A recession is when the economy is bad … or something. But what does that really mean? How bad does it have to get before you call it a recession? Does it have to do with the “two quarters” we keep hearing about?
When people talk about recessions they usually mean one of two different things. And if you can’t distinguish them you’ll end up confused: someone might declare a recession that doesn’t look like much. At other times, an expert might say we avoided a recession while the world seems to go down the drainage. To understand those “mixed signals” read on.
Recession in 2 minutes
- People mean different things with “recession”
- You have a technical recession when GDP goes down for two quarters in a row. (It’s not a very helpful definition. Read why below.)
- More broadly: recessions are a time when the economy of a country or area keeps getting worse.
- Can’t just be one industry: the economy must be affected broadly.
- It starts at the previous high and ends when the economy is heading up again. The end of a recession does not mean that the economic situation is rosy again.
- Recessions are downturns that make themselves worse: for example, people lose their jobs -> they have less money to spend -> companies sell less -> they fire more people
- In the US, the National Bureau of Economic Research (NBER) is declaring recessions. It does not use the “two quarters” definition.
Recessions and love (or why it's complicated)
So, let’s talk about being in love. Yes, because being in an economic recession is a bit like being in love: when you are, you just know. And then sometimes it’s also not like being in love at all: because you can’t be a bit in love, but you can be a bit in a recession. When it’s not that bad … yet, that’s when everyone starts arguing:
- Are we in a recession, or just a slowdown?
- Is it a small dip or are we heading down for a long while?
- When did the recession start?
- Will it evolve into a full-blown depression?
- etc etc.
These days the word recession matters because we’re hearing a lot about them: The Federal Reserve thinks the US economy might avoid one, while Elon Musk disagrees. The Bank of England warns of a recession, and Australia hopes to minimize the effects of a global one.
There are two reasons why the word recession pops up all over the place. For one, journalists and social media love the word because it makes people click. The other reason is that we might already be in one.
So, in this article I’ll discuss the different definitions of “recession”, who announces them in various countries, and we’ll look at examples. My goal is that you get a better idea of what a recession is—but also that it’s not a dry-and-cut term. Being officially in a recession doesn’t mean things are good, nor is being in a technical recession (what is that?) always the end of the world.
Let’s start with the most famous definiton of the word.
The “two quarters” definition (a “technical recession”)
The most widely known definition of a recession is this:
A recession is when GDP goes down for two quarters in a row.
That’s also sometimes called a “technical recession”. You can find it all over Yahoo News.
It’s awesome because it’s very simple to understand and figure out. Come July 1 you can tell if the first half of the year was recessionary or not. Ah, wait, you actually can’t because GDP numbers are usually not reliable until many months after the fact. (That’s one of the reasons why it took the US one year to officially say: yes, December 2007 was the start of a recession.)
Then why on earth are you and I reading those announcements on July 1? Well, financial analysts and journalists use preliminary GDP data to call a recession. It helps them predict a bit better if things are looking up or not. If the economy has been in a technical recession, then chances are the next few months won’t be amazing either.
Problems with “two quarters” recessions (the US doesn’t use it)
So, GDP numbers are not final any time soon after a quarter ends. If it was a close call, you might have to come out later and say: folks we just got the updated GDP data and as it turns out: we really did have (or did not have) a recession. Sorry! That’s not great. But there is more.
Remember 2020? Pandemic, lockdowns, the economy collapses in many countries, unemployment skyrockets? Turns out, in the US things were not too bad: there was no recession! At least, that is, if you use this two-quarters definition. GDP went down only for two months: March and April.
Things were bad though and the economy was plunging. The US had an economic recession—just a brief one. That—plus a bunch of other reasons—is why the US and other countries and institutions don’t use the two-quarters definition.
Not all news sites are using this definition either. Forbes gives more of an overview and a random article on the Wall Street Journal also points to multiple definitions.
Where does this definition come from anyway? It was popularized by a 1974 article in the New York Times. Learn more about the two quarters definition and its problems here.
Let’s step back a bit and consider what we want to say with the word.
What does Recession mean?
When talking about a recession, people often get hung up on the technical details of how to measure economic activity. So we’ll instead start with something that most people agree on:
Economy doing badly means the economy is shrinking, not growing. A few things are important here:
Recessions are about the economy of a country or other geographic region. When someone says “there will be a recession” you have to ask: where?
A bad weekend is not enough to call a recession. We’re talking about months or years.
A big chunk of the economy must be affected. It’s not enough if, say, the hair salons have a bad month or two.
Sometimes you hear “negative growth” instead of shrinking. Whatever.
Is every economic slump a recession?
No. Sometimes the economy just “corrects” a bit. So what’s the difference? When is a slowdown a recession?
We already talked about that the duration matters—a bad weekend doesn’t make a recession—but there is more:
The idea that the direction is downhill is why the Euro-zone folks insist on recessions being “diminishing” periods where activity goes down, not just “diminished” ones where the economy works but at lower levels. It’s why the Economic Cycle Research Institute calls a recession a “self-reinforcing downturn”.
The idea is that something, for example an oil price shock or a debt crisis, makes people and companies spend less. If people spend less eventually companies will throttle production and that leads to them firing people. Fewer jobs means less money to be spent, and we’re back at the beginning. The whole thing repeats and spreads through the economy in a downward spiral. That’s why not every downturn is a recession.
So, when does a recession officially start and when does it end?
When does a recession start? And does it end when recovery is complete?
To understand how long a recession lasts officially, let’s talk about the economy and how it goes up and down: an economic expansion followed by an economic contraction. Round and round it goes.
You’ll have those economic cycles in specific industries, regions, and so on but when they hit the economy at large that’s then called “The Business Cycle”, and GDP, employment, wages, sales, etc, often go up (or down) together.
Because in many countries we had a long time of economic growth (in the US from 2009 to 2020), some people thought that the business cycle (and with it recessions!) were a thing of the past. “The economy is going up forever!” But, as they say: what goes up must come down. The business cycle is very much alive.
Read more about the business cycle on Investopedia or this prescient article from 2019 by the ECRI.
If you’re looking at the business cycle of an economy then a recession starts at the highest point of economy activity (the peak), after which the economy starts falling. The recession ends the moment that the economy hits the lowest point (the trough), after which it starts rising again.
Question: So when the recession ends the economy is doing good again?
Answer: No. A recession ends the moment the economy starts growing again. That doesn’t mean that the economic situation for the people is great: A lot of people might still be out of a job, and wages may still be way down. During the recession the economy went down, and when the recession ends we’re not back up yet—we just stopped going down.
So when you hear a suit on TV say that the recession ended while you’re thinking: hello? things are still crap! What do you mean the recession ended?? Remember that the suit on TV only means that the economy is going up again—even if from a very low valley.
Capturing the idea of an economic recession
A more precise way of defining recession
Let’s put all those pieces together:
- A recession is a period of time where the broader economy keeps going down.
- Usually you’d measure the economy with a mix of GDP, unemployment, wages,
- During that time things get worse and worse—it’s a self-reinforcing downturn.
- A recession officially lasts from the top of the business cycle until the bottom.
- And just because it ends doesn’t mean things are great again; it just means the economy goes up.
Now that we’ve a better sense of what people try to capture.
How different countries and organizations define a recession (and who announces them)
I’m collecting here a few organizations that call recessions for some country or economic area.
None of these are “right”. They just try to find something that works for them.
United States: The NBER definition of recession
In the US, the National Bureau of Economic Research (NBER) is usually the one calling a recession.
You can find its definition for “recession” on it's Business Cycle FAQ.
The NBER’s traditional definition of a recession is that it is a significant decline in economic activity that is spread across the economy and that lasts more than a few months.
Curious about what times they declared a recession? See the full list of all US recessions since 1857 here.
European Union: How the EABCDC defines a recession
For the Euro-area it’s the Euro Area Business Cycle Dating Committee (EABCDC) who announces start and end of recessions. It’s the EU equivalent to the NBER in the United States.
Note that they don’t look at individual countries, only at the Eurozone as a whole. So they don’t, for example, proclaim recessions for Germany or Spain.
Anyway, here is their definition:
A significant decline in the level of economic activity, spread across the economy of the euro area, usually visible in two or more consecutive quarters of negative growth in GDP, employment and other measures of aggregate economic activity for the euro area as a whole.
See the EABCDC's Methodology page.
Btw, did you also stumble over “EABCDC”? In a way it’s awe-inspiring how complicated the EU can make things.
The ECRI definition
The Economic Cycle Research Institute is proud to mostly be right about calling recessions. Their definition tries to capture the nature of the downturn:
A recession is a self-reinforcing downturn in economic activity, when a drop in spending leads to cutbacks in production and thus jobs, triggering a loss of income that spreads across the country and from industry to industry, hurting sales and in turn feeding back into a further drop in production - in effect a vicious cycle.
They continue to say that a proper definition “cannot be limited to GDP and industrial production, but must also include jobs, income and spending”, taking a swipe at the popular definition of “two consecutive quarters”.
What is a GDP per capita recession?
According to the technical definition above a country can’t have a recession while its economy is growing. We measure this growth by GDP—the economic output of a country. But there is a trick.
You see, the simplest way to grow the economy (if we’re looking at GDP) is to increase the number of people working. If more people are in work you got more people earning and spending and producing and—tada!—GDP rises. In that way GDP measures the “size” of the economy but that doesn’t mean that it’s growing when measured per person. That’s what GDP per capita is for.
WHen you define a recession not as a declining overall economy but a declining economy per person, often the picture changes.
Btw… let’s say the economy is growing on a per person basis. Does that mean that life improves for you and me? Sure, it might! Unfortunately, life can also stay the same or get worse for the majority of people. That’s what rising inequality is about.
Is a recession the same as a contraction of the economy?
A contraction means the economy is shrinking. Because of that, contraction has been proposed as an alternative to “recession”, which maybe sounds a bit less negative.
Nowadays, I’d argue the two terms are not the same anymore: contraction does not have the historical baggage that’s associated with a recession, for example the two quarters.
Are a recession and an economic depression the same thing?
If a recession is having a cold for a weekend, depression is lying in bad with a bad case of flu for a week.
Originally, any economic downturn was called a depression. Then, to distinguish the mild from the really bad ones, they started using “recession” for the not-so-bad downturns.
What is the difference between a recession and period of stagflation?
A stagflation is a time on very little or no economic growth combined with high inflation.
If we ignore the case of “negligible growth” then yes, stagflation is a recession plus inflation.
Who announces recessions officially?
This depends on the country. In the US for example, it’s the NBER institute. TODO
For more examples, see the sections on definitions above. TODO LINK
Is the economy only doing badly when there is a recession?
No. The economy can also do badly when officially there is no recession.
It’s important to remember:
“Recession” is a word that economists made up.
Is a recession bad for all businesses equally?
No—and that’s key to running a business during a recession and to invest successfully.
When a recession happens it changes consumer and business behaviors. People have less money—so they start buying cheaper things, for example they might prefer budget chocolate over premium imported one. Companies are forced to automate more because they can’t afford to hire. If you’re ahead in recognizing these behavior changes, you can do exceptionally well.
Read more about how recessions change behavior here.