Recessions strike fear, but what do they mean?
The mere mention of the word can cause serious jitters for Canadians who hold a job, invest in mutual funds or are thinking about making a large purchase.
And when one is about to hit, you hear the word "recession" mentioned a lot.
The Economist magazine has an index to gauge an economic downturn, by counting the number of times the word "recession" appears within stories in the New York Times and Washington Post.
The "R-word index" successfully pinpointed the start of U.S. recessions in 1981, 1990 and 2001, which followed big spikes in the use of the word. And don't look now, but a similar uptick was noted at the end of 2007.
Whether all the talk causes a recession or whether an impending recession fuels the talk is a matter of debate. But as the first few weeks of 2008 demonstrated, there's no escaping the doom and gloom in media headlines and analysts' forecasts.
That said, while the U.S. may be in a recession or headed into one, Canada did not appear to be following suit. Bank economists predicted in January 2008 that Canada would avoid a recession for the year.
But hold on: What exactly is a recession, and does it necessarily mean financial ruin? Let's take a closer look, with answers to some frequently asked questions.
What exactly is a recession?
The textbook definition of a recession is two consecutive quarters of negative economic growth, as measured in real gross domestic product (GDP). That explains some of the speculation -- a country could be in a recession, yet still not aware of it until the financial numbers are reported.
But this definition may not be as black and white as it seems. Labelling a recession is sometimes a matter of judgment.
The National Bureau of Economic Research, a leading U.S. economic think-tank, says there are other factors involved. Its definition involves "a significant decline in economic activity," which also takes into account the depth of the decline, monthly indicators and factors other than real GDP.
The average length of a postwar recession -- excluding a short downturn in 2001 -- is about 11 months, according to the NBER.
If a decline becomes more prolonged and severe, a recession can become a depression, much like the economic disaster of the 1930s, the Great Depression. When a recession crosses that line is, again, a matter of judgment.
There's a saying in economic circles, attributed to multiple sources: "It's a recession when your neighbour loses his job. It's a depression when you lose your own."
What causes a recession?
The precise trigger of an economic downturn often remains a puzzle. At times, a natural disaster like a drought has been blamed. Other times, it's been a rise in interest rates or a drop in consumer confidence. More likely, it's a mix of economic factors.
In reality, a recession is a natural, if desperately unwanted, part of the normal business cycle. To oversimplify: What goes up during a time of economic expansion must come down.
How do we know if we're in a recession?
Economists comb through data to see if the economy is actually stalling. Not surprisingly, considering the number of factors and statistics that comprise the big economic picture, their track record in this regard is somewhat spotty.
In fact, it can take up to 18 months to make a final determination of whether an economy is in an official recession.
How does a recession affect me?
There are several broad impacts to a recession, but the real financial pain varies from household to household.
Generally, though, consumers and investors are nervous in a time of recession, and employees have more woes about job security.
As the economy grinds to a halt, companies reduce outputs, which forces them to lay off workers. Those workers have less to spend on goods and services, and the rest of us read the news and delay making large purchases.
This takes even more activity out of the economy, causing a spiral effect as more companies tighten their belts.
Can a recession be avoided?
Governments and central banks have a number of tools at their disposal to help prevent a recession or minimize its effects.
First, there's fiscal policy. A government can introduce tax cuts or increase spending to shore up consumer confidence. This is why, in early January 2008, the Bush government in the U.S. introduced a $145 billion stimulus package to help jumpstart that country's economy.
Then, there's monetary policy. A central bank can lower interest rates, and commercial banks will follow suit. That creates more demand for goods and services, because the cost of borrowing becomes cheaper, and the money earned on an individual's savings drops.
What about inflation?
When the economy heats up, prices tend to rise. So you get inflation, which the central bank can try to cool off by raising interest rates and providing more incentive to save.
But inflation can occur when the economy is not quite so hot. During periods in the 1970s, there was something called stagflation -- the economy was performing poorly while prices were rising rapidly. So inflation can occur at the same time as a recession.
What does a U.S. recession mean for Canada?
Whenever the economy of Canada's largest trading partner takes a nosedive, it's never good news. However, it doesn't necessarily mean Canada will follow lockstep into a recession.
An example from the recent past: The U.S. went into an official recession in 2001, but Canada managed to avoid following suit, thanks to a series of aggressive interest rate cuts by the Bank of Canada.
The Schacter Team - Langley Real Estate