Photo by: Derek Farr

If you’ve picked up a newspaper, turned on the radio or television, you’ve heard the R word: recession. But what does it mean and how does it affect the average person? Pete returns with what I hope is a bi-weekly blog entry. Today, it’s all about recession.

What is a recession?

A recession is when the gross domestic product of a country or region shrinks for two consecutive quarters. Since the idea of this is to put fancy economic terms into words normal people can understand, let me try that again…

The Gross Domestic Product (or GDP) of a country is the total value of all the goods and services produced within the country. If you add up the economic value of every single manufactured item and service sold (a ridiculously huge concept to think about) you get the country’s GDP. Canada’s GDP in 2006, for example, was $1.178 trillion — that’s the total value of every Tim Hortons coffee, dollar-store umbrella, sky-diving lesson and grocery bill sold during the whole year. In simple terms, if that number gets bigger, the economy is expanding. If that number gets smaller, the economy is contracting.

In finance, years are divided into quarters — periods of three months. So by a literal definition, a country is in recession when its economy shrinks for six consecutive months. Strictly speaking, that hasn’t happened yet in Canada or the U.S.A. But my hunch is we’re pretty damn close.
What do people think a recession is?

The term “recession” tends to get bandied about when people want to express that some aspect of the economy — average salaries, housing prices, unemployment, the stock market — seems to be getting worse. If your stock portfolio is tanking, your house value is plummeting, and you can’t find a job, you might assume that “we’re in a recession.” Technically, all of those things can be happening, but as long as GDP is still increasing, it’s not a recession. A country can be in a recession while real estate prices are rising and the stock market is booming — but that’s probably unlikely to happen for very long as these things are all interconnected.

How do we end up in a recession?

That’s a tricky one. The economy is a delicate balance between countless different factors. Any change in one typically has an impact on all the others. But it’s also true that no single factor is any more powerful than any other. As I said, a recession happens when the total value of goods in an economy starts to shrink. That can happen for a bunch of reasons — the country runs out of the natural resource on which their economy was based, businesses get scared of their prospects so they stop expanding their business and hiring new people, a large number of people lose their jobs (which means they have no money to buy stuff, which means companies stop making money because they’re not selling stuff, so GDP tanks) — anything, really.

Any aspect of the economy (in this case GDP) can be so irrationally dependent on the ones around it that if something big and bad enough impacts any one, that will reverberate into the others. It’s an unsatisfying answer, but there isn’t really any one reason why recessions happen. The important thing to realize is that they’re unavoidable, but they’re not the end of the world when they happen. They’re very cyclical, so recessions sometimes hit for no other real reason than the economy has been doing too well for too long, and it needs to slow down and take a breather.

How does it affect the everyday citizen?

Lots of ways. Probably the most direct one is the job market. If the economy is shrinking, there are less jobs to go around to the same (or larger) number of people. So it’s a lot harder to keep your job, or get a raise — or find one, if you haven’t got one. It’s a little more indirect, but recessions often have an impact on things like house values and the stock market. If people don’t have jobs, there’s less people out there willing and able to buy your house off of you — and they’re not willing to pay quite as much as they used to. So even if your job is rock solid, a recession would impact you that way. Similarly, in a situation where companies are seeing their profits shrinking, people are a lot less willing to own them as investments. Why would I pay to own a company that makes less money today than it did yesterday? And may make less tomorrow? Chances are, at the very least, I’ll only buy that stock off of you for a reduced price.

The economy is like a big pie. If it’s a recession and the pie’s getting smaller, it’s a lot harder to get the same size slice you’re used to getting, and hold on to it.

Related Posts: