Photo of a winding road indicating the pattern of economic recessions.

How to spot a recession (and worry less about its effects)

Fears of another United States recession spiked in March as the spread of coronavirus rattled financial markets, triggering widespread volatility. We’ve since seen an almost complete shutdown of the service-sector economy, millions of job losses, and unprecedented federal stimulus to help businesses and households rebound.

Considering this fresh worry over an economic recession in 2020, maybe you wonder when the next one really is expected to arrive?

Or maybe you wonder, what even is a recession?

We’ve got the details.

Getting to know GDP (gross domestic product)

To understand and define recession, first you should know a little about an economic number called gross domestic product, or GDP.

Every day, people nationwide—farmers and factory workers and babysitters and social media influencers—all head to work. Together, they produce all the goods and services that make up what we think of as the U.S. economy.

If you add up the dollar value of all the things they make and the services they deliver, you get the national GDP. When the economy grows, the GDP gets bigger as workers make more stuff and perform more services.

Occasionally, the GDP shrinks. That’s a recession.

Recession hits after a peak

“A recession is part of the cycle that economies go through,” says Bob Baur, Ph.D., chief global economist for Principal® Global Investors. “A really simple way to think of that cycle is like seasons for an economy, except instead of repeating spring, summer, autumn, and winter annually, economic cycles may last for years.”

When businesses are doing well and the economy is growing, it’s sort of like spring. Lots of new companies pop up and consumers buy tons of things. Then the economy overheats—it grows at an unsustainable rate, and GDP hits a summer-like peak.

A recession is part of the cycle that economies go through.”

Bob Baur, Ph.D., chief global economist

After the peak, the economy starts to cool again, and growth falls back for a while—that’s a recession. Businesses and consumers become more cautious. Some weaker businesses might even close. Eventually, after the worst is over, the economy starts heating back up, growth returns, and the cycle starts over.

How do we know when we’re in a recession?

Typically, economists will say a recession is happening when GDP has declined for two consecutive quarters.

“A committee at the National Bureau of Economic Research (NBER) is responsible for officially declaring when recessions start and end,” Baur says.

The NBER looks at several pieces of data such as total employment numbers, inflation-adjusted household income, wholesale and retail sales figures, and industrial production. When the NBER committee sees a sizable decline in all four pieces of data for several months or quarters, they’ll call it a recession.

Recessions have come in different shapes and sizes over the years. According to the NBER, there have been 11 business cycles in the U.S. since the end of World War II, and the average recession lasted for 11 months. The 2008 recession was particularly bad and lasted for about 18 months. But it came after the U.S. economy had been growing for about six years. The recession before that, in 2001, only lasted about eight months, and it came after about 10 years of growth.

What about the next recession?

Investors and the media already were focused on the possibility of a recession in 2019, thanks to trade tensions between the U.S. and China and worries that economic growth might stall. And today people wonder about recession due to the COVID-19 shutdowns and a plunge in oil prices.

For now it’s better to think of 2020 as a massive and unique economic contraction, Baur says. The U.S. began the year with strong growth and consumers in much better shape compared to a dozen years ago.

Total household debt as a percent of GDP had steadily decreased. Some trouble spots in the economy (corporate credit, auto-loan delinquencies, and student loan debt) had been offset by hot housing and job markets, low interest rates, and gains in capital spending and manufacturing.

Now the question is whether COVID-19 can be contained and the federal stimulus can help jolt the economy back to life by summer.

“If consumers lose their confidence, they try to raise savings by not spending, which then leads to a vicious circle of less consumer spending, more job losses, more wage cuts,” Baur says.

That could compound the turmoil of other economic factors, such as huge levels of corporate credit, a struggle over oil between Russia and Saudi Arabia, and the presidential election in November.

Businesses and households losing confidence in the economy throughout 2020 could help trigger the next traditional recession. Or we may yet get by, Baur says, with a temporary—albeit severe—contraction.  

What to do next?

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