Takeaways
- A recession is marked by months of contracting business and economic activity.
- Recessions can increase reliance on credit cards, increasing consumer debt.
- Recessions can span months, quarters, or years until economic activity increases.
- Economic shocks, such as tariffs or supply chain issues, can trigger recessions.
- The Federal Reserve uses monetary and fiscal policy to try and ease recessions.
What Is a Recession?
A recession is a significant decline in economic activity that lasts for an extended period. One classic definition that helps economics and financial media understand periods of recessions is when a country's gross domestic product (GDP) falls for two consecutive quarters. However, there are other definitions, such as the National Bureau of Economic Research, which defines a recession as a significant decline in economic activity lasting for more than a few months.[1]
During a recession, businesses may see reduced sales, companies might slow hiring or lay off workers, and consumers tend to spend less due to uncertainty about the future.
Recessions are a natural part of the economic cycle, marked by a period of economic contraction and often following periods of growth. While they can be unsettling, they correct imbalances in the economy and lead to stronger long-term stability when recovery begins. The Federal Reserve uses monetary policy to control economic cycles like recessions.
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How a Recession Works
Regular business cycles consist of periods of economic expansion and contraction. These bull and bear markets are part of a healthy economic cycle. During a recession, many areas of the economy are affected simultaneously. When economic output begins to decline or slow, it usually triggers a chain reaction.
For example, businesses may cut costs by reducing their workforce as they earn less revenue. As unemployment rises, consumer spending decreases because fewer people have a steady income. This reduction in spending can cause other businesses to lose revenue, creating a ripple effect across industry sectors.
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How a Recession Works
Several economic indicators suggest a recession may be approaching or is already underway. Some of the most common signs include:
- Gross Domestic Product (GDP) Decline: The most widely accepted measure of a recession is a consistent drop in GDP, typically for at least two consecutive quarters.
- Rising Unemployment: A sharp increase in unemployment rates is a key warning sign, showing that businesses are struggling and reducing their workforce. (Check out our guide to get a new job).
- Decrease in Consumer Spending: When people spend less on goods and services, it signals a lack of confidence in the economy. During downturns, increasing consumer debt levels can occur as consumers rely on debt to fund their lifestyles.
- Falling Retail Sales: A slowdown in retail activity is a strong indicator of weakened consumer demand. Slower demand leads to slower growth and rising unemployment.
Economists and policymakers monitor these indicators closely to anticipate downturns and take corrective action when needed.
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What Causes Recessions?
A variety of economic factors can cause recessions, and in many cases, multiple elements combine or compound to catalyze a cyclical downturn. Some of the most common causes include:
- High Inflation: When prices rise too quickly, consumers lose purchasing power, leading to decreased overall spending. (Read about 26 Smart Ways to Beat Inflation).
- High Interest Rates: To combat inflation, central banks may raise interest rates, which makes borrowing more expensive and slows down economic activity. (Read more about the Federal Funds Rate).
- Financial Crises: Banking collapses, credit crunches, or stock market crashes can quickly erode confidence and freeze lending, leading to economic contraction.
- Geopolitical Events: Wars, natural disasters, and global pandemics can disrupt supply chains, reduce productivity, and strain national economies.
- Overleveraging: When businesses and consumers take on too much debt, any sudden economic shift can make it difficult to repay loans, leading to widespread defaults and financial instability. (Read more about how you pay off debt).
5 Ways to Prepare for a Recession
You probably won't predict the next U.S. recession, but you can take steps to protect your money. Here are some tips on how to recession-proof your finances:
1. Save an emergency fund: Shoring up your savings with an emergency fund is a smart money move. Financial experts advocate having at least $1,000 to $3,000 in savings. You can keep these savings in a checking or savings account.
2. Create a slush fund: Once you have an emergency fund, the next step is to save a slush fund. It should have three to six months’ worth of living expenses. A slush fund can protect you in a recession if you lose your job or are trying to get a new job.
3. Decrease your spending: You can bolster your personal balance sheet by saving and reducing your consumption. Try a 30-day No-spending Challenge or learn how to decrease excessive spending.
4. Pay off debt: Getting rid of credit cards, student loans, or personal loan payments can free up monthly cash flow. You will have more financial flexibility during times of economic stress if you are debt-free. (Read more about how to pay off debt).
5. Invest your excess cash: Growing your savings is another super valuable step in protecting yourself from a recession. While a recession can cause declining asset prices, not all assets will be affected the same. You can hedge against market declines if you have an income-producing portfolio.
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Recent Recessions
Over the past few decades, several recessions have shaped the U.S. and global economies. Here are several recent recessions to know:
- COVID-19 Recession (2020): This sudden economic downturn was caused by the global spread of the coronavirus. Lockdowns, travel restrictions, and supply chain disruptions brought many industries to a halt. Although it was brief, the impact was sharp, and it required significant government intervention through stimulus checks, business loans, and unemployment benefits.[2]
- Great Recession (2007–2009): Triggered by the collapse of the housing market and a global financial crisis, this recession led to widespread foreclosures, massive job losses, and the failure of several major financial institutions. Governments around the world implemented stimulus programs to stabilize their economies.[3]
- Dot-com Recession (2001): Caused by the dot-com bubble burst, this recession was relatively mild but still affected millions of workers and investors. It was worsened by the terrorist attacks on September 11, 2001, which further shook economic confidence.[4]
Recession vs. Depression
While the terms "recession" and "depression" are sometimes used interchangeably, they refer to drastically different levels of economic decline. Here are the differences:
- Recession: A recession is a relatively short-term downturn, often lasting just a few months to a couple of years. Although it can cause widespread job losses and hardship, most economies recover from a recession and can morph into periods of economic growth afterward.
- Depression: Depressions, on the other hand, are a more severe and prolonged economic decline. Economic depressions are rare and typically involve double-digit unemployment, a significant drop in GDP, deflation, and long-lasting financial instability. While both are serious economic events, depression is far more damaging and protracted than a typical recession.
Smart Summary
A recession is a significant, widespread decline in economic activity that affects employment, spending, investment, and consumer confidence. Factors including inflation, high interest rates, financial crises, and global disruptions can cause recessions. While a recession can bring hardship, it is also a natural part of the economic cycle—and with the proper measures, recovery is always possible.
Smart Money requires our expert writers to rely on trusted primary sources—academic research, government reports, expert interviews, original reporting, and peer-reviewed data—to deliver precise and up-to-date content. All of our content is thoroughly fact-checked. We also incorporate relevant research from reputable publishers when it aligns with our editorial focus. For a closer look at our rigorous journalistic standards, explore our editorial guidelines.
(1) National Bureau of Economic Crease. Business Cycle Dating. Last Accessed April 14, 2025.
(2) Federal Reserve. The Federal Reserve’s Policy Actions during the Financial Crisis and Lessons for the Future. Last Accessed April 14, 2025.
(3) Center on Budget and Policy Priorities. Chart Book: Tracking the Recovery From the Pandemic Recession. Last Accessed April 14, 2025.
(4) Britannica. Dot-com. Bubble. Last Accessed April 14, 2025.
