Recession: CNBC Explains
Senior Editor, CNBC
Every few years, countries experience an economic downturns, also known as a recession. Companies lay off workers, consumers stop spending, and the average American experiences a financial pinch.
But what exactly is a recession? How does it differ from a depression? And when does a recession end? Here are the basics.
What is a recession?
The textbook definition of a recession is a downturn in economic activity, characterized by at least two consecutive quarters of decline in a country's gross domestic product (GDP).
Translation? A big drop in consumer spending ending in a loss of jobs, personal income and business profits. This is usually the result of an economic shock, such as a 'bubble' bursting.
An economic bubble happens when products, such as stocks or homes, become worth more than their actual value. When the bubble bursts, the prices of these products fall.
This is usually coupled with less business investing, because business profits drastically decline. The slowdown in business investing in turn results in more bankruptcies, both personal and business, and higher unemployment rates because too many people are chasing too few jobs.
What causes recessions?
They usually result from an economic shock. There are many ways a shock can come about.
The 2007-2009 recession was mostly blamed on a housing bubble. After a run-up in housing prices in the early part of the decade, home prices plummeted, then thousands of borrowers couldn't afford to pay their loans. Meanwhile, Wall Street sold financial instruments tied to the loans that were eventually discovered to be of little value.
Looking at other recessions, we can see their 'shocks.' The recession of 2001 was caused by the 'Internet Bubble,' in which internet stocks and businesses eventually fell to much lower prices. That brought about a huge decline in business investing and a spike in unemployment.
The recession of 1973-1975 in the U.S. came about because of rocketing gas prices caused by OPEC's raising oil prices as well as embargoing oil exports to the U.S. Other major factors included heavy government spending on the Vietnam War, and a Wall Street stock crash in 1973-74.
At the time, this recession was the worst in the U.S. since the Great Depression. Today, most economists believe the Great Recession of 2007-2009 superseded the 1973-1975 recession in intensity.
There was even a recession during the Great Depression, say economists — and at the time it was the worst recession in the nation's history.
The 'recession' in 1937 and 1938 had several causes. When the U.S. was trying to get out of the Great Depression, it spent a lot of money. That was the New Deal — President Franklin Roosevelt's plan to get the economy moving — which started in 1933.
But as the economy appeared to be recovering in 1937 and because Congress wanted to balance the budget, the government pulled back on spending and then raised taxes. That was enough of a 'shock' to put the economy into recession. Unemployment rose again and business profits declined, as did business investing.
As a result, the Great Depression continued, economists say, until the U.S. entered World War II in 1941.
What's the difference between a recession and a depression?
Harry Truman, the 33rd president, is credited with saying, "A recession is when your neighbor loses his job. A depression is when you lose yours."
A depression is a far more serious downturn in a country's economic growth for a longer period of time, resulting in much higher unemployment and much less spending by consumers, than a recession.
That's why the Great Depression of the late 1920's and 1930's was called just that. The economic suffering was long and painful. In fact, the term recession became more commonplace after World War II to describe an economic downturn less severe than a depression. Before that, almost all economic downturns in the U.S. were called depressions or panics.
The Great Depression was primarily started by the Wall Street crash of 1929, as well as bank failures in the early 1930's. Depositors' money was not insured by the Federal Government as it is now. That insurance is a legacy of the New Deal.
Also helping to bring on the Great Depression were protectionist trade policies to help boost American businesses but put higher prices on products—plus a severe drought in the Midwest known as the Dust Bowl that put thousands of farmers out of work.
The U.S. hasn’t experienced anything close to a depression since World War II.
Can a recession get worse?
Yes. It can become a depression — meaning the economic slowdown can deepen and go on for a longer time.
There hasn't been an official case of that transition yet, but as noted above, the 1937-38 recession helped prolong the Great Depression.
A recession can also 'double dip.' This is often referred to as a W-shaped recession. That means a recession can end for a time but come roaring back because of another economic shock.
Economists point to a double dip recession in the 1980's. The first part of the double dip started in January 1980 and lasted through July of that year. After the economy started growing for a while—and considered out of recession—the Federal Reserve raised interest rates to stop inflation.
That turned out to be an economic shock and sent the country into another recession from July 1981 to November 1982. That made it a double dip.
When Does a Recession End?
Technically, a recession ends when economists say it does, but those on the streets may feel differently.
The National Bureau of Economic Research—an independent group of economists—is charged with the official proclamation of a U.S. recession's end.
In general, however, a recession ends when the economy starts to grow for a period of time, usually two or more business quarters. That means companies are hiring again, consumers are spending, and businesses are investing.
That doesn't mean everyone has gotten their jobs back or businesses are investing more than before the recession. It just means a country's overall economy is expanding or growing on a somewhat more consistent basis.