What is a Recession?

When you hear the word “recession” mentioned in news headlines and conversations, it automatically sends fear with reminders of the dot.com bubble burst in the late 1990s and the 2008 financial crisis.

What Does Recession Mean?

A recession is a significant decline in an economy with countries defining a recession as a decline in GDP in two or more consecutive quarters. GDP gives a good indication of a country’s productivity. However, other contributions can determine a country’s economy. Here are five key areas that define a country’s economy.

• Employment

• Retail Sales

• Manufacturing

• Income

• Gross Domestic Product (GDP) - the value of all goods and services made by a country

What Causes a Recession?

There are many ways for a recession to start. Here are the main reasons for a recession to occur:

Asset Bubbles

During a strong economy, investors can become too optimistic. Investing decisions are often driven by emotion therefore if an asset type such as the real estate market pops, panic selling can crash the market.

Inflation

Excessive inflation causes prices to increase exponentially for consumers. Central banks like to see inflation increase 2% every year. When inflation happens central banks can increase interest rates to depress economic activity. A rapid increase in interest rate will severely depress economic activity and cause inflation.

Inflation can be complicated to control for central banks, check out the “How Does Inflation Work?” post to gain a better understanding of inflation.

Deflation

Deflation is when prices decline over time causing wages to contract that further depressing prices. Deflation will cause people and businesses to stop spending which will shrink the economy even further.

Technological Change

New technologies can increase productivity and help the economy over the long term. The introduction of new technologies will need short-term periods of adjustment. The industrial revolution had seen a shift in the workforce with the introduction of machines which caused some professions to become obsolete and sparking recessions.

Excessive Debt

Individuals or businesses that take on too much debt can get too much for them to keep up with payments. Growing debt defaults and bankruptcies can capsize the economy. This was seen in the financial crisis in 2008.

Sudden Economic Shock

An economic shock is a surprise unforeseen problem such as the coronavirus pandemic or the Ukraine war that can create serious financial damage. These unforeseen events can cripple a nation or global economy.

What Can a Recession Cause?

When the above areas are in decline and the overall country’s economy has been in significant decline for two or more consecutive quarters, the country will then declare a recession. A recession can be a difficult time for both businesses and the public. A recession period will see the following:

• Reduction in retail sales

• Manufacturing will slow down

• Businesses forced to downsize or close

• Increase unemployment

• Unemployment means consumers will have less spending power

• A recession will also prompt households to reduce spending

How Long Does Recession Last For?

There is no definitive number on how long a recession will last as a recession relies on several factors highlighted before to improve. The Financial Crisis recession lasted 2 years whiles the COVID-19 recession lasted for two months.

How Can You Protect Yourself Against a Recession?

There are many ways to lessen the impact of a recession on your financial situation.

Review Your Incomings and Outgoings

The first step is to understand and streamline your finances by doing the following:

• Review the past few months’ expenditures including mortgage/rent, bills, groceries, transport costs, spending money and savings

• Review your bills and subscriptions to see where you can cut costs – cancelling a streaming service you don’t use often or a utility provider

Avoid Using Credit

If you have a credit card, avoid using it for big purchases as you will want to avoid tying yourself into a monthly payment which will dig into your monthly expenditures.

Emergency Fund

Build an emergency fund for you to fall back on if you lose your job or be placed on a furlough scheme similar to the one seen during the coronavirus pandemic. A minimum of 3 months' outgoings should be kept accessible in case of emergencies.

Make Yourself More Valuable at Work

A recession can mean redundancies and job losses. It is a good idea to try and protect yourself from redundancy by aiming to make yourself as valuable as possible at work. Taking on extra responsibilities, working overtime shifts or picking up knowledge in other specialist or business areas that could make you more valuable to your employer.

Review Your Investments

Investors should review their investment portfolio and make sure they are comfortable with the level of risk they are currently taking.

Summary

Recessions often happen in the world of economics as asset bubbles burst, inflation and deflation occur, or excessive debt is taken on. Many factors can contribute to a recession to happen. Central banks have powers to prevent or soften the effects of a recession such as increasing interest rates to combat inflation. Households should review their financials and cancel any subscriptions that they no longer use and start an emergency fund with at least 3 months’ worth of their expenditure.