Recession Primer, Part Two: Features of a Recession

David Frost // Blog, Market Outlook


February 24  

This is part two of a series on recessions, specifically on features of a recession and what happens when a recession is underway. Click here for part one.

The National Bureau of Economic Research (NBER) is the organization that officially declares a recession. However, the recession is already underway by the time it has been declared. Certain effects must be observed in the economy before a recession will be declared. This article will focus on how a recession looks in terms of data points.

Anecdotally, recessions are marked by extensive job loss and business closings. Banks may buckle, and companies see their revenues decline significantly. Consumers just don’t spend as much money as they did before the recession, and the economy enters a period of obvious slowdown. Looking beyond the anecdotes, recessions can be observed in several key data points. 

The NBER requires that a decline in economic activity be underway for at least two quarters before a recession can be declared. The organization states that recessions can be seen in five key areas: “real GDP, real income, employment, industrial production and wholesale-retail sales.” All five of these areas say something about how spending is going in the economy. When there is a slowdown in one or more of these areas, it signals that consumers and/ or employers are not spending as much as they were, which indicates that the economy is starting to slow.

Real GDP

When an economist considers whether a recession is underway, one of the most important data points to look at is the gross domestic product. If GDP growth is in the negative for at least two consecutive quarters, then it suggests a recession is occurring. Economists use the real GDP, which removes the effects of inflation. 

The real GDP measures the value of the country’s output. It tells the value of all the goods and services being produced by the U.S. economy. Because it strips out the effect of inflation, real GDP tracks changes in prices and more accurately estimates economic growth. If real GDP growth is negative, it indicates that the economy is shrinking, which is a major sign of a recession. 

Real income and employment

Two other factors to take into consideration when determining whether there’s a recession are real income and employment. Real income is important because it indicates how much money consumers have to spend. Real income measures the consumer’s actual purchasing power after factoring in inflation.

Employment is an important consideration because consumers who don’t have jobs don’t have much spending power. Some economists say the market is in a recession if unemployment rises by 1.5 to two percentage points within 12 months, but that’s not the only way employment can be used when trying to gauge whether there’s a recession.

As the recession drags on, so unemployment tends to increase as more and more workers lose their jobs. Thus, rising unemployment may not be seen early in the economic downturn. This is a development that can take time to surface. As consumers lose their jobs, they lose the ability to spend money, which then causes the real GDP to shrink even more. 

Industrial production and wholesale-retail sales

When industrial production declines, it means the factory sector is in a recession of its own. This is also an indicator that a broader recession is either occurring or about to occur. Companies start producing fewer goods when they aren’t selling as much. Demand for discretionary goods declines during a recession because consumers don’t have as much money to spend. As a result, when production falls, it means consumers aren’t spending as much. It sends ripple effects through the economy and the GDP. 

Wholesale-retail sales go hand in hand with industrial production. Factories produce fewer goods in response to a decline in wholesale-retail sales. Retail sales fall because consumers aren’t spending as much money as they were. Retail sales also decline in response to falling production because the available supply of goods has shrunk. The economy hinges on how much money consumers are spending, so when spending declines, it has impacts on many aspects of the economy. 

Other signs that a recession is underway

These factors are only two of a host of areas that are affected by a recession. Other factors which are affected include consumption, investment, exports, government spending, household savings, government policies and more.

Declines in consumption

Consumption declines because consumers spend less money on items they don’t need. Demand for everyday items is more durable because those items are still needed even during a recession. However, the consumer discretionary sector, in particular, sees declining sales during a recession. Household savings may increase somewhat as consumers worry about spending money. However, as more and more consumers lose their jobs, household savings may start to drop because consumers are spending what they saved up for the lean times. 

Change in investments

Investors also change how they invest during a recession. Safe-haven investments such as gold and government bonds become bigger parts of investor portfolios as they seek protection from the recession. Investors may be less interested in riskier assets, or they will require a higher return on riskier assets in exchange for the extra risk they are taking on by holding those investments.

Decline in exports

Exports also decline during a recession because factories are producing fewer goods. In the case of a global recession, overseas consumers will slow or stop purchases of imported goods because they tend to be more expensive than goods produced inside their country. Thus, overseas demand also declines. 

Increase in government spending

One way policymakers respond when there’s a recession is to increase government spending. By boosting spending, the government increases the amount of money that’s available in the economy. Government contractors can retain and hire more employees because there is plenty of government work to go around. By spending money, the government helps ease conditions for consumers. 

Monetary policies during recessions

Officials also adjust their monetary policies during times of recession. The first course of action is generally to cut interest rates, making it cheaper and easier for consumers and businesses to borrow money. This injects capital into the economy, thus enabling businesses to keep and hire more employees. The Fed may also increase its purchases of government securities. We will discuss more about how the Federal Reserve responds to a recession in a future article in this series.

About the Author

Trading and investing in markets is second nature to some, but a mystery to others. The goal is to provide a forum where everyday people aspiring to be part time or full time traders will learn how view markets differently and profit beyond their wildest dreams.

David Frost