We’re hearing more in the news about the economic “r” word — a recession. Economists’ opinions today are split on whether a recession is occurring or will occur, but the mere mention of the possibility sends shivers through both Main Street and Wall Street.
So let me use this column to answer some common questions about recessions. Then you will be better armed to decide what a recession means and how it can affect your personal economy.
What is a recession? Recessions are defined from the perspective of the entire economy, and not from the viewpoint of any individual, company, or industry. Typically the economy grows, or expands, over time, meaning a greater value of goods and services is produced each year.
But when this growth stops, and further, when the economy goes into reverse and produces a lower value of goods and services than in the past, then it is said the economy has receded, in other words, a recession has occurred. Usually this downturn has to occur for a minimum of six months for an official recession to be declared.
How frequent are recessions and how long do they last? There have been 11 recessions since World War II, the last being in 2001. One of the positive trends in recent years has been the shortening of recessions. In the first half of the 20th century, recessions were typically half as long as economic growth periods, meaning the average recession lasted 1 1/2 years. The last two recessions have lasted only one-tenth as long as their corresponding expansions, making their length only eight months.
How are bad are recessions? The cost of recessions is judged by two factors: the loss of income and the rise in unemployment. While income and jobs are still lost during recessions, the costs have become smaller. The peak unemployment rate during the 1981-82 recession was almost 10 percent, but in the 1990-91 downturn it was 7.5 percent, and during the 2001 recession the top jobless rate hit 6 percent. Likewise, the loss of income has become relatively smaller, to where the usual recession today results in a 1 percent to 1.5 percent drop in national income.
To put these numbers in perspective, consider what happened during the recession of 1929-33. Unemployment peaked at 25 percent, and income plunged almost 30 percent.
What causes recessions? This is truly one of the “big” questions in economics. Some say recessions just happen naturally as the economy runs out of steam. Think of a sprinter who has to take a break after several dashes around the track.
Of course, reductions in the availability of a key input in the economy, such as oil, can cause the economy to falter. Reductions in oil supplies, with the corresponding increases in oil prices, were clearly behind two recessions in the 1970s. However, recessions don’t usually follow rises in oil prices that are caused by increased usage of oil and oil products.
Recessions can also come about from “too much of a good thing, ” like the stomachache you would get after eating too much. Here the good thing is investment in some “hot” market, like commercial real estate in the 1980s, the tech sector in the 1990s, and residential housing in the 2000s. If these investments get ahead of themselves, meaning they go up too far too fast, then they can set themselves up for a fall. If the fall is big enough, the entire economy can stumble into a recession.
Can recessions be prevented? Many people look to the federal government to prevent recessions, but four problems make this goal difficult. One is simply knowing a recession is occurring or is about to occur. Second is deciding what to do about a recession. By its nature, public policy takes time to debate and formulate. Third is the lag it takes for government actions to have an impact. Once any government policy is developed and agreed to, between six and 18 months might be needed for the “medicine” to work.
Fourth is the recognition that any “stimulus” today must be “paid for” later, either through higher taxes or higher interest rates. This should give all of us pause about how effective anti-recessionary policies can be.
Dr. Michael Walden is a William Neal Reynolds distinguished professor at North Carolina State University.