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What Is a Recession?

(August 08, 2011)

Summary: The economy changes slowly, contracting and expanding over a period of months or years. To recognize the beginning and end of a recession (a period of economic contraction), we must look backwards over a long period of time.

You hear a lot of talk about recessions, but what exactly are they?

The nature of the economy is that it is always changing. Over the long term, economic changes come in cycles, in which a period of expansion is followed by a period of contraction. During an EXPANSION, we see an increase in production, income, employment and trade, which causes the economy to grow. Life gets better and better.

During a CONTRACTION, production, income, employment and trade decrease and the economy shrinks. Life becomes more difficult. The term RECESSION is just another name for an economic contraction.

Economic cycles are long, playing out over months or even years, and the duration of the expansions and contractions (recessions) varies considerably. In economic terms, a single up-and-down fluctuation — for example, an expansion followed by a recession — is called a BUSINESS CYCLE.

All countries and economic regions go through such cycles. In the last 155 years, the United States economy has gone through 33 business cycles. Thus, we can say that the U.S. economy has had 33 recessions in the last 150 years. (It has also had 33 expansions.)

Here is a recent example. In March 2001, the U.S. economy was at high point of economic expansion (called a PEAK). From this peak, the economy contracted until it reached a bottom point (called a TROUGH) in November 2001. The economy then expanded until it reached a new peak in December 2007, at which point a new contraction began. This final contraction ended in June 2009, at which time the economy began expanding once again. To summarize:

Economic Cycles of the 21st Century

Contraction: Mar 2001 Nov 2001 (8 months)
Expansion: Nov 2001 Dec 2007 (120 months)
Contraction: Dec 2007 Jun 2009 (18 months)
Expansion: Jun 2009 ? (? months)

As a general rule, a recession lasts from 6 to 12 months, although this is not always the case. The most severe recession took place from August 1929 to March 1933, a total of 43 months. This contraction was so extreme that it created the GREAT DEPRESSION, a long period of economic suffering.

The Great Depression started in November 1929, with the collapse of the U.S. stock market and grew to affect most of the world, including Europe and Canada. Although the actual recession — that is, the economic contraction — ended in 1933, it took a long time for the world economy to recover. In fact, the Great Depression itself did not really end until the late 1930s, when massive government spending (to prepare for World War II) infused a huge amount of money into the global economy.

At this point you might be wondering, how do we know when recessions and expansions start and end? The answer is, we can't tell at the time: we figure it out by looking backwards. Sometimes it takes months, or even years, to discover the peaks and troughs, a fact of life that confuses and irritates people, especially politicians and news commentators looking for simple answers to complicated questions.

You may, from time to time, hear someone say that a recession can be identified by two consecutive quarters of decreasing GDP. (The GDP, or gross domestic product, is a measure of the total goods and services produced within a country.) When you hear such comments, ignore them. Identifying recessions and expansions is a complicated task. There is no simple way for most economists — let alone politicians and news commentators — to identify the ups and downs of business cycles.

So who makes the call? In the U.S., the job of identifying business cycles — and recessions — falls to a private organization called the National Bureau of Economic Research (NBER). Specifically, the official declarations are made by the NBER's "Business Cycle Dating Committee", a group of nine people (eight men and one woman).

This committee spends countless hours ploughing through huge mounds of complicated, incomplete, and often confusing data. Eventually, it is these nine people who decide, in retrospect, just when the U.S. economy entered into a recession (contraction) or an expansion.

The last official decision made by the Business Cycle Dating Committee was on September 19, 2010. During a conference call, they agreed that a trough (low point) in economic activity had occurred 15 months earlier, in June 2009.

That low point marked the end of a recession that had began in December 2007. The recession had lasted 18 months, the longest economic contraction since World War II (which is why there had been so much suffering). Nevertheless, the June 2009 trough also marked the beginning of the current expansion, which means the recession is long over.

If this doesn't seem to be the case, it is because the economy is huge and does not change quickly. Both expansions and contractions can take a long time to play out, so be patient.