What Happens In A Recession?

In the normal course of things, economies expand and contract in a fluctuating pattern known as the business cycle. When there’s growth in a country’s goods and services outputs, its gross domestic product (GDP), it’s a good sign of flourishing economic activity.

But unimpeded growth is unsustainable.

After the highs of any cycle, there will inevitably be lows. So, in some months, the GDP growth rate will be lower. And sometimes, output growth will be negative.

A prolonged decline in GDP raises fears of recession — a widespread economic downturn that lasts many months.

Because the impacts of a recession are broad, it’s important to understand what happens and how a recession could affect you.

What Is A Recession?

An economy is often described in the media as having entered a ‘technical recession’ when negative GDP growth continues for a period of six months, or two quarters.

Slowdowns and recessions are usually caused by external or financial shocks, or the monetary or fiscal policies a country applies. For instance:

Above: Australia has experienced a number of economic declines throughout its history.

If There’s No Official Definition, When Do We Worry?

Two quarters of negative growth is not the definition used by all governments and economists to evaluate economic health.

A ‘technical recession’ can be triggered without rising jobless rates or serious risk of a persistent slowdown.

For instance, Australia was widely considered to be in a ‘per capita recession’ for the last few years:

Essentially, growth in 2024 was the slowest its been since ‘91 — with the exception of the short, sharp decline at the start of the Covid pandemic.

But unemployment remained low throughout 2024, which doesn’t fit the narrative of a widespread downturn.

Above: Annual percent change in GDP since 1980 shows multiple fluctuations in the growth rate.

What Happens To The Economy During A Recession?

It’s understandable to worry about recessions because sluggish growth and more people out of work can lead to:

Mass layoffs, bankruptcies and business failures are especially damaging — people’s livelihoods are deeply affected and it hurts the economy’s capacity to regain momentum.

AMP’s chief economist Shane Oliver points out that Australia has avoided recessions since the 1990s by adopting smart measures.

These include:

Australian economist Michael Blythe said that because public spending can moderate the impact of a downturn, his preferred measure of the state of the business cycle is private spending.

He said a typical recession involves peak-to-trough falls in private spending of 1-4%.

“Outright falls in private spending clearly mark the five major recessions of the early 1960s, the mid 1970s, early 1980s, the early 1990s and 2020.” — Michael Blythe, economist

What Happened During The GFC?

The so-called ‘Great Recession’ that followed the GFC saw:

Australia fared much better. Our GDP growth didn’t decline for two quarters, but the unemployment rate rose from around 4% to 5.75% between early 2008 to mid 2009.

Analysis from the RBA shows there was a longer-than-usual lag between when the GFC downturn started and when unemployment started rising, reflecting tightness in the labour market.

Many employers looked to hold on to talent as they knew they’d be hard to replace.

What Happened During The COVID Pandemic?

The COVID pandemic that swept the globe starting in late 2019 resulted in a series of lockdowns that forced a pause in business activity in many countries.

Here’s what happened that year:

By October 2020, there were some signs of recovery and Q3 GDP results for 2020 revealed the Australian economy had grown by 3.3%.

The United States, the United Kingdom, Japan, Germany, France, Canada and Italy all saw negative growth in the first two quarters of 2020.

The need to re-start economies after the initial waves of the pandemic resulted in low interest rates and significant government stimulus being delivered.

Which led to more consumer spending, and saw recessions lift.

Above: The US economy expanded by 33.1% in the third quarter of 2020, the largest quarterly growth rate recorded in the US.

COVID was a uniquely disruptive event, rather than a part of the usual business cycle — and its effects are still being felt through persistent inflationary pressure.

The US economy saw two quarters of negative GDP growth when the pandemic emerged, but the US Bureau of Economic Research (NBER) found that America’s economy experienced a recession of just two months in 2020.

Capital Group U.S. economist Darrell Spence said the US’ 2020 downturn was described as a recession for lack of a better word.

Are There Upsides To A Recession?

There may be silver linings.

Contractions in the business cycle can be deflationary — businesses might lower prices or offer more special deals to try to bolster demand.

The Reserve Bank of Australia (RBA) is also more likely to cut the official cash rate to stimulate economic activity.

As banks lower their rates, it becomes cheaper to borrow which encourages investment and spending.

While you’d expect asset prices to fall in a recession, history tells us that property prices don’t necessarily crash.

House prices actually rose in many parts of Australia during the worst months of the early 90s recession, but they did fall during the GFC.

How Good Are We At Predicting Recessions?

It’s incredibly difficult to predict how the economy will behave.

Recession concerns increased in both the US and Australia in 2023-24, but both economies avoided a technical recession.

In December 2023 — when fears of a US recession were still very much alive — head of global aggregate bonds at J.P Morgan Asset Management, Myles Bradshaw said it was hard to foresee the timing of an economic cycle’s contraction.

Naturally, this doesn’t stop economists and others from speculating.

Most predictions are based on mathematic modelling and patterns from historical data.

They’ll look at things like: data about the labour market, retail sales, consumer spending and household income; consumer and business sentiment surveys; and the performance of housing and financial markets.

In addition, indicators commonly used to help predict recessions include:

Some less conventional ways that people take stock of the economy include:

Indicators aren’t perfect, simply a guide to how the business cycle is unfolding and whether a recession is more or less likely.

How Long Do Recessions Last And What Happens Afterwards?

Recessions vary in length and impact depending on their breadth and depth. If the recession is mild and short-lived, the economy may rebound quickly.

Looking at 122 recessions in 21 advanced economies in the period between 1960-2007, the International Monetary Fund found that they typically last about one year and result in a 2% decline in GDP.

While a recession ends when growth picks up again, that doesn’t mean an economy’s troubles disappear.

The World Economic Forum gives the example of the global Great Recession of 2008, where quantitative easing was initiated to pump trillions into world economies:

Can You Recession-Proof Yourself?

Avoiding financial risk and panicked decisions is wise during a recession.

You may seek to rebalance your portfolio to lower-risk assets like government bonds and gold, but speak with a financial adviser before you do so.

Markets are likely to rebound eventually, so inaction may be the right approach.

What poses a risk to you will depend on your current financial situation and how much risk you can handle without losing sleep.

Your vulnerability during a recession is largely tied to your income-generating potential. Consider how you’ll fare if you lose your job or your business revenue declines?

Another way to think about recession-proofing yourself is to invest in skills and innovation capacity — so that you’re positioned to pivot or capitalise on the most in-demand areas of the economy or job market, regardless of how it’s travelling.

Jody