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YOU DECIDE: Should you fear a recession?

January 25, 2008

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

Dr. Mike Walden
Media representatives: For a black-and-white or color copy of this photo, call 919.513.3127 or e-mail dave_caldwell@ncsu.edu.

We're hearing more in the news about the economic "R" word: a recession.

Economists today are split on whether a recession will occur, but the mere mention of the possibility sends shivers through both Main Street and Wall Street.

So let me use this week's column to answer some common questions about recessions. Then you'll be better armed to decide what a recession means and how it can affect your personal economy.

What is a recession?

Recessions are defined from the perspective of the entire economy and not from the viewpoint of any individual, company or industry. Typically our economy grows, or expands, over time, meaning a greater value of goods and services is produced each year.

But when this growth stops, and further, when the economy goes into reverse and produces a lower value of goods and services than in the past, then it is said the economy has receded; in other words, a recession has occurred. Usually this downturn has to occur for a minimum of six months for an official recession to be declared.

How frequent are recessions and how long do they last?

There have been 11 recessions since World War II, the last in 2001. One of the positive trends in recent years has been the shortening of recessions. In the first half of the 20th century, recessions were typically half as long as economic growth periods, meaning the average recession lasted a year and a half. The last two recessions have lasted only one-tenth as long as their corresponding expansions, making their length only eight months.

How are bad are recessions?

The cost of recessions is judged by two factors: income loss and the rise in unemployment. While income and jobs are still lost during recessions, the costs have become smaller. The peak unemployment rate during the 1981-82 recession was almost 10 percent, but in the 1990-91 downturn it was 7.5 percent and during the 2001 recession the top jobless rate hit 6 percent. Likewise, the loss of income has become relatively smaller, to the point that the usual recession today results in a 1-to-1.5 percent drop in national income.

To put these numbers in perspective, consider what happened during the recession of 1929-33. Unemployment peaked at 25 percent, and income plunged almost 30 percent!

What causes recessions?

This is truly a major question in economics. Some say recessions just happen naturally as the economy runs out of steam. Think of a sprinter who has to take a break after several dashes around the track.

Of course, reductions in the availability of a key input in the economy - like oil - can cause the economy to falter. Reductions in oil supplies, with the corresponding increases in oil prices, were clearly behind two recessions in the 1970s. However, recessions don't usually follow rises in oil prices that are caused by increased usage of oil and oil products.

Recessions can also come about from too much of a good thing, sort of like the stomachache you'd get after eating too much. Here, the good thing is investment in some "hot" market, like commercial real estate in the 1980s, the tech sector in the 1990s and residential housing in the 2000s. If these investments get ahead of themselves - meaning they go up too far, too fast - then they can set themselves up for a fall. And if the fall is big enough, the entire economy can stumble into a recession.

Can recessions be prevented?

We usually look to the federal government to prevent recessions, but three problems make this goal difficult. One is simply knowing a recession is occurring or is about to occur. Second is deciding what to do about a recession. By its nature, public policy takes time to debate and formulate. Third is the time lag it takes for government actions to have an impact. Once any government policy is developed and agreed to, between six and 18 months may be needed for the "medicine" to work its wonders.

Recessions appear to be coming about once every eight-to-10 years. This means each of us has to decide how to live through them until better days come.

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm

Related audio files are at http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html

Posted by Dave at January 25, 2008 09:19 AM