Recession

What is a recession?

A recession is a significant, widespread decline in economic activity lasting more than a few months. Experts define this period as two consecutive quarters of contracting real gross domestic product (GDP), with associated declines in a variety of other economic indicators, especially relating to employment. Recessions are considered a normal feature of the business cycle, and typically impact every sector of the economy.

Deeper definition

The economy naturally vacillates between periods of growth and decline. Businesses take advantage of low interest rates to invest in growth and hiring, and consumer optimism grows along with spending, further expanding the economy. This virtuous cycle creates steady earnings for companies, and the stock market rises.

When the cycle reaches its peak, investors become overconfident and asset bubbles appear, as irrational exuberance inflates the prices of stocks and other assets. In this context, buyers don’t properly gauge underlying asset values, and the arrival of a financial crisis or other shocks triggers a rapid fall in stock prices, prompting investors to panic and sell. The effect trickles down to consumers, causing them to lose economic confidence and stop spending.

This series of events causes the economy to begin contracting, leading to recession. The decline makes banks hesitant to lend, further compounding the fall-off in investing and business spending. Central banks respond to contracting growth by easing monetary policy and providing emergency liquidity. Eventually, consumer confidence returns and more normal spending patterns are restored after the economy reaches a trough or contraction low point.

In the United States, the National Bureau of Economic Research (NBER) is the body that officially declares the start and end dates of recessions. In addition to two consecutive quarters of negative GDP growth, the NBER tracks other economic metrics to decide whether a recession is happening. The NBER officially defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Recession example

The run-away growth in the U.S. tech industry in the late 1990s and early 2000s led to a recession that lasted for most of 2001, aggravated by the terrorist attacks on September 11th, 2001. The emergence of small, dynamic and rapidly growing tech companies involved in the internet in the late 1990s inflated a very large bubble in the stock prices of such companies. There was limited understanding of the commercial potential of internet businesses in the period, and companies promised very rapid rapid growth to investors that was, in hindsight, totally unsustainable.

After the tech bubble in stock markets deflated rapidly in early 2001, the U.S. economy sank into a recession that lasted from March 2001 to November 2001. The 9/11 terrorist attacks extended the impact of the recession. Enemployment peaked at 6.3 percent in June 2003, indicating that difficult economic conditions lasted long past the official end of the recession.

Other Investing Terms

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Repurchase agreement (repo loan)

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Derivative

Derivative

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