What Is a Recession?

A recession is a period of diminishing economic activity that affects personal finance and the national and international markets. In the U.S., a group of economists evaluates the economy and declares a recession — they’re called the Business Cycle Dating Committee (BCDC), and they’re part of the National Bureau of Economic Research (NBER).

The BCDC monitors several types of economic data to identify when economic activity peaks and when it hits its lowest point. The period between these dates is labeled a recession, and might be referred to colloquially as a financial crisis.

According to economists, there have been 33 recessions in the United States between 1854 and 2018, and ten recessions since 1948. The most recent recession was between December 2007 and June 2009.

How Is a Recession Different from a Depression?

There is no standard definition of a depression, which can make it hard to distinguish from a recession. The easiest way to explain a depression? It’s worse than a recession.

The best-known depression is the Great Depression. According to the NBER, the Great Depression in the U.S. consisted of two severe economic downturns. The first lasted from August 1929 until March 1933, followed by an economic expansion from March 1933 to May 1937. But the economy slipped again from May 1937 until June 1938.

Here’s a comparison that might illustrate the difference between a recession and a depression: During the Great Depression, U.S. unemployment reached 25 percent. However, a downturn between 1973 and 1975 led to unemployment levels of just nine percent. That’s still incredibly stressful for United States workers, but not nearly as severe. Additionally, the U.S. real gross domestic product (GDP) fell by about 25 percent during the Great Depression. In the 1970s recession, the real GDP only dropped by 3.4 percent.

How Is a U.S. Recession Measured?

The BCDC monitors several indicators of the U.S. economy, such as real GDP, industrial production, manufacturing, wholesale-retail sales, real income, and the unemployment rate. Just because one of these factors might decline for several months in a row doesn’t mean we’re in a recession. The BCDC requires a consensus decline across all measures for several consecutive quarters.

Real GDP covers all goods and services produced by a country’s economy. It accounts for inflation by measuring only economic growth, not price increases. In this way, real GDP differs from nominal GDP, which includes rising prices.

The U.S. Bureau of Economic Analysis (USBEA) releases real GDP numbers every quarter. Because of this timing, a slowdown may have begun before the latest numbers show a significant decline in real GDP. This is one of the reasons the BCDC considers other economic data when it evaluates a recession.

The BCDC also assesses the real income of people in the U.S., adjusted for inflation. This number also excludes payments from programs like Social Security. A decline in real income can indicate a drop in consumer spending, which in turn affects the manufacturing supply chain.

Employment numbers provided by the Bureau of Labor Statistics help the BCDC measure economic activity. The BCDC also uses manufacturing and retail sales figures and the Federal Reserve System’s monthly industrial production data.
The BCDC does not consider stock market performance, however. Wall Street stock prices change based on investors’ expectations, not economic activity.

What Causes a Recession?

While there are a number of economic theories that attempt to explain recessions, there’s no one true answer. In reality, many factors throughout the global economy can trigger recessions. Economists have blamed recessions on shifts in industries, a drop in consumer and investor confidence, a combination of business errors, government or central bank mismanagement, and overexpansion of credit or financial risk.

For example, several factors caused the 2007 to 2009 recession, which is often called the "Great Recession." Consumers started purchasing fewer durable goods in October 2006, and the Federal Reserve didn’t raise interest rates in 2004 and 2005. Stagnant rates allowed home values to reach exuberant heights. Home prices then started falling in late 2006, depriving homeowners of equity. Banks lost money when home values plummeted, and investors who owned mortgage-backed securities panicked. All of this led to a significant downturn in the world economy. 

What Are the Impacts of a Recession?

Because each recession is different, the impacts of a recession can vary. A common outcome of a downturn is job loss — unemployment peaked at 10 percent during the 2007 to 2009 recession. Finding employment is also hard, especially for new college graduates.

High unemployment numbers mean less spending, which slows the economy further. Businesses like manufacturers, retail stores, and restaurants may suffer first. But if a recession lasts long enough, or is severe enough, other businesses could be negatively affected. For example, people may fall behind on their mortgage payments. Borrowers not paying their mortgages may cause banks to struggle.
Despite all the downside, there is one positive impact of a recession: It prevents inflation. Inflation is the steady increase in the average prices of goods and services. During a recession, prices typically stay the same or might even drop.

How Does a Recession Impact Real Estate Investing?

For real estate investors, recessions can be opportunities for investment. Clever investment can even help you get rich during the next recession. Here’s how: Home prices often drop during recessions. Cheaper real estate costs can mean higher profit margins for investors. This can be true in charging rent and rising property values, once the economy recovers. Plus, interest rates may be lower during a recession, making mortgages more affordable. Rate cuts, combined with lower prices, can help new investors enter a market that was previously too expensive.

But there are risks and challenges to investing in real estate during a recession. For one thing, banks may be more hesitant to lend money. Even if interest rates are low, investors may find it challenging to secure financing. And a recession’s length can affect an investor’s return, depending on their investment strategy. For example, it can take years following an economic downturn for property values to rise. Lack of home price appreciation can keep an investor from profiting by flipping a property.

It’s important to stay smart during a recession by avoiding the seductive temptress of the first upturn — when the first investors after a downturn cause a brief, unsustainable dip. 

Other variables, such as location and timing, can also determine the outcome of a real estate investment. For example, in Seattle, the median home price dropped as low as $308,000 following the 2007 to 2009 recession. By 2016, the median price increased 79 percent to $550,000, an increase of 79 percent. In Toledo, Ohio, home values over the same period rose two percent.

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Related terms
Note
Mortgage notes are a written promise to repay a specified sum of money plus interest at a specified rate and length of time to fulfill the promise.
Real Estate
Real estate refers to property containing land, buildings, or both.
Consumer Price Index
The Consumer Price Index indicates how much prices of consumer goods and services have increased over a set period of time.