What Is a Recession? How To Prepare

anilakkus / iStock.com

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

The most commonly accepted definition of recession is two consecutive quarters of declining gross domestic product, or GDP.

Here’s what you need to know about what a recession is and how to prepare for one.

How Do Economists Identify Downturns?

There isn’t a single definition for recession that economists agree on. GDP is the value of all of the goods and services a country produces, so if that value declines for two quarters in a row, indicating that the country is producing fewer goods and services, a recession is likely.

The International Monetary Fund considers this definition somewhat narrow and adds other recession indicators, such as unemployment and real income — in other words, inflation. The National Bureau of Economic Research, or NBER, defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”

What Causes a Recession?

A recession is rarely caused by a single factor, and there are often several things at play at the same time. Here are some of the factors that can lead to a recession.

Declines in Consumer Spending

When consumers reduce their spending, demand is dampened and production declines. Fewer goods are produced because there is less demand, and prices may be depressed.

Supply Chain Issues

When companies are not able to get the materials they need to make their products, or when then have to pay more than they expect for them, it impacts pricing, demand and profitability.

Monetary Policy

Central banks can raise interest rates if they think inflation is too high. This can cause a decline in real income because money is more expensive, which curbs spending. This can lead to a downturn.

Market Volatility

Rapidly rising prices in some sectors, like housing, can contribute to or cause a recession.

The Housing Bubble and Recession

The 2007 housing crisis is a good example of this, as housing prices rose rapidly and credit was exceptionally ‘loose,’ meaning more people could qualify for a home loan. This led to even higher prices, which caused borrowers to become overextended. When people began to default on the loans they couldn’t afford, the housing market came crashing down.

What Happens in a Recession?

Even though a recession can’t be formally identified until it’s over, there are effects of a recession that people can recognize in their everyday lives, such as:

• Layoffs or trouble finding a new job
• Higher unemployment
• Inflation slows as spending decreases
• Consumer confidence declines
• Business profits and investments may take a hit
• Stock market often suffers a downturn

Recession vs. Depression: What’s the Difference?

The words “recession” and “depression” are often used together, but there’s a marked difference. A depression is a much more severe and prolonged downturn than a recession and has much higher unemployment and a much steeper decline in GDP.

How To Survive a Recession and Prepare for Economic Uncertainty

Regardless of which definition of recession you recognize, the factors that indicate a recession — GDP contraction, unemployment, inflation — are backward-looking. This makes it difficult to predict a recession in advance. But that doesn’t mean you can’t prepare for a recession.

Here are some steps you can take to help you survive a recession.

1. Have an emergency fund: Three to six months’ worth of expenses is the standard for this, but if you suspect a recession is on the horizon, you can always build it up a little more.
2. Reduce your debt: The fewer bills you have to pay when a recession hits, the more likely you are to come out of it relatively unscathed.
3. Review your budget: Identify which items are nonessential so you know where to cut if you need to.
4. Diversify your investments: You never know which industries are going to take the biggest hit when a recession hits. If your investments are well diversified, you’ll be more insulated against big losses in a specific industry.
5. Become invaluable at work: Keep your skills up-to-date and go the extra mile for your employer. This could protect you from a layoff or make it easier to find another position if you are let go.

Remember that recessions are a natural part of the economic cycle, and that, while they may be unpleasant at the time, they rarely have lasting consequences. Being prepared and avoiding panic can go a long way toward helping you survive a recession.

Share This Article: