What is a Financial Recession?

A financial recession is an economic contraction that results in negative changes to economic conditions. This term is not universally defined and there is some argument about how to define a recession and how to differentiate between a recession and a depression. President Ronald Reagan once described the difference as, “A recession is when your neighbor loses his job. A depression is when you lose yours.”

The most simplistic definition of a financial recession is a decline in the gross domestic product (GDP) that persists over two quarters. Declines in production marked by drops in the GDP do indeed occur during recessions and a steady decline can be a sign that an economy is struggling. This rule of thumb is widely applied in the media, but it is not very popular with economists. People who study economics argue that recessions are complex and that this definition does not adequately incorporate other factors that may be involved.

Looking at unemployment can provide important information about whether a recession is ongoing. Unemployment tends to rise in a recession, and it stays high. Furthermore, the number of discouraged workers, people who are no longer looking for work because they think it is not available, also climbs. There also tends to be a rise in claims for government benefits as more people fall below the poverty level and need assistance with the costs of living.

Other financial changes can also be indicative of a financial recession. A tightening of credit markets usually means that there are concerns in the financial industry about economic health, and can precede a financial recession or occur simultaneously. Interest rate changes are also a warning sign. All of this information can be factored together to determine whether an economy is in recession, and to explore the depth of the recession if one is indeed occurring.

Currency devaluation can occur during a financial recession, exacerbating the problem. Nations may have difficulty finding trading partners and citizens may find that inflation makes their money less valuable. This in turn contributes to the development of further financial problems as people attempt to make limited funds go further.

Governments and economists are not just split on how to define a financial recession. They also debate the measures that can and should be taken to address recessions. Some favor intervention in the economy, while others prefer a hands-off approach that is designed to allow for self-correction.