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What a Recession Actually Is—And How to Know If the U.S Is Entering One

8 minute read

Concerns that the U.S. economy could be heading into a recession intensified after official figures released July 28 showed that the U.S. economy shrank for the second straight quarter, just days after the International Monetary Fund (IMF) forecast a global recession. Pierre-Olivier Gourinchas, the Economic Counsellor and the Director of Research of the IMF, cites the pandemic and ongoing war in Ukraine as the main reasons for the “increasingly gloomy and uncertain outlook,” of the global economy.

While a recession has traditionally been defined as two back-to-back quarters of declining gross domestic product (GDP), there has been some discussion about whether the current economy can be classified the same way due to some of the abnormal factors at play, including a robust labor market.

Treasury Secretary Janet Yellen indicated that the economy was only “in a period of transition” during a White House press briefing on July 24. “I would be amazed if they would declare this period to be a recession, even if it happens to have two quarters of negative growth.” Yellen said, adding that the economy had rapidly grown 5.5% last year. “We have a very strong labor market. When you are creating almost 400,000 jobs a month, that is not a recession.”

The conversation about what makes a recession has also sparked controversy on Twitter.

Here’s what you need to know about the state of the economy.

What is a recession?

Many experts—including former Federal Reserve economist Claudia Sahm, who spoke to TIME—agree that, although the technical definition of a recession is two consecutive quarters of declining GDP, a measure of economic growth, that is not enough to make the call. The United States’ National Bureau of Economic Research (NBER), a nonprofit organization whose business cycle committee tracks peak and trough months of economic growth, instead defines a recession as a widespread contraction in the economy that lasts more than a few months, with each of the three criteria—depth, diffusion, and duration—being met to some degree.

Read More: Why a Recession Isn’t Inevitable

“It’s a national event,” Sahm said. “Consumers spend less, people lose their jobs, businesses cut back on investment, industrial production slows down. There are many different signs but there’s no one indicator.” During the second quarter of 2022, growth slowed at a 0.9% annualized rate, which some economists would consider to be the start of the recession. But the NBER’s Business Cycle Dating Committee, “has never accepted the two-quarters idea” as the official definition, Charles Radin, the NBER Director of Public Information, wrote in an email to TIME.

The U.S. differs from other countries when tracking the economy, which can make it difficult to make like-for-like comparisons. “There are a lot of countries that don’t have a dating committee so that’s a definition and rule of thumb used in a lot of the world,” Sahm noted. The U.S. last experienced a recession at the height of COVID-19 from March to April 2020, according to Reuters. Though this recession only officially lasted two months, the NBER found that most recessions after World War II averaged “just over 10 months.”

The NBER notes the country had not returned to normal by May 2020, but the swift growth experienced after the brief period of significant decline led the committee to mark that short period as a recession. That is not to say the nation did not continue to experience hardships. Nearly 22 million jobs disappeared during the last short recession, and in July 2020 there were still 16.9 million people unemployed, according to the United States Department of Labor. These high unemployment rates are exactly what we should try to avoid, according to Sahm. “What makes a recession bad is people lose jobs, they suffer and there are long-term consequences. We’re not there right now but there is no guarantee we won’t get there,” Sahm said.

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What causes a recession?

Previous recessions were caused by market-related shocks to the economy, such as the financial crisis in 2008, which was spurred by inadequate lending standards and a housing crisis, or the dotcom crash in the early 2000s that followed overzealous investment in technology stocks. The Federal Reserve, the central bank that oversees America’s monetary policy, works to prevent recessions through its policy decisions. In recent months it has increased interest rates to combat inflation.

Monetary policymaking requires a fine balance. More than two-thirds of the recessions Americans have experienced since World War II were caused by an increase in interest rates that was too fast for the economy to handle, according to NPR. The Federal Reserve increased interest rates by three-quarters of a percentage point in June and again on July 27, though it will take several months before the effects of these changes are seen. And COVID-19 has had an enormous impact on the economy. “It was one of the engines of inflation,” James W. Hughes, Dean Emeritus at the School of Planning and Public Policy at Rutgers, told TIME. “The pandemic caused the economy to be shut down. Livelihoods were sacrificed in order to save lives and so that took away a lot of production in the United States, China, and around the world.” Inflation is currently at a 40-year high, reaching 9.1% in June, according to the U.S. Bureau of Labor Statistics. This strongly affects consumers, as the last few months have seen gas prices that reached $5 per gallon in June, though they have since fallen to $4.30, according to AAA.

Inflation is harmful because it “reduces your salary or income, because your income isn’t increasing as much as inflation” according to Hughes. “It erodes your purchasing power, your savings, and the value of your house.” And though the pandemic is nowhere near its end, consumers’ increased spending in the months following the brunt of COVID-19 meant that suppliers initially struggled to catch up to buyers.

Read more: The Surprising Thing That Could Help Ease Inflation

Retailers like Target and Walmart have since struggled to predict the right amount and type of goods consumers need, creating a surplus of inventory people don’t want to buy. These large-scale mistakes contribute to the declining growth that could push the U.S. to a recession.

Are we currently in a recession?

While economists agree that we are not currently in a recession, the outlook is not rosy. A survey of 49 U.S. macroeconomists conducted by the Financial Times and the Initiative on Global Markets found that more than two-thirds believe a recession will hit in 2023. Experts generally agree that it is difficult to predict if, when and how long a recession will last, with so many conflicting factors at play in the economy.

Sahm believes that there’s even a possibility we could avoid a recession because of the strong labor market. Unemployment rates in June remained at a low of 3.6%, the same percentage it had been in the previous three months. And U.S. job openings also remain high, with nearly 1.9 jobs available for every unemployed person in May, Bloomberg reports. Facebook’s owner Meta—one of the largest publicly traded companies in the U.S.—and Twitter, are among companies that have announced hiring freezes that may seem concerning, but Sahm said that this is not entirely bad news. Removing job postings aren’t ideal, but “that means instead of someone losing their job there’s a job posting that goes away. And that is so much better than someone losing their job.” And though companies like Netflix have announced layoffs, this could generally be attributed to large sectoral hits post-pandemic. “There were industries and parts of the economy that even though the rest of everything was contracting, they were growing,” Sahm said. “We are largely coming out of [COVID-19] and so that means companies that banked on this being a permanent change, are finding out, well, not so much.”

Read More: What a Bear Market Means for Consumers, Investors and the U.S. Economy

How should we prepare?

While the fear of an upcoming recession looms over many Americans, there is still time to adjust. “It’s extremely unusual and frankly bizarre that we have forecast this recession,” Sahm said, “but it could also be for families to prepare like they never had.” Economic experts suggest people set some money aside if possible. Savings will give them a cushion they may rely on down the line and decreasing their spending could also help to reduce inflation.

Read More: The Economy is Great. The Middle Class is Mad

And though both Sahm and Hughes predict low wage workers, and particularly workers of color, will be disproportionately impacted by a recession, neither economist believes an economic downturn will happen until at least next year. “People shouldn’t panic,” said Sahm. “This is not a done deal and recessions are always bad, but this has all the makings, if it happens to be a mild recession.”

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