Recession

In economics, a recession refers to a phase of the business cycle characterised by a broad and sustained decline in economic activity. Recessions typically follow a peak in the economic cycle and are marked by reductions in output, income, employment and spending. Although a recession is commonly associated with falling gross domestic product (GDP), its causes and manifestations are wide-ranging, often involving shifts in demand, supply, financial conditions and broader social or psychological indicators.
Recessions are usually triggered by adverse shocks, such as financial crises, trade disruptions, supply constraints, the bursting of asset bubbles or large-scale hazards including pandemics and natural disasters. Because recessions affect multiple dimensions of economic life, understanding them requires a comprehensive examination of both quantitative indicators and underlying behavioural and structural factors.

Definitions and Measurement

There is no single global definition of a recession. The International Monetary Fund emphasises the absence of an official universal definition, reflecting the complexity and diversity of economic downturns across different countries.
In the United States, the benchmark authority is the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER). The NBER defines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months, typically observable in real GDP, real income, employment, industrial production and wholesale or retail sales. A recession begins at the peak of economic activity and ends at the trough, marking the turning points of the business cycle.
By contrast, the commonly cited rule of “two consecutive quarters of negative growth” is not an official U.S. definition but rather a rule-of-thumb. The Bureau of Economic Analysis highlights that formal dating rests with the NBER’s broader methodology.
The European Union uses a definition similar to the NBER, incorporating GDP alongside employment and a range of other indicators. This multidimensional approach enables a more robust assessment of economic conditions.
In the United Kingdom and Canada, a recession is officially recognised when the economy experiences negative economic growth for two consecutive quarters based on seasonally adjusted real GDP.
The Organisation for Economic Co-operation and Development (OECD) adopts a still broader framework, characterising a recession as a period of at least two years during which the cumulative output gap reaches at least two per cent of GDP, with the gap at least one per cent for one of those years. Relatedly, a GDP-per-capita recession identifies downturns based on contractions in real GDP per capita.
These variations illustrate the diversity of approaches to classifying economic downturns, reflecting the multifaceted nature of recessionary processes.

Attributes and Drivers of Recessions

A recession typically involves declines across several components of GDP:

• Consumption, as households reduce spending owing to lower confidence, job insecurity or reduced income.
• Investment, as firms postpone or cancel capital expenditure.
• Government spending, which may contract under austerity or expand under countercyclical policy.
• Net exports, often affected by global conditions and exchange rate movements.

These summary indicators are influenced by underlying structural and behavioural drivers, including employment levels and labour skills, savings rates, business expectations, interest rates, demographic trends and government policy frameworks. By analysing these elements together, economists can better understand the drivers of downturns and develop appropriate policy responses.
Under stable conditions, households are typically net savers while corporations are net borrowers, with government budgets near balance and trade roughly neutral. Deviations from these conditions, especially when combined with major shocks, often precede recessions.
A severe and prolonged recession—such as one in which GDP declines by around ten per cent or persists for several years—is sometimes described as a depression, though economists remain divided over whether depressions are distinct phenomena with different causes and remedies.

Types and Shapes of Recessions

Economists often use geometric analogies to describe the depth and duration of recessions and their recoveries:

• V-shaped recessions involve sharp, short contractions followed by rapid recovery. Examples in the United States include 1954 and 1990–1991.
• U-shaped recessions feature more prolonged slumps with gradual recoveries, as seen in 1974–1975 or in Japan in the mid-1990s.
• W-shaped recessions (or double-dip recessions) involve a recovery followed by another downturn; notable U.S. examples occurred in 1949 and 1980–1982.
• L-shaped recessions describe long periods of stagnation following an initial large decline, such as Japan’s extended contraction from 1997 to 1999.

These shapes help describe the behavioural patterns of economies under stress and guide expectations regarding recovery trajectories.

Psychological Aspects and Economic Sentiment

Recessions are strongly influenced by psychological factors and shifts in economic confidence. When firms anticipate future downturns, they may cut investment and employment, reinforcing the slowdown. Consumers may simultaneously reduce spending, further depressing demand.
Consumer confidence indices provide insight into prevailing economic sentiment. The concept of animal spirits, introduced by John Maynard Keynes, highlights the role of emotions, trust and perceptions of fairness in shaping economic activity. Negative animal spirits can lead households and firms to delay or reduce expenditure.
Behavioural economics identifies cognitive biases—such as the availability heuristic, money illusion and normalcy bias—that may amplify recessionary dynamics by distorting expectations and decision-making.

Balance Sheet Recessions

A particular form of recession, known as a balance sheet recession, arises when consumers or corporations carry excessive debt, often after the collapse of asset prices. In such cases, households and firms shift from borrowing and spending to aggressively paying down debt, reducing demand across the economy. Because assets must equal liabilities plus equity, a fall in asset values below the level of debt results in negative equity, compelling borrowers to deleverage.
Economist Paul Krugman has argued that the subprime mortgage crisis illustrated this broader pattern of excessive debt accumulation. In these circumstances, traditional monetary policy may be insufficient, and fiscal stimulus combined with debt restructuring may be necessary to support recovery.
Japan’s prolonged downturn beginning in the early 1990s is a classic example of a balance sheet recession. Despite near-zero interest rates and an expanding money supply, many Japanese corporations focused on reducing debt rather than investing, weakening corporate investment—a core component of GDP—and prolonging stagnation.