What is a recession?


A recession is a sustained period of falling economic output and rising unemployment.

In technical terms, a recession is two consecutive quarters of negative economic growth, where gross domestic product (GDP) contracts. However, not everyone agrees with this definition. A short period of negative growth bookended by strong growth could be a mere stumbling block caused by one-off events and might not be classified a recession by many. Whereas a recession lasting years would earn the epithet ‘great’.   

Spotting when an economy is in on the precipice of a major recession versus when it is experiencing a bump in the road can be tricky. In the US in 2022, for example, GDP shrank, but wages and employment continued to grow. So, despite much talk of a recession, the National Bureau of Economic Research (NBER) did not declare a recession. This is because NBER factors in not just GDP, but also employment, income, sales and industrial production. Other economists use the three Ds – deep, durable and diffuse (across many areas of the economy) – to classify a recession. 

History of recessions 

The technical definition of a recession was popularised during the 1970s, but recessions have been with us a lot longer.  

Dr Jason Lennard, Assistant Professor, Department of Economic History at the London School of Economics has been studying cycles of growth and contraction (recession) in the UK from 1700 to 2010.   

He has found that the length of recessions has not changed much over time, but the growth phase has increased significantly. He notes: “In the 18th century this lasted about two years but has increased since World War II to about 14 years. Growth periods have become much longer over time and the gap between recessions has become much bigger.” 

Dr Lennard sees two reasons for this change: “Firstly, our economy is no longer heavily vulnerable to good and bad harvests which can be very volatile. Secondly, economic policy now plays a much more prominent role in stabilising the economy, with policymakers having the power to make a big difference.”  

Recent trends in recessions  

Many countries entered recession in the wake of the Covid-19 pandemic, which saw widespread business closures as a result of lockdowns and reduced trade. Policymakers in countries such as the UK and France attempted to lessen the economic impact through wage support schemes, which enabled businesses to retain and pay staff even while there was not enough work for them.  

While policymakers may try to avert or lessen recessions, central banks can sometimes create them. We have seen this dynamic play out recently in the UK, where the Bank of England has set high interest rates in an attempt to dampen inflation, with the knock-on effect of nudging the economy towards recession.  

A similar scenario is occurring in the US. Two of the big drivers of inflation have been the rising cost of energy as a result of the war in Ukraine and worker shortages.  

Advantages of recession 

Aside from putting the brakes on inflation, there are some other surprising advantages to a recession.  

It can make economies more efficient in the long term. Less resilient firms go out of business, allowing labour and capital to be diverted to innovative new companies. 

According to research by Morgan Stanley, nearly half of all Fortune 500 companies were started during an economic crisis or recession.  

For those companies resilient enough to see out a recession, the downturn can be an opportunity to reevaluate strategy, processes and technology. With business slower, it is less costly to shake up operations or stop production and retool in preparation for boom times.  

Certain sectors can also directly benefit from recession as people shift spending to less costly ‘luxury’ goods. Rather than buying designer clothes, for example, they might buy designer cosmetics, or rather than eating out, they might buy expensive beer. This is known as the ‘lipstick effect’.  

Sectors targeting low-cost spending, such as DIY shops, can also fare better. But there is no hard and fast rule as each recession has a different context.  

Disadvantages of recessions   

When a deep recession does darken our doorsteps, it leads to a drop in demand for products and services. The knock-on effect is layoffs and higher rates of unemployment. This compounds the recession as people who lose their jobs are forced to cut spending, further reducing demand for products and services. 

While companies can be quick to let staff go during a recession, it takes time for them rehire once the economy starts to recover. This means unemployment improves long after the official end of a recession.