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Defining Recession

by on December 23, 2018 5:00 AM

 

By Brittany N. Cox 
Registered Investment Advisor at Nestlerode & Loy Investment Advisors

It seems the news is filled with talk about an upcoming recession in 2019. I overheard a couple speaking about the coming recession over their dinner earlier this week. So, I thought it may be beneficial to discuss recession, define it and the many terms used to describe it.

A recession, according to Investopedia, is “a significant decline in economic activity that goes on for more than a few months.” A technical indicator of recession is two consecutive quarters of negative economic growth, which is measured by the country’s GDP, or gross domestic product. What do these terms mean to us? Economic activity is essentially any action that involves producing, distributing, or consuming goods. If money and a product is exchanged, an economic activity has occurred. So, where do we see economic activity in numbers? We can watch the industrial production levels, employment, real income levels, and retail trade.

We are also told in the definition that the indicator is economic growth measured by GDP. Let’s define those. The economic growth rate is a measure of the rate of change that a nation’s gross domestic product (GDP) goes through from one year to the next. The economic growth rate provides insight into the general direction and magnitude of growth for the overall economy. While economic growth is most often assumed to refer to positive movement, economic changes can be positive or negative. In the United States, for example, the long-term economic growth rate is around 2 to 5 percent. Lower economic growth rates are seen most in highly industrialized countries. Fast-growing economies, on the other hand, see rates as high as 10 percent, although this rate of growth is not likely to be sustainable over the long term.

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within the country in a specific time period. GDP is essentially a broad measurement of all the economic activity in the nation. Businesses will commonly use GDP to decide whether they should be expanding or slowing their production, as well as, other business activities. Investors also like to keep an eye on the GDP as it provides insight into corporate profits and inventories to help aid investment decisions.

So, what does it mean for us? A recession is a normal phase of the business cycle, even though it is not an exciting part. A recession will typically last between six and 18 months. Usually, interest rates will fall during this period to stimulate the economy. Also, unemployment rates generally rise as workers are laid off. Inflation also tends to fall as demand lowers across the economy and housing prices will tend to fall because of the lower demand.

One thing that took me by surprise, at first, is that individual household savings tends to rise during a recession. How could this be? Well, people start to worry that they will be laid off or unemployed and try to prepare for such an event by stashing away extra money instead of spending it on nonessential things. Hence, the decrease in demand. While this is better for individuals, this tends to increase the pain of the recession for the nation as a whole since consumer spending decreases further, and demand lowers more. As the demand and consumer spending lowers, the stock market tends to fall as company profits suffer.

Why are so many people talking about the next recession now? Some of the signs we are seeing recently include some weakness in a few major sectors like auto manufacturing, agriculture, home building, the stock market volatility, and, of course, the fear of the trade wars. Also, some analysts worry that we are simply overdue for a recession. The expansion we are seeing is the second-largest on record and recessions are commonly preceded by a large expansion.

There are many different impacts and indicators of a recession and I certainly couldn’t cover all of them in this article. However, the bottom line when it comes to the recession talk is that often, a recession comes as a surprise. Instead of trying to predict the future, it could be beneficial to plan for the long term. Try to keep your focus on the long term instead of the short-term market movements.


 

 



Geoff Rushton is managing editor for StateCollege.com. Contact him at [email protected] or find him on Twitter at @geoffrushton.
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