According to the National Bureau of Economic Research (NBER) our most recent U.S. recession began in December 2007 and ended 18 months later in June 2009. There are no precise criteria for deciding when recessions begin and end. Instead, the NBER uses a variety of economic data to reach a consensus on the dates. The general idea is to look for turning points in economic activity. A peak, when economic activity begins a sustained fall is the beginning of a recession. A trough, when the economy stops shrinking and begins to expand again is the end. One commonly used rule of thumb is that a recession is at least two quarters of falling inflation-adjusted gross domestic product (GDP), while a recovery is two quarters of rising GDP.
Not all recessions and recoveries are equal, however. A downturn can be mild as the one from July 1990 to March 1991 was, when GDP fell by 1.3%. Or it can be severe like the most recent one where GDP fell by 5.1% from peak to trough. In addition, recoveries can be anemic or robust. For example GDP grew almost 14% in the two years following the 1981-82 recession, while it has only grown 5% in the two years since the end of the last recession.
What exactly causes a recession is a matter of intense debate amongst macroeconomists. It is likely that there are many causes.
Keynesian theories focus on the role that consumer confidence plays in recessions. When consumers begin to feel pessimistic about the future, they will save more and spend less. This leads to a decrease in demand for goods and services. If the prices of goods are slow to adjust, this will, in turn, lead to a surplus of production and firms will begin to lay off workers.
New classical economic theories point to the role of technology. When there is a drop in productivity, firms will be unable to produce as many goods as they could previously. The drop in worker productivity leads firms to lay off workers and leads to a recession. It also causes capital to be less productive and this leads to large drops in purchases of investment goods. New classical economists realize that technology rarely decreases, but they point out that energy price increases and increases in taxes are often identical in terms of their effects on firms.
Financial crises can also cause recession if they have a major impact on the banking sector. When banks are in financial trouble they are reluctant to lend to businesses, and many sectors of the economy rely on bank lending to cover up front costs. Residential construction and shipbuilding are two good examples. A loss of lending forces these firms to lay off workers since they cannot borrow the money to pay their wages.
Our most recent recession was caused primarily by the subprime mortgage financial crisis. The resulting drop in consumer confidence was likely an important contributing factor. The anemic recovery, however, is likely due to other causes. One facet of recent recoveries has been the slow rebound in employment. This is especially true of the past two years. A great deal of this is due to government policy. Increases in personal and corporate income taxes are very similar to drops in technology from the point of view of firms hiring workers. It makes no difference to the firm if revenue is lost because the firm is less efficient than before or because the government takes more in taxes. Expectations of increased taxes act as a powerful disincentive to businesses. Since most business operators dislike dealing with uncertainty concerning the future business environment, even uncertainty about whether taxes will go up or not, can act as a drag on the economy. The expectation of increased government regulation can also mimic a productivity drop. When particular methods of production are banned or made more costly, this forces firms to adopt different production techniques that are likely less efficient (else the firm would already be using them).
Are we headed toward another recession soon? It is difficult or impossible to say for certain. Unpredictable future events will have bigger effects than anything foreseeable right now. The unfolding sovereign debt crisis in Europe has the potential to stress the banking sector. But a banking meltdown is not a foregone conclusion. Increased taxes are a possibility, particularly with the increased attention the public and policymakers are placing on reigning in government deficits. However, budgets can be balanced by cutting spending rather as well, so it is entirely possible that tax rates will not be raised. The implementation of Obamacare has the potential to impose costly regulation on firms that would lead to a drop in productivity.
One thing that is certain is that there will be another recession sometime. It may begin this year or we may be lucky enough to go a decade or more without one. When making financial plans for the future it is always a good idea to remember that recessions are a recurring feature of the economy.
