What's a recession, and how does it work?

Here's what to know about extended economic dips, including how to weather one.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print

Key takeaways

  • A recession is an extended period of economic decline.
  • In the US, the National Bureau of Economic Research (NBER) announces a recession's start and end.
  • Certain indicators, like corporate earnings, consumer spending, and jobs data can give you a hint at the economy's overall health.

Recessions are the normal part of the economic life cycle when things aren't going well. It's the opposite of economic expansion. While experiencing a recession may be unavoidable, understanding what they are and how they work can provide some perspective and help you prepare to weather the next one.

Fidelity Smart Money. Feed your brain, fund your future. Subscribe now to the Smart Money newsletter.

What is a recession?

A recession is a prolonged period of negative economic growth in a country. It's 1 of 4 phases in the endless economic circle of life, spanning from growth to peak to recession to trough (a.k.a. the bottom of the recession)—and back again. While it's frustrating that economic progress doesn't travel in a straight upward line, it is helpful to keep in mind that historically, periods of recession have occurred much less than periods of expansion and growth. And the US has recovered from every recession it's encountered in history.

In the US, the National Bureau of Economic Research (NBER)—a nonprofit, nonpartisan economic research organization—decides if we're in a recession by looking at signs of sustained economic decline across many parts of the economy. The data points it examines include real income, or individuals' purchasing power after considering inflation; employment levels; how much industrial producers output; how much wholesale retailers sell; and gross domestic product (GDP), or the value of all the goods and services produced during a time period.1

The NBER usually requires that these data points fall for more than a few months to ensure it's not a short-term fluke, but this isn't always the case: The 2020 Covid-19 recession only lasted 2 months.

An important note: Recessions are different than bear markets, even though many people think they refer to the same thing. Recessions relate to a country's economy, while bear markets only refer to its stock market. While stock performance may fall the 20% or more necessary to enter into a bear market during a recession, there are instances when bear markets have not led to recessions.

What happens during a recession?

In a recession, the economy shrinks, which can lead to lower levels of employment, worsening corporate performance, deteriorating stock market results, and higher borrowing costs for both consumers and companies.

Many recession effects cause negative chain reactions. For example, when a recession looms, people may become more conservative with their spending. While this helps them feel more financially secure, it can negatively impact the businesses they usually support. This in turn causes layoffs, which decreases the amount of income others have to spend to grow the economy and may harm the company's performance in the stock market. This could cause even more people to rein in spending, continuing the negative cycle. In some extreme cases, this decrease in demand can also lead to deflation, or decreases in prices.

Recessions may correct themselves over time or be helped along by governmental intervention.

What causes a recession?

There is no single cause for every recession. But recessions are often the result of:

  • Unexpected shocks to the world. Economies prefer predictability. When they're hit abruptly with wars, pandemics, or international financial collapses, the resulting instability and uncertainty can send companies and people into a panic. When they become more conservative about spending, the economy can contract, as seen in the short-lived 2020 COVID-19-induced recession.
  • Asset bubbles bursting. When specific industries grow too quickly, their values may rise faster than is realistic or sustainable, creating what's called an asset bubble. This puts them in a position to burst if new money suddenly becomes unavailable or the overall economy changes, and they have no way to continue—or even simply maintain—their current level of expansion. When asset bubbles have grown large enough, as they did with dot-com-era tech companies or the 2007-2008 housing market, the bust can have far-reaching consequences, leading to a recession.
  • Overheating economies. When the economy grows too quickly, businesses reach the maximum supply of resources available, from raw materials to the people they need to hire. This forces them to shell out more for the same goods and services, causing inflation. Rising prices and stiffer competition lead some businesses to struggle and fail, ringing alarm bells for investors who realize their expectations may have been too high. As they cut their losses by selling their investments, companies may undergo layoffs or freeze their hiring to remain profitable. This can compound quickly—as fewer people can work, there is less consumer demand, leading to even worse company performance and recession-level economic contractions.2

How long do recessions last?

Recessions have lasted an average of 11 months since 1945, but they can vary widely. The Great Recession of 2008-2009 latest 18 months, while the 2020 COVID-19 recession was just 2 months. Recessions occur on average about once every 5 years.3

Recession vs. depression

When talk of a recession starts, people almost inevitably become concerned we may be headed for another depression. Up until 1929, economists used "depression" to describe all prolonged periods of economic shrinking. But after the Great Depression's 43 months of economic decline, economists feared that using "depression" again would incite fear and panic and started using the milder term of "recession."4 These days, there is no clear definition of what would classify as a "depression," though it would likely have to be a severe recession lasting years.

Are we in a recession?

Due to the time-based requirement for recessions, it can be hard to know when you're in a recession, and as in the case of the COVID-19 recession, you may be out of it before you fully know you're in it. That's why experts often look to a few key indicators while they wait for the official verdict from the NBER.

Corporate earnings

Corporate earnings for public companies are released quarterly and give investors a look at companies' bottom lines. If companies are reporting losses and losing money, that could indicate economic decline.

And so far this year company earnings have been mostly positive. Corporate profits for the first quarter have exceeded or met expectations for nearly 79% of the S&P 500, and expectations for full-year 2022 earnings have moved slightly higher on average.5

Consumer spending

Consumer spending and saving estimates give us a peak at how everyday people are using their money. If people are spending less, that may point to a weakened economy.

Through the second quarter of 2022, consumer spending remained strong compared to last year, although rising prices have recently led to a slower growth rate in spending for lower-income consumers.6

Jobs

Jobs and unemployment are key indicators of a healthy economy. The higher the unemployment, the less productive an economy can be.

As of the second quarter of 2022, the job market remains healthy due to strong demand for goods and services. The labor market is on track to return to pre-pandemic levels within the year.7

Yield curve

The yield curve is a graph displaying the interest rates paid by bonds with different maturity dates. Because it visualizes the premiums offered for people to loan money for increasingly longer periods of time, yield curves are often viewed as a stand-in for bond investors' feelings about risk.

Normally, the interest rates bonds pay go up as the length of their term increases. That's because people generally don't want to lock up their money in a bond at a low rate now when they might be able to get a better rate later. That means bond issuers typically have to offer higher rates for longer terms to compensate investors for the risk they're taking by committing their money for years at a time.

The yield curve is said to "invert" when interest rates for longer-term bonds become lower than those for short-term bonds. This suggests investors feel uneasy about the short-term future and are rushing to lock in rates for longer terms, increasing demand and decreasing the premium issuers normally have to pay. In the past, this inverted yield curve, particularly of federally issued debts like US Treasuries, has been viewed as a recession indicator.

Since March 2022, the US Treasury yield curve has been flattening and inverting. While this could signal an economic contraction is coming, this has not always proven to be the case.

The bottom line on recessions

It's very difficult to predict when a recession will occur, how long it may last, or its financial impacts. But there are steps you can take now (or anytime) to prepare for a recession, like adding to your emergency savings so you have a financial cushion and maintaining a professional network in the event you experience a job loss. It's also a good idea to develop a long-term investment strategy that you can stick with even when the economy and markets get bumpy.

Next steps to consider



Get more Fidelity
Smart MoneySM


Subscribe to our weekly newsletter.



Trading guide


Learn what you need to know before trading the market.



Visit the Fidelity Learning Center


Get recent market insights, read in-depth articles or watch videos to learn more.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print
close
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
close

Your e-mail has been sent.

Subscribe to Fidelity Smart Money

Find out what the news means for your money, plus tips to help you spend, save, and invest better—delivered to your inbox every week.