Recession is an economic slowdown that usually involves falling sales and sluggish production. It’s not always possible to predict when a recession will hit or how long it might last, but there are steps people can take to prepare, such as adding to their emergency savings and creating a budget to track their cash flow.
Recessions are usually caused by a combination of financial, psychological, and fundamental economic factors. The most straightforward explanation is that when consumer demand drops, businesses respond by cutting back on spending and laying off workers to save money. This reduces people’s purchasing power and, if it continues for too long, can trigger a negative feedback loop that further lowers consumption and leads to more layoffs and more cutting back on spending.
A number of governments have established fiscal and monetary policies intended to prevent recessions, like cutting taxes or interest rates to encourage investment. In addition, some economists believe that a bubble burst can also contribute to a recession, such as the housing market collapse of 2007.
While there is no one-size-fits-all definition for a recession, several indicators tend to cluster together when a downturn is underway or imminent. For example, economist Claudia Sahm’s “Sahm Rule” states that a recession is likely to occur when the unemployment rate rises more than 0.5 percentage points above its average during the previous 12 months. This is typically a clearer warning sign than just watching GDP or even the stock market, and it often happens well before the National Bureau of Economic Research (NBER) officially declares a recession.