Note: This is the latest entry in the Acton blog series, “What Christians Should Know About Economics.” For other entries in the series see this post.
What it means: The economy shifts from periods of increasing economic activity, known as economic expansions, to periods of decreasing economic activity, known as recessions. This is known as the business cycle and includes four phases: expansion, peak, contraction, and trough. An expansion is a period between a trough and a peak, and a recession is a period between a peak and a trough.
The Explanation: What is a recession? If you ask the average American to define “recession” they’ll likely say it’s when the economy is in “bad shape” (and their opinion about what shape the economy is in will depend on who is president). Ask a reader of the financial press and they’ll likely give a more specific definition, saying that a recession is two consecutive quarters of decline in real GDP.
Neither of those definitions is entirely accurate. The organization credited with identifying business cycles in the United States is the Business Cycle Dating Committee at the National Bureau of Economic Research (NBER), an independent, nonprofit, research group. The NBER defines a recession more broadly as a period where there is a significant decline in economic activity that spreads across the economy.
What happens during a recession?
Periods of economic decline often produce a range of negative effects. For example, when investment in business slows, fewer people are hired and unemployment increases. Entrepreneurs have a harder time raising money and fewer small businesses open. People become worried about the future which leads them to spend less, thus driving down demand for goods and services (such as automobiles). The lack of demand in housing can cause a drop in home prices, which reduces economic mobility.
Even if the recession is short, the effects on individual opportunities and finances can last decades—or even a lifetime.
What causes recessions?
Many economists believe that recessions are not inevitable. Empirical evidence from the past 70 years shows that recessions do not become more likely simply because there has been a long period of expansion. As Federal Reserve Chair Janet Yellen has said, “I think it’s a myth that expansions die of old age.”
But expansions are like people in that the longer they survive the more they are likely to be affected by negative events. Some examples of events that can cause a recession are:
Overheating – An overheated economy is one in which demand outstrips supply, expanding past full employment and the maximum capacity of the nation’s resources.
Asset Bubbles – An asset bubble is when the price of an asset, such as housing or stocks, become bid up beyond a sustainable value. Less savvy investors tend to buy assets when they see rising prices and assume they will continue indefinitely. When the price drops it can wipe out people’s wealth. Two recessions this century are attributable in large part to asset bubbles. The “dot-com” bubble is often credited with an early 2000s recession and the housing bubble with the recession that began in 2007.
Economic Shocks – An economic “shock” is an unexpected, external event that can disrupt the economy. A prime example is oil shocks, when the price of oil spikes because of events like the Suez Crisis of 1956-57, the OPEC oil embargo of 1973-1974, or the Iranian revolution of 1978-1979. The disruption of a widely-used resource can have a ripple effect that leads to weakened economic activity across a nation.
Government Policy – Interference in the markets or in the money supply is often to blame for the downturns in the economy.
Why it Matters: Even if recessions are not inevitable, they occur with enough frequency that Christians should be prepared for them.
On a personal level we should ensure that we are not living beyond our means or putting too much of our wealth into a single asset (i.e., our housing). We should also make contingency plans for an unexpected downturn. For example, we might consider how a recession in the next year affect our choices of education for ourselves or our children.
We should also remember, as pastor-theologian John Piper notes, that God can use recessions for our growth. One way is that it can be a tool to expose hidden sin and so bring us to repentance and cleansing. Another way is that it provides opportunities for the church to care for its hurting members and to grow in the gift of love.
Other Stuff You Might Want to Know:
• The NBER has identified 32 U.S. recessions since the mid-1850s.
• On average, recession tend to last about 10 to 18 months. From 1854 to 1919, the average recession lasted 22 months. From 1919 to 1945, recessions lasted an average 18 months. From 1945 to 2001, recessions lasted an average 10 months. The Great Recession (2007-2009) lasted only 18 months, which is less than half the length of the Great Depression (43 months).
• While there is no standard definition for a depression, it is commonly defined as a more severe version of a recession.