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What is a Recession?

According to the National Bureau of Economic Research (NBER), an economic recession is a period when a significant decline in economic activity spreads across the economy and can last from a few months to more than a year. Generally speaking, recessions are recurring economic phenomena which are characterized by a slow-down in economic activity. Recessions occur routinely, but unpredictably, due to the cyclical nature of the world economy. The duration of a recession can only be identified in hindsight, but the experience of living through one is easily identifiable.

The most recent recession in 2008-2009 was also the most severe in many decades. Not surprisingly, the impact from this contraction is still being felt throughout the global economy. Common events that accompany a recession include layoffs, a declining stock market, slowing economic activity, falling consumer confidence, and an interest rate lowering cycle used by the Federal Reserve to artificially stimulate economic activity (e.g. increase demand for lending products to fund expansionary business plans). Understanding the process of a recession can be overwhelming but as Albert Einstein said, “Everything should be made as simple as possible, but no simpler.”

Taking Einstein’s lead, it can help to visualize economic cycles as waves with each wave representing a period of distinct economic activity. Based on NBER’s perspective, a recession is the time period from the peak of one wave to the trough of the next wave. During this period in which the wave falls, general economic indicators will be declining too. Conversely, the expansion or recovery (i.e. opposite of recession) arises from the trough to the apex of the following wave and is accompanied by increasing values for economic data. At the peak, economic indicators, like the stock market, consumer confidence and spending, will be higher than the previous trough when the last recession ended. After a top, the subsequent wave will begin to fall and eventually trough before the next wave up. Again, this slowing period in the economy leading up to the trough (i.e. a falling wave) is the recession. This is a perpetual, yet irregular, cycle.

At this point you may be wondering if we are always in a recession or expansion. While there are some transition periods around the crest and trough of the economic cycle between leading, coincident and lagging indicators, based on the NBER’s interpretation there can only be two phases of economic activity: Expansion or Recession.

For investors and savers it is important to be able to identify the current point in the economic cycle as this will impact your financial decisions like taking out a loan, buying a house, looking for or taking a new job, or deciding where to invest your savings. Taking a quick glance at recent stock market prices and interest rates is a good starting point that every investor can do.   


From a historical perspective, recessions are a transitory contraction in economic activity. You as an investor should make an effort to understand the cyclical nature of an economy as it ebbs and flows between recession and recovery as this will be beneficial in managing your financial matters.  

As always, if you have questions or comments, feel free to send me a message. Thanks for reading.


JD

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