer is yes, for most people, home prices will drop during a recession. In order to predict how much prices could dip, the real estate company Redfin researched changes in home values during the last recession. They found average home values dropped 9% per year during the Great Recession, with single-family homes holding their value the best (losing an average of 8%). Townhomes lost 9.3% value per year, and condos lost 13.1% during the same time.

One reason for the drop in home values involves consumer anxiety. The less secure buyers feel about their jobs, the less likely they are to pay top dollar for a home.

How to prepare for a recession

Because we know there will be recessions in the future, we have a chance to prepare. That's a positive. The following steps can help you weather an economic downturn:

  • Build a budget. If you don't already have one, create a budget that takes your current situation into account.
  • Fill your emergency fund. If you are still working, your top priority should be to build up three to six months' worth of living expenses. Whether you're working or not, consider adding a side hustle that could give you some extra cash during the crisis.
  • Save that extra cash. These unprecedented times may also bring some unexpected savings. Put the money you might normally spend on dining out or entertainment straight into your savings account. If you have children at home, save any money you may not currently be paying to daycare.
  • Bolster your skills. Even if you're working from home, explore ways to expand your education through free online courses. Anything "extra" you can add to your resume will help you stand out from the crowd in the employment pool.

How to ride out a recession

Someday, someone may ask you: "What is a recession?" Beyond letting them know about unemployment, lack of economic growth, what happens to the GDP, and how consumer spending is impacted, be sure to tell them that a recession is one of those events in life that we know will occur, and one that we can plan for.

There are things you can do to keep afloat and ride out the recession without losing too much ground. They include:

  • Cut unnecessary expenses. For example, if you currently pay for the Cadillac of cable packages, cut it back to basic, switch to a less expensive streaming service, or get by with an antenna until the recession is over. Make more meals at home, consolidate high-interest debt into a lower-interest personal loan, stop smoking, shop for lower insurance premiums, grow a garden, reduce utility use, and find other ways to cut your budget for the time being.
  • Pay down debt. If you are still employed and have an emergency fund in place, chip away at your debt. If you are unable to pay down your debt, at least try to shift your credit card debt to a 0% balance transfer card.
  • Diversify your income. If you are unemployed, use this time to prepare for a new career by taking classes or applying for an internship.
  • Continue to invest. The best way to make money with stocks is to buy and hold -- through good times and bad. As the stock market begins to fall, people tend to panic, and investing can feel counterintuitive. But if you invest for the long term, you should keep investing when there's a potential recession. If you have enough in savings to see you through the short term, using these online stock brokers to buy stocks while the prices are depressed means your dollar will buy more. Once the recession is over, your portfolio will be healthier for it.

Our Personal Finance Expert