What Is A Recession?

Just what is a recession? And can we predict what's going to happen in the UK by looking at recessions around the world? Serena Cowdy finds out.

This article has already been sent to Fools as part of our 'Cracking The Credit Crunch' email series. In this article I'm going to look at what a recession actually is - and how long one usually lasts. I'll also examine two of the nastiest recessions in living memory - and outline their main causes. What is a recession? Economists usually define a recession as two consecutive quarters (three-month financial periods in a year) in which the gross domestic product (GDP) of a country decreases. In simple terms, this means six months of declining business activity. It's very often accompanied by decreased demand in most markets, and increased unemployment. As an old economist joke goes: "what's the difference between a recession and a depression? A recession is when your neighbour loses their job; a depression is when you lose yours." How long does one normally last? This is the good news. The evidence suggests that periods of recession rarely last longer than about three years and are normally shorter. The stock market is a good (though by no means perfect) indicator of wider economic conditions. Stock market falls tend to signal that either a slowdown is approaching, or we're in one already. Conversely, a rising stock market generally implies that either an economy is buoyant, or that the end of a recession is approaching. And since WWI, the UK stock market has never fallen for more than four years in a row.* What's more, research suggests that since 1950 in the US, typical recessions have lasted just ten months. However, as we'll see, there are exceptions to every rule... One of the worst - The Great Depression The worst economic depression in US history started in 1929 and lasted for much of the 30s. The effects of the slump were not only catastrophic in the States, but reverberated around the world. The reasons behind it - and the exact relationship between events - are still controversial. However, experts agree that the slump was caused by a disastrous combination of domestic and global conditions. These include the stock market crash of 1929 (now widely seen to be the trigger, rather than the underlying cause); widespread bank failures, a massive reduction in consumer purchasing, the disruption of international trade, poor Government policy and severe drought conditions. The slump ravaged the US population - particularly the poorer in society - as hunger and poverty became widespread. Unemployment also rocketed to record levels. By 1933 the US unemployment rate had hit 25%. Many consumers who'd taken advantage of easy credit during the 1920s found they were unable to make their monthly payments (sound familiar?) and repossessions of houses, cars and household goods became common. And many wealthy individuals, with stock market investments, found their huge fortunes wiped out overnight by the 1929 crash. One of the longest - Japan in the last 20 years In recent years, Japan has suffered an extremely long period of recession - or more accurately, a series of crippling recessions one after the other. During a period of low inflation, low unemployment and huge corporate profits in the 1980s, the Japanese economic 'bubble' had expanded as excessive funds poured into the stock and real estate markets. The problems started when this bubble burst at the beginning of 1990. Share prices plummeted, huge amounts of 'bad debt' were created, and several large banks began to fail. In 1998 and 1999, the Government stuffed public money into the banking sector to stabilise the financial system (ring any bells?). And foundering companies were forced to cut jobs - as well as investment in plants and equipment. In 1999, the country's economy started to make a stuttering recovery, only to be knocked back when the dot.com bubble burst in 2000. And the deterioration in the world economy in 2001 (following the 9/11 terror attacks) made matters even worse. At the time of writing, Japan's economy does appear to (slowly) recovering. Unfortunately, many Japanese are yet to see the effect of this on their reduced salaries and poor employment prospects. So what about us? Well, no one can ever be certain about any economic forecasts. Economists with Phds from Harvard or Cambridge get these things wrong. Frequently! But even if we are hit by recession in the coming months, I suspect it probably won't be as severe, or as lengthy, as the two I've described. Both recessions were very unusual. What's more, politicians and central bankers should hopefully have learned the lessons from those events. Still, the parallels are there for all to see. Consumer spending is beginning to slow, the end of cheap credit is hitting many people hard, and the Government has already stepped in to stabilise the banking sector. I can't help worrying a bit... Are you looking to start a rainy day fund? Visit The Fool's Savings Centre to find the best deal for you. For more on the credit crunch, read Stearns Goes Pear Shaped... Who's Next?* Based on research by Barclays Equity Gilt Study 2008