It's important to know how to identify signs that indicate a recession so that you can take measures to prepare for it. There are a few key economic indicators that can help you determine when a recession might begin.
What is recession?
During arecession, there's a general decline in economic activity and a widespread drop in spending. Recessions can be triggered by a wide range of events – a natural disaster, a financial crisis, political unrest, and more.
An inflationary period can also trigger a recession. To reduce inflation, central banks tend to raise interest rates in the hopes of slowing the economy. This rise in interest rates increases the cost of borrowing which typically results in an increase to the price of products and services. You lose purchasing power when prices go up. As consumers and corporations spend less, businesses are forced to reallocate resources, thereby resulting in more layoffs and fewer jobs. This economic downturn further leads to recession.
How a recession can affect individuals
Recessions can be tough on individuals, especially those who are just entering the job market. Here are a few ways a recession can affect individuals:
- Job openings decrease and those who have just graduated may find it harder to get their first job.
- Those who are currently working may find it harder to get promoted or suddenly find themselves unemployed.
- Some individuals may make less money on account of their hours being reduced forcing them to tap into their savings.
- Inflation can cause the price of necessities to increase.
- The cost of financing debt increases.
- Cars and homes become less affordable.
The thing to remember is that the fallout of a recession is not the same for everyone and this can lead to an increase in inequality.
Top indicators of recession
If you're worried about the onset of a recession, here are some of the signs you should look out for.
- Volatility Index (VIX):
The VIX or Volatility Index can help investors measure the levels of fear, stress, and risk in the market. Introduced by the Chicago Board of Options Exchange (CBOE), the Volatility Index is based on the implied volatility of S&P 500 Index options. The VIX being high indicates a decline of S&P 500 prices.
Generally, VIX values that are greater than 30 signal heightened volatility in the market due to increased uncertainty, risk, and fear. On the other hand, VIX values that are below 20 indicate periods of lower stress and increased stability in the market. - GDP Contraction
GDP stands for gross domestic product. It’s a metric that measures a country’s economic output i.e., the market value of all final goods and services produced within the country. A GDP contraction or downturn often signals an economic downturn, and many times turn into a recession. Recessions then lead to declines in employment, economic output, and consumer demand. It is widely believed that two consecutive quarters of decline in GDP constitute a recession. - Low Industrial Output and sales
During a slump or downturn, companies often cut down their production and minimize exposure to risk. This has a ripple effect. As fewer goods are produced, fewer resources like raw materials and labor are needed. As output falls, sales and margins are affected, which eventually leads to a drop in hiring as well as an increase in layoffs. An example of an economic indicator is construction spending that measures the amount of monthly expenditure towards new construction. - Growing unemployment rate or Sahm Recession Indicator
The Sahm Recession Indicator signals the start of recession. It is based on real-time unemployment data which is published monthly by the Bureau of Labor Statistics. The BLS also collects data on nonfarm payrolls and updates the unemployment rate at the beginning of every year, once the December unemployment rate for the prior year is published. The Sahm Recession Indicator tracks the changes in unemployment rate. When the three-month moving average of the national unemployment rate (U3) increases by 0.50 percentage points or more relative to its low during the previous 12 months, it’s marked as the beginning of a recession. - Inverted Yield Curve
Historically, this has been one of the most accurate recession indicators. A yield curve is said to be inverted when long-term interest rates drop below short-term rates. This signifies that a number of investors are moving their money away from short-term bonds and into long-term ones. An inverted yield curve can suggest that the market is losing confidence in the economic prospects for the near future.
Signs that we are not in a recession
- Improving GDP
The true measure of the size and health of a country's economy is its GDP or gross domestic product. Essentially, it is the total value of goods and services produced by a country over a specific time period. An increasing GDP signals economic strength while a decreasing or negative GDP indicates economic weakness or decline. - Constant or increasing household spending
A major economic indicator is consumer confidence. This measures the level of optimism that consumers have regarding the economy as well their own financial situation. A number of economists believe that consumer spending is an important indicator of aggregate demand and economic performance. If households are confident about their finances, they spend more money. This allows companies to keep hiring and expanding in order to meet increased demand. In this manner, household spending can lead to economic growth. - An increase in corporate revenues and profits
Once a corporation has paid all its costs, any surplus is profit. This profit can be seen as a monetary reward to the owners and shareholders of a business. An increase in profitability will encourage business owners to expand, take risks and invest. When this happens on a large scale, it can lead to increased economic opportunities, new employment, and higher growth. - Strong labour market
The labour market is also known as the job market. It refers to the supply and demand of labour and is a major component of any economy. In a healthy economy, demand for products and services increases. In response to this demand, companies increase their output. They do this by hiring more workers. These newly hired workers then spend money in the economy which propels it forward.
Recession Indicators: Frequently Asked Questions
- Who decides if a recession has officially begun?
The entity responsible for declaring the existence of a recession is the National Bureau of Economic Research (NBER). This body studies various economic factors before arriving at a conclusion. - How can I minimize the effects of a recession?
There are various things you can do to minimize the effects of a recession. It's a good idea to have an emergency fund, strong credit, and multiple sources of income. Living within your means can also help you get through a turbulent time in the economy.
See Also
Yield Curve