In the second quarter (three-month period) of 2022, the gross domestic product (GDP) of the United States declined by 0.9 percent. Since GDP also declined in Q1, a second consecutive quarterly decline marks the dreaded threshold most economists use to define a recession. However, the numbers are still in an adjustment period, meaning there may have been no GDP decline in Q2. But, unless GDP growth was positive in Q2, which would be a significant upward adjustment, our nation will technically be in a recession.
Defining a Recession
The first component of a recession is a decline in economic output, measured by gross domestic product.
- Gross Domestic Product: The value of all final goods and services produced within a nation during one year.
- Final goods: Goods purchased by the consumer, meaning purchased at retail price.
For a true recession, GDP must decline – meaning to shrink – from a previous high point. This is where politics can obscure things, as critics of a current administration may use the term “recession” in a generic sense when GDP growth is slower than usual. While a 0.5 percent annual GDP growth rate would be slower than desired by all metrics, it would still be economic growth and not a recession.
The second component of a recession is the length of the decline in GDP. Unlike the definition of GDP, which is widely agreed upon, the defined length of time before a recession is official is more flexible. Most definitions use two successive quarters (six months). Again, politics can complicate the picture, as the administration in office will likely want to delay declaring a recession as long as possible. Conversely, opponents of the administration will want to declare a recession as quickly as possible to point out that the administration has failed to maintain a strong economy.
What a Decline in GDP Does
A decline in GDP usually correlates to a decrease in jobs, meaning an increase in unemployment. There is no fixed percent correlation between a decline in GDP and an increase in unemployment, but Okun’s Law states that a 2% decline in GDP leads to a 1% increase in unemployment. However, the data used by economist Arthur Okun was from the early 1960s, and more recent data deviates from it. Still, it is widely agreed that a recession will lead to increased joblessness.
While some workers may be laid off during a recession, most individuals who are invested in the stock market worry about the value of their stock portfolio. However, the stock market has typically not suffered much during recessions after the Great Depression. Although a recession may have begun with a steep drop in the stock market (meaning a decline in the value of major stock indexes like the Dow Jones Industrial Average and the S&P 500), the stock market usually recovers quickly. In fact, the stock market may recover well before the economy as a whole is considered to have recovered.
Since the Great Depression, it has become widely expected for the federal government to use fiscal policy (taxing and spending) and monetary policy (controlling the money supply) to help the nation recover quickly from a recession. Monetary policy is conducted by an independent regulatory agency, the Federal Reserve, and adjusts interest rates to affect the amount of borrowing – and therefore spending – in the economy. Fiscal policy, however, is conducted by Congress through the federal budget.
While the Federal Reserve can act freely, based on the analyses of its expert staff, Congress is only more free to use fiscal policy to stimulate the economy once a recession has been declared. If the current news does lead to a formal recession, Congress will likely pass more bills to spend money on big projects that stimulate the economy. When there is no formal recession, the political party not a majority in Congress may declare such big projects to be wasteful spending. An actual recession, however, increases public support among all citizens for increased government spending.
However, government action at the state and local levels may be the opposite. Only the federal government can spend freely by going into debt through deficit spending. During recessions, there is less concern about deficit spending if it reduces unemployment. However, state and local governments are less able to engage in deficit spending, as most must balance their budgets each year. This means that city, county, and state governments may be hurt during recessions by less tax revenue and have to cut services and lay off employees. For example, state funding for higher education fell substantially during and after the Great Recession (2008-2009) due to decreased tax revenue.
What You Can Do
Because a recession can lead to a reduction in pay raises and bonuses, or even cause layoffs, it is a time for careful financial planning. Workers in industries hardest hit by recessions must pay attention to news about their companies’ futures and plan accordingly. Traditionally, industries like restaurants, hospitality (hotels and vacation spots), real estate, and durable goods like cars, tractors, and heavy equipment are most susceptible to a drop in revenue during recessions. These are the areas where consumers and businesses first cut spending. If you work in one of these industries, ensure you are a valuable employee!
However, do not fall into the mindset that you should stop investing and hoard all of your money! Investing during a recession is often considered a good idea, as the market always rises in the long run. For those with savings and/or secure employment, the lower prices and interest rates experienced during a recession represent an excellent opportunity to purchase that new home or vehicle. In fact, the purpose of the Federal Reserve lowering interest rates during a recession is to help get consumers and businesses spending money again! Sellers will definitely appreciate you spending money during a recession – just make sure you have budgeted carefully.