What is a Recession?
Headlines are somewhere between slyly hinting and overtly proclaiming that a recession might be coming. Unfortunately, we probably won’t know if it is here or if is to be a mild and short lived recession or a significant downturn until after it is all over.
Let’s explore what a recession is, their history, and what is likely to happen if one materializes in 2023.
What is a Recession?
A recession is a period of economic decline characterized by a significant decrease in economic activity across an entire country or region. In a recession, there is a decline in gross domestic product (GDP), income, employment, and trade, leading to an overall slowdown in economic growth.
Recessions are typically marked by a decrease in consumer spending, a decrease in business investment, a decrease in job creation, and an increase in unemployment rates.
While recessions can be devastating to many households, mild recessions aren’t always noticeable by the general public. In fact, you might not even know that we have had a recession until after it is over.
Economists typically don’t even agree about when or if we are in a recession until after we are in recovery. They look at economic activity and indicators and analyze trends from recent history to identify a combination of factors that suggest recession.
Recessions can have a significant impact on individuals, businesses, and governments, and can result in prolonged economic hardships if not addressed effectively.
However, it is important to note that the recessionary experiences of regular people can be vastly different from others. How well you weather a recession may depend on your individual circumstances. Some people may experience job loss and other hardships while others will barely notice anything is wrong.
Governments often take measures to stimulate economic growth during a recession, such as increasing government spending, lowering interest rates, and implementing other monetary and fiscal policies.
The economy is in a somewhat odd state of affairs with strength and good news in some areas and signs of weakness and bad news in others.
The following are some of the general indicators that an economist might use to determine if we are experiencing a recession.
Consumer spending tends to decrease during a recession as people have less disposable income.
There are signs that after two years of strong spending, consumers may be slowing their expenditures.
Yield curve refers to a line that is plotted on a graph to show the interest rates paid on bonds over a period of time.
- A normal yield curve would show rates increasing over time with short term rates being lower than long term rates.
- A flat yield curve shows rates being the same over time.
- And, an inverted yield curve shows that rates are higher now than they will be in the future.
An inverted yield curve can occur when investors lose confidence in the economy’s future and start to demand higher returns for short-term investments. The resulting decrease in demand for long-term bonds leads to lower long-term interest rates and an inverted yield curve.
An inverted yield curve is seen as a sign that investors are expecting a slowdown or recession in the economy in the near future. This can lead to decreased lending and investment activity as businesses and individuals become more cautious about taking on debt or investing in new projects.
We are currently seeing an inverted yield curve.
GDP measures the value of all goods and services produced within a country’s borders. A recession is typically characterized by two consecutive quarters of negative GDP growth.
The last three quarters have shown growth in U.S. GDP.
High levels of unemployment, particularly sustained over a long period, are a sign of a recession. There are many different measures of unemployment, but coming out of the recession, we have seen record employment.
Even the most recent numbers show low unemployment.
During a recession, businesses may cut back on spending, including investment in new projects or expansion.
There are many different indicators used to analyze business investment trends. And, the truth of where business investment stands is hard to measure.
Housing starts data are reported monthly by government agencies such as the U.S. Census Bureau and are closely watched by economists, real estate professionals, and investors. An increase in housing starts typically indicates that builders are optimistic about the demand for new homes and are willing to invest in new construction. Conversely, a decline in housing starts may suggest a lack of confidence in the housing market and a slowing of economic growth.
Housing starts were up in February, 2023.
Consumer confidence refers to the level of optimism that consumers have about the overall state of the economy and their personal financial situation. It is a measure of how willing consumers are to spend money and make big purchases, such as buying a home or a car.
If consumers lack confidence in the economy, they are less likely to spend money, which can exacerbate a recession.
The most recent measure of consumer confidence, taken after the Silicon Valley bank run, was up. This came as a surprise to many economists.
Preparing for a recession involves effective management of your financial plan, which always involves taking steps to protect yourself and make sure that you have a solid financial foundation that can withstand economic challenges.
Here are some ways to prepare for a recession or any negative economic impact:
With any bad economic news it is really important that you don’t panic. Emotions can trigger bad decision making and turn your financial situation worse. And, if everyone is worried about the economy, those concerns can often become a self fulfilling prophecy.
The economy is fluid, things will change, and it will always always always get better.
It is always important to maintain an emergency fund. An emergency fund should be liquid assets that are held in a cash or otherwise safe or very conservatively invested vehicle. Most people who are still working will want an emergency fund that could cover 4-6 months of expenses. After retirement, you may want to increase your fund or reallocate your money so that you are not at risk of having to sell investments at a loss to cover a longer economic downturn. An emergency fund can help you weather any financial storm that may come your way.
In hard times, it can be tempting to take on debt. However, high interest debt is not your friend and it is almost always a good idea to pay it off as quickly as possible. The less debt you have, the better positioned you’ll be to handle a recession.
While high interest debt should be avoided, home equity loans and lines of credit can be flexible funding options to consider during times of trouble. Learn more about the pros and cons of securing a home equity loan before retirement.
Job loss is a concern in a recession. As such, it can be a good idea to consider the stability of your job if you are still working and to even look at adding a side hustle or diversifying your income streams so that you have multiple sources of income.
If you are already retired and are worried about withdrawing from savings or making ends meet, consider adding a job. A little bit of income can go a long way and it is possible to find a job you might love.
Diversifying work or income retirement income can help you weather a recession.
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You probably have two kinds of expenses: fixed and variable. Fixed expenses are those that you have to spend on every month no matter what. Variable expenses are things you don’t really need. When times are tough, it is good to cut back on non-essential spending. This can include eating out less, curtailing trips to the mall, staycations, and finding ways to save on your bills.
The economy is going to up and down. And, the good news is that it will mostly go up over the long term. If you can stay focused on a viable long term plan for your money, then you will know that you can weather short term peaks and valleys in stocks, inflation, income, anything.
We designed the NewRetirement Financial Planner to help you focus on the long term. Keep your eye on future net worth which is going to fluctuate far less than today’s bank account.
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