What is a recession?

What is a recession?

Joseph Darby

& what does a recession mean for you?

A recession is a significant decline in general economic activity in a designated region, most often measured by country. It is usually recognised as two consecutive quarters of economic decline, as reflected by Gross Domestic Product (GDP). GDP is the total monetary or market value of all the finished goods and services produced within a specific area – such as a country or state – during a year.

Businesses, investors, and government officials track various economic indicators that can help predict or confirm the onset of recessions. Currently, all these indicators are “flashing red” – which means a recession both in NZ and globally is a near certainty. However, we don’t formally know that until after it’s already started, and sometimes has already finished!

What causes recessions?

Numerous economic theories attempt to explain why and how recessions occur. These theories can be broadly categorised as one or a combination of: real economic factors, financial reasons, or psychological factors.

Obviously, this recession has been caused by the rapid global spread of a virus, which has caused global economies to “lock down” and cease economic activity.

So what?

Be mindful that ultimately, economic activity pays for everything. This is either:

  1. Directly. For example, companies pay wages to employees who then spend on goods and services. Companies also pay for many goods and services themselves (such as commercial rent, machinery or equipment used by the business, insurance, the products they may sell, and services including computers and IT), or
  2. Indirectly. For example, taxes such as GST or income tax (PAYE) are paid to the government, who spend it.

What does all this mean practically?

A recession is short, typically nine to 18 months. But its impact can be long-lasting and it usually comes with very real effects. These can include:

  • Increased bankruptcies,
  • A drop in income for businesses, as sales drop off, businesses stop expanding. Soon afterward businesses will stop hiring new workers. Some people will be laid off (made “redundant”),
  • Lower employment rates – more people will be unemployed or only in part-time or casual work,
  • A drop in average personal income,
  • As employment rates and income levels fall, consumer purchases drop, which will lead to the failure of some businesses. With the lockdown, you may have noticed that in NZ this has already happened to a limited degree in areas such as the travel, tourism, and media sectors. Some businesses might not fail, but might permanently close (be “wound up”) or be purchased by a competitor as they become uneconomic,
  • Lower house prices,
  • Sadly, there is an increase in crime and mental health issues,
  • Politicians who control the government budget usually try to stimulate the economy as much as possible by spending more on social programs, lowering taxes, borrowing more, and ignoring the budget deficit (i.e. they spend more than they receive in taxes),
  • Reduced industrial and commercial production, and
  • Reduced sales of goods and services. Perhaps the hardest hit during this recession will be the NZ tourism sector, and regions of NZ most reliant on tourists.

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This sounds grim, what does it mean for me?

With many media predictions about economic doom, it is easy to get carried away by a wave of pessimism. While the information above may sound grim, there can be practical benefits of a recession, which might include:

  • People who have stable employment, including most government employees, can be in a sound financial position to make the most of the opportunities explained in the next few points,
  • House prices are likely to drop. This works well for first home buyers, and for long-term property investors who may be able to purchase more property at a discount then hold for a sustained period,
  • Lower interest rates encourage borrowing. This can be bad news for savers – such as retirees – though it can favour those repaying a mortgage or about to take on debt to buy a first home,
  • Companies who have entered the recession in a strong position – perhaps by having little or no debt and diverse sources of income – will come out stronger. This is a positive for the investors who invest in those companies and for the people employed by them,
  • New and innovative businesses will be founded and flourish. Many of these will eventually make our lives simpler and better. A 2009 Kauffman Foundation sponsored-study showed that over half of the largest US companies were founded during a recession or downturn, including Microsoft, Airbnb, Apple, Disney, and CNN. Many other successful global heavyweights were started just before a recession or other economic turmoil, including Google,
  • Specific to this recession, many NZ households have saved money during the period of lockdown. These personal funds could bolster an emergency fund, be invested for long-term personal goals, or serve another worthy purpose, and
  • People with sound skillsets may find themselves in an enviable position. For instance, someone who is highly skilled at sales or customer services may find that demand for them increases, as during the good times it was easy to perform such roles, but now, during a recession, businesses are desperate to keep existing customers happy as well as find new customers – so are willing to pay more to those skilful enough to achieve it. In fact, such skills could be critical to many businesses surviving (and even thriving) through the recession.

The bottom line - what is a recession?

A recession is an economic downturn, when the economy gets a little worse instead of steadily getting better.

Remember – every past recession has eventually come to an end, and so will this one!

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