What is a recession? The economic concept explained and what happens during one. – USA TODAY
As prices increase and gross domestic product declines, many people worry about a potential economic downturn, also known as a recession.
Consumer prices rose 8.3% from a year earlier in August while core prices, which exclude volatile food and energy items, climbed 6.3% annually, according to the Labor Department’s Consumer Price Index.
Meanwhile, GDP, or the value of all goods and services produced in the U.S., dropped at an annual rate of 1.6% in the first three months of the year and 0.6% in the second three.
Adding to concerns, Jamie Dimon, chief executive of JPMorgan Chase, the largest bank in the U.S. warned at a conference in London on Monday that a “very, very serious” mix of challenges was likely to push both the U.S. and global economy into recession by the middle of next year, CNBC reported. For now, he noted, the U.S. economy was “actually still doing well” and consumers were likely to be in better shape compared with the 2008 global financial crisis.
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In simple terms, a recession is “a contraction in economic activity” or “when the economy shrinks,” said Sameer Samana, senior global market strategist for the Wells Fargo Investment Institute.
To be more specific, a recession is “a significant decline in economic activity that spreads across the economy and lasts more than a few months,” said Michael Pugliese, an economist with Wells Fargo. In determining whether a recession has occurred, the nonprofit National Bureau of Economic Research doesn’t just look at GDP but rather at a variety of indicators such as employment, consumer spending, retail sales and industrial production.
When it comes to defining a recession, it could be a technical recession or a true recession, said Samana.
“The biggest distinction is the severity,” he explained. “A technical recession is more of a mathematical downshift. A true recession is a more meaningful contraction across a broader range of categories.”
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During a recession, the economy shrinks as a result of a pullback on individual spending, said Samana.
“Consumption, consumer spending makes up about 70% of the U.S. economy,” he said, explaining that during a recession, the cutback in spending “then feeds into overall demand for services.”
From this, companies can pull back on the number of people they employ, further contributing to the contraction of economy activity. Unemployment often rises during recessions, and total employment levels can flatline or turn negative, said Pugliese.
In addition, GDP growth tends to shrink during recessions because there’s less consumer demand and fewer employees, leading to lower production of goods and services.
“If you have fewer employees, all else equal, you’re going to potentially produce less in a recession,” Pugliese said. “All of these things are tied together. Most of those indicators are either slowing down in growth terms, or in many cases, contracting.”
Wages are also affected by recessions, said Samana.
“It’s harder to argue for wage increases,” he explained. If unemployment is high, employers could deny the salary request and claim a worker could be replaced by someone else for a lower wage, instead of a higher one.
Much like other goods and services, housing prices can also decrease during a recession, he said.
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To be categorized as a recession, an economy must experience a couple of back-to-back quarters of shrinking output, said Samana.
However, there is no definite timeframe for how long a recession must last, and the length of a downturn can vary, explained Pugliese.
“You can have some that are very short and quick. You could have others that are a lot more long-lasting.”
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Anyone can be impacted during a recession, said Samana, such as lower-income people or unskilled laborers.
It is hard to generalize that one group may experience a greater impact more than others, said Pugliese. During the 2020 recession due to COVID-19, the hardest hit industries were leisure and hospitality, but in the 2001 recession, the tech industry struggled, he explained.
“I think it just depends a lot of what’s driving the slowdown in the first place,” said Pugliese.
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Historically, when the economy has slowed, inflation appears to remain high. But as a recession sets in, inflation will begin to fall. This can occur after a quarter or two of economic contraction, said Samana.
“The tricky part this time around is how much does it come off,” he said. “How it should work is the economy would need to roll over first; people would need to feel the impacts of that rollover. They’ll probably start to rein in their spending, which will then start to filter into those prices.”
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Despite the unemployment rate either being flat to declining, nonfarm payroll growth has been very strong in the last several months, said Pugliese. Nonfarm payrolls are “the measure of the number of workers in the U.S., excluding farm workers and workers in a handful of other job classifications,” according to Investopedia.
“You can still have an economy that’s slowing down, it’s losing momentum that’s not actually in a recession,” Pugliese said.
However, “just because we’re not in a recession doesn’t mean the economy is completely fine and doesn’t face any problem,” he explained.
As for the potential ofa recession, Samana said the Wells Fargo Investment Institute does anticipate one could occur in the future, leading to “a meaningful decline in economic activity.”
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