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Paul Tracy

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Updated September 30, 2020

What is a Recession?

A recession is two consecutive quarters of declining gross domestic product (GDP)

How Does a Recession Work?

Let's assume that there has been a significant decline in industrial production, employment, and wholesale or retail trade. These things may cause GDP to decline for a three-month period (a quarter). If the situation continues in the next quarter, most economists will declare that the economy is in a recession.

The effects of a recession are far-reaching. Employment levels fall, discretionary income falls, and overall consumer spending falls, leading to tough times for most companies, which in turn lay off more workers and reduce overall consumer spending further. Few businesses expand and few consumers spend money, which lowers the demand for loans. Interest rates usually fall, as banks try to encourage consumers to take out loans.

The National Bureau of Economic Research has identified 32 recessions in the United States since the mid-1850s.

Why Does a Recession Matter?

Recessions are a normal part of the business cycle, but government fiscal and monetary policies often play key roles in making sure recessions do not go on for long. These policies involve increasing or decreasing government spending on entitlement programs and public works projects that create jobs, and they may involve changing bank reserve requirements, the interest rate at which the Federal Reserve lends money to banks, or the purchase or sale of Treasury securities.

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