What Happens in a Recession?

A recession is typically identified by a change in five economic factors, including income, employment, real gross domestic product (GDP), retail sales and manufacturing.

When these areas are in a downturn, the economy steadily declines over the course of several months which leads to a recession. The National Bureau of Economic Research monitors the data associated with these areas to identify when a recession is imminent.

Contrary to popular belief, the recession does not begin with an obvious impact to the real GDP. It is more likely that one of the other influencing factors takes a hit well before the effects are felt by the GDP. Manufacturing often suffers first when a recession is forming, as these companies order product months in advance and thus can track a decline in consumer demand. Once this happens, the recession begins to form, and the four remaining factors see varying signs of impact.

What Are the First Warning Signs of a Recession?

There are several ways to identify when a recession is looming, and learning how to spot these warning signs can help you to prepare for any financial difficulties you may experience during this economic downturn. The primary warning signs that suggest the start of a recession include the following:

  • A stock market decline. This occurs when the market is drained of capital, because investors lose confidence in their stocks and begin to rescind their investments. In turn, this forces businesses to lose profit, which leads to a steady decline of the economy.
  • A drop in housing prices or housing sales. This occurs when home owners are no longer financially able to make payments to their mortgage, and are forced to sell their homes to avoid foreclosure. Consequently, when people are losing income they are less likely to purchase new homes, leading to a decline in the number of homes sold per year.
  • A decrease in manufacturing orders. This is typically the foremost warning sign associated with a recession as manufactures create orders several months in advance to meet consumer demand. A drop-off in manufacturing orders can appear up to two months before the recession hits.

It is worth noting that a recession is not solely comprised of negative growth. In fact, positive growth still occurs in many areas, though it is usually limited. The positive growth then commonly slows as the quarters progress, which leads to further economic turmoil.

What Are the Effects of a Recession?

When the U.S. falls into a recession, the negative impact of this event is widespread. Typically, unemployment rates rise as businesses are no longer able to afford to pay wages to their employees. As this happens, consumer purchases decline because the average American can no longer afford to buy frivolous items. This impacts the economy even further, as businesses struggle to stay afloat. When there is less demand from the consumer, the business suffers and many are forced to file for bankruptcy before the economy is restored to a functioning balance.

The lack of employment and decline of local businesses ultimately leads to a loss in the real estate market as well. New homebuyers are no longer able to purchase a new home once their source of income has been severed. Additionally, workers who are laid off or forced to close their businesses may struggle to pay their bills each month and lose their homes as a result.

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Moreover, students who graduate from college just prior to a recession often find it difficult to locate gainful employment, as the pool of job openings dwindles during this period. This places students at a financial disadvantage. Many are forced to take lower paying jobs to support themselves until the economy begins to stabilize. A cycle of effects is started when this takes place, as young people are less likely to buy new homes or invest in consumer products when they are unable to make a livable wage.

How Long Does a Recession Last?

The length of a recession varies depending upon the factors influencing the economic downturn. The longer it takes for the GDP to regain momentum, or for the job market to steady itself, the longer the recession becomes. On average, a recession in America lasts around six months. However, there are instances in which a recession can last longer. Some may stretch between nine and 18 months depending upon the severity of the economic decline. While the actual recession period is generally short, the effects often last longer than the decline itself.

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Restoration to essential areas such as the housing market and manufacturing industry may take years to return to the stability held prior to the recession. Therefore, do not expect to see an immediate, positive change once the recession starts to subside. It often takes several weeks or months for graduates to find new employment, for workers to reclaim their former positions or for new businesses to grow. The economy slowly rebuilds itself over time, once each contributing factor receives the support it needs to regain momentum.

What Is the Difference Between a Recession and a Depression?

A recession grows into a depression if the duration of the economic decline exceeds two consecutive quarters. During a recession, the economy contracts and experiences debilitating side effects. When this contraction exceeds a two-quarter period, the country enters a depression which sees further damage to the economy.

Depressions last several years as opposed to lasting several months, which further harms the job market, the housing market, the real GDP and retail sales. The highest unemployment rate recorded during a recession was around 10 percent, but the Great Depression of the 1920s and 1930s saw an unemployment rate of 25 percent. During a depression, the housing prices often decrease by up to 30 percent. When coupled with the unemployment rate, this creates widespread devastation to the economy.

Fortunately, a depression is significantly less common than a recession. The U.S. has not suffered through one of these eras since the Great Depression ended in 1939. Other the other hand, recessions occur at a normal rate, with approximately 33 recessions occurring in the U.S. since 1854.

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