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What is a recession and what does it mean for me?

The continued impact of COVID-19 has played a significant role in the uncertainty of the economy. While recessions are a common part of economic cycles, understanding their effect and taking steps to plan ahead can help ensure that you and your family will be prepared when the next one occurs.

What is a recession?

The U.S. Bureau of Economic Analysis defines a recession as "a marked slippage in economic activity." You can think of it as a downturn or contraction, or the opposite of an expansion.

Whatever you call it, a recession can impact your finances. Economic expansions create opportunities: new businesses, more jobs, and higher wages. Recessions eliminate opportunities: failed businesses, fewer jobs, and lower wages.

Recessions normally don't happen every year, but they're not unusual. The National Bureau of Economic Research has tracked recessions in the U.S. all the way back to 1857. The most recent recession occurred over 10 years ago, from December 2007 to June 2009. Since 1945, there have been 11 recessions, which lasted 11.1 months, on average. The shortest was six months, the longest 18 months.

The prospect of a recession, which may—or may not—occur in 2020, is no reason to panic. Since downturns happen cyclically, each presents an opportunity to learn and prepare for the next. Smart planning can help you and your family get ready for the next recession, whether it occurs in 2020 or further into the future.

Why do recessions happen?

Recessions occur because the U.S. economy is cyclical. Economic activity expands until it reaches a peak of performance. The expansion then falters until it bottoms out in a recession. Then activity begins to expand again. What goes up must come down.

A May 2019 Federal Reserve research note observed that "recessions are notoriously difficult to predict." Economists use charts (and more charts and more charts) to identify patterns in economic cycles that may explain why recessions occur, why some are more severe than others, and when the next one might happen.

Certain economic indicators are of particular interest because they tend to occur just before changes in the economy. For example, this chart from the Federal Reserve Bank of St. Louis shows economic recessions and the four-week moving average of weekly initial unemployment claims, a leading indicator, from 1967 to the present.

The Federal Reserve plays a special role in moderating economic cycles. By adjusting the federal funds rate and taking other actions that affect the economy, the Fed can try to soften a downturn so that it might not be as severe as it would have been without the Fed's involvement.

What happens during a recession?

Recessions can have a wide range of effects on individuals and families.

  • Job losses.  When economic activity slows, businesses eliminate jobs(see pg. 7 of the report) and curtail their expenditures for advertising, training, product research, and other operations. Payrolls shrink as companies eliminate jobs to lower their costs. Continuing your education, networking with your professional peers, and staying up-to-date on trends in your industry could help you if you need to change jobs during a recession.
  • Health consequences. The most recent recession in 2007-2009 had multiple consequences for workers who lost their jobs, according to the Social Security Administration. Job losses impacted not only workers' employment and earnings, but also their health insurance coverage, retirement savings contributions, financial security, and health-related behaviors and outcomes. Workers who lost their job were more likely to receive government "safety net" assistance, like disability insurance and supplemental security income benefits, even after the recession ended.
  • Student loans. Recessions can have long-lasting effects for younger adults, who may experience unusual difficulty finding or keeping a job during a downturn, says the U.S. Bureau of Labor Statistics (BLS). Moreover, "any delay in employment can reduce asset accumulation over their lifetimes," the BLS said in a June 2019 report. Higher levels of student loan debt can compound these recession-related challenges for younger adults. Paying down student debt now can give you more financial flexibility if you're unemployed or need to accept a lower-paying job during a recession.
  • Opportunities. Recessions don't affect everyone the same way. For instance, some businesses are said to be " recession-proof which means they tend not to suffer as much during a downturn. Examples include disaster cleanup services, car repair shops, hair salons, and other goods and services that people need regardless of the economy's ups and downs.

How you can prepare for a recession

  1. Boost your savings. If you lost your job tomorrow, would you have enough savings to pay your bills for one month, two months, six months or maybe even a year until you found another job? If you don't have at least six months of expenses in your savings account, start building up your savings today. The more you save, the less chance there will be that you'll have to max out your credit cards, raid your retirement accounts, sell your valuables, borrow from your friends, or move in with your parents or adult children if you're out of work.

  2. Pay off debt. Paying off debt lowers your monthly interest expense and frees up income for other needs. It doesn't mean you should avoid all debt forever, but rather, that you should focus on debt that improves your financial situation. In times of uncertainty, you shouldn't borrow more than you could afford to repay on a reduced income. Refinancing to a low-rate mortgage may make sense, and stay away from maxing out high-rate credit cards (which never makes financial sense).

  3. Prioritize purchases. Start by thinking about what about you need vs. what you want. Like that expensive vacation, a new car, or eating out at restaurants. (Even that daily latte can add up over the month). Review your budget and decide which items you can either eliminate or put on hold. This could save your thousands of dollars per year.  Learning to get by with less is the key to recession-proof living.

  4. Recession-proof your career. If your job doesn't feel secure for the long run, consider updating your resume, learning more marketable skills, networking with friends and colleagues, and trying to get a promotion or more secure job lined up. A second job or side hustle in the gig economy can also help you survive financially if you lose your job or your employer reduces your wages or hours during a recession.

Recessions can be financially painful, but given the historical pattern, it's likely that you'll experience a few of them during your lifetime. Planning ahead can help you survive and support your family, whenever the next one occurs.

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