What is a recession, and how can you prepare?

Key Points:

• A recession is a sustained period of low economic output.
• Recessions are a normal part of the business cycle, but they can have negative impacts.
• High unemployment is one of the most important warning signs of an impending recession.

Australians have been copping it from all angles. Between soaring inflation, supply chain chaos, and a central bank determined on an absurdly aggressive round of rate hikes, living costs have mushroomed in the last year. Now, economists warn another threat may loom on the horizon: recession.

But what exactly does this mean? And how can we prepare?

Generally when economists and the media talk about a recession, they mean a ‘technical recession’, which happens when a country’s gross domestic product (GDP) falls or comes up negative for two quarters in a row. 

This indicates a sustained period of slow economic output which puts financial stress on both the country and its citizens. Recessions can last for a few months to a few years.

The classic symptoms of a recession include:

• Drops in household spending. 
  
• Significant job loss. 
  
• Decreasing business investment. 
  
• Company shutdowns. 
  
• Rising loan default rates as people and businesses struggle to repay debt.
  

There are some other ways to define a recession, too, such as falling GDP per capita, a significant rise in unemployment, or merely the descending peak-to-trough section of the business cycle. Generally speaking, however, the technical recession is the main one.

Examples of prior recessions include:

• COVID-19 aftermath recession* (March - June 2020)
  
• The Global Financial Crisis (GFC) (2007 - 2009)
  
• Early Nineties Recession (1991 - 1992)
  
• OPEC Oil Embargo (1973 - 1975)
  

*Unfortunately this economic downturn is still unfolding, with interrupted periods of growth and decline. Time will tell whether the SARS-CoV-2 pandemic was an economic hiccup or a genuine recession.

Recession vs. depression

The difference between a recession and depression is the severity. While recessions are sustained periods of negative growth, depressions crash harder for longer. The classic example is the Great Depression of the 1930s, which put millions out of a job and lasted the better part of a decade.

Recessions can occur for a variety of complex reasons. Most of the time, several factors cluster into a giant economic mess, which can make it difficult to pinpoint what exactly is to blame. In this way, many recessions are just perfect storms.

Some common causes of a recession include:

• High interest rates. 
• Low consumer confidence. 
• Stagnant or declining wages.
• Enormous debt build-up.
• Supply-chain disruptions.
• Rising unemployment.
• Unchecked inflation.
• Asset bubbles (such as the housing bubble that caused the GFC).
• Significant stock market losses or crashes. 
• Sociopolitical problems like pandemics, trade embargoes, or war.
• Close trading partners of a country experiencing a recession. 

If any of these sound familiar, you’re not imagining things. The fact that our current economic environment ticks so many of these boxes is what has economists concerned about an impending dive, especially now that New Zealand has officially entered a technical recession in 2023. 

Indeed, Commonwealth Bank has issued multiple warnings of a per capita recession if the Reserve Bank of Australia overdoes their inflation-fighting rate hikes, and as mortgage stress mounts on the general population, experts have begun to flash amber lights. CBA now puts the risk of a recession in 2023 at 50% – a coin flip.

However, while Australian unemployment has ticked up slightly in the last few months, overall job levels seem strong. This metric tends to be the most reliable bellwether for recessions: if not enough people have income, spending collapses. So we can probably breathe easy for now. 

Recessions are usually spotted in hindsight, however, with the signs becoming obvious when it's far too late. Sometimes the triggers and symptoms of a recession can be hard to distinguish, as well. For example, rising unemployment can be both a cause and effect of a recession, so it’s up to economists – and sometimes historians – to draw the line.

Ultimately, though, recessions are an unavoidable part of the business cycle, even in their mildest forms. So it may not be a matter of ‘if’ so much as ‘when’.

If Australia enters a recession, many people will have a tough time, whether through job loss, home loss, or even just a struggle to pay the bills.

Whole markets will tank or lose significant value and many businesses will likely go bankrupt. The Reserve Bank of Australia will also slash interest rates to begin an emergency economic stimulus. The government may implement some emergency fiscal measures of its own.

Likely the rest of the world would be in a similar period of economic decline, too, so global problems may contribute to our own situation.

Recessions don't affect all Australians equally. We wouldn’t so much be in the same boat as the same storm, each rowing the rafts we’ve been given. Some might suffer little to no ill-effects, while others will have it much worse.

Tragically, one of the grimmest outcomes of recessions is a correlation between a rise in unemployment and mortality , particularly in vulnerable social groups.

There may be a few silver linings, however, which muddies the impact. For instance, some benefits of a recession can include:

• Falling house prices, which enables some to buy in who couldn’t before.
  
• Long-term corrections of financial inequality or inflation. 
  
• Cheaper asset prices, which could benefit investors able to hold out for a while.
  

It can be tricky to focus on the positives when recessions seem like a scary inevitability. However, fortune favours the prepared, and there are things you can do to ‘recession-proof’ your finances. When the anxiety sets in, don’t shut down: get proactive.

The best way to insulate yourself from a recession is to reduce your exposure to the fallout. The economy may not be within your control, but your money certainly is.

For starters, grow your emergency savings. Ideally, you want enough cushion to theoretically weather at least three months of little to no income. Compare high interest savings accounts if you need an attractive place to park your nest egg, or download one of these amazing budgeting apps to help you track your progress. 

Secondly, avoid taking on any unnecessary or extra debt. People overextending themselves when it comes to loans is one of the most common precursors – and signs – of a recession. Cut back on credit card expenditure, make good on any loan repayments (like on your mortgage), and if you have the funds, clear as much debt as possible. 

While you’re at it, make sure you keep your credit score high, as this will put you in better stead with your lenders. Australia recently passed stricter protections for consumers experiencing financial hardship, so it’s in your best interest to work with your lender if you’re struggling to afford repayments. After all, they’d rather keep you on than write you off as bad debt. 

Some other strategies that may help include:

• Having a fallback source of income. Whether it’s selling crochet cats, tutoring, or consulting on the side, it doesn’t hurt to have a way to make a little extra cash when times get tough.
  
• Avoiding risky investments. This might be a no-brainer, but safer investments with lower returns might be a better option than riskier ones for the time being.
  
• Diversifying your investments. Baskets and eggs come to mind. If you diversify your investments, it reduces the likelihood of your whole portfolio losing money when the stock market crashes. 

With any luck, one or a combination of these tactics could help you weather the storm.

For more economic tips and tricks, check out our family finances hub, including why understanding monetary policy could save you money. 

Compare high interest savings accounts below to get started on your rainy day fund.