What Happens to Unemployment During a Recession?


During an economic problem like inflation, Unemployment decreases as companies profit more from the increase in goods and services, thus making it possible for them to hire more workers. Of course, it is vice versa when inflation is at its lowest. Since Unemployment decreases during inflation, can we say the same for a recession? What happens to Unemployment during a recession?

During a recession, Unemployment increases as companies try to deal with reducing demand, profits, and increased debt by laying off workers. They often do this to reduce costs and avoid bankruptcy.

Recession can be a result of several factors. When recession hits an economy, it experiences a decline. Individuals and businesses suffer the consequences. But what about those looking for employment? Do recession affects employment? What happens to Unemployment when a recession hits? You will soon find out.

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What Happens to Unemployment During a Recession?

Before we proceed, let’s consider what a recession is.

A recession is a macroeconomic term that means a significant downturn in general economic activities in a certain region. It had been generally recognized as two consecutive quarters of economic downturn, as displayed by GDP together with monthly indicators like a rise in Unemployment.

But, the National Bureau of Economic Research (NBER), which officially declares recessions, says the two consecutive quarters of a downturn in real GDP aren’t how it is defined anymore. The NBER defines a recession as a notable reduction in economic activity spread across the economy, lasting over a few months, typically visible in real GDP, real income, employment, industrial production, including wholesale-retail sales.

Recession, like inflation, is visible in industrial production employment, real income, and wholesale, retail trade. The working definition of a recession is two successive quarters of negative economic growth as measured by a country’s gross domestic product (GDP). Although the Nation Bureau of Economic Research (NBER) does not necessarily need to see this happen to call a recession and use more frequently reported monthly data to make its choices, quarterly downturns in GDP don’t often conform to the decision to declare a recession.

Understanding Recession:

Since the industrial revolution, the long-term macroeconomic trend In several countries has been an economic upturn. Along with this long-term growth, however, have been short-term changes when significant macroeconomic indicators have shown slowdowns or even complete decreasing performance, over time frames of six months up to several years, before returning to their long-term growth trend. These short-term downturns are widely regarded as recessions.

A recession is a normal but unpleasant part of the business cycle. Recessions are followed by a rash of business collapses, bank failures, slow or negative growth in production, and elevated unemployment. The economic decline caused by recessions, though short-term, can have a huge impact that changes an economy. This can happen because of structural changes in the economy as prone or outdated firms, industries, or techs fail and are discarded; dramatic policy reactions by government and monetary authorities, which can literally rewrite the business rules; or social and political tumult resulting from prevalent Unemployment and economic issues.

For investors, one of the best tactics to have during a recession is to invest in companies with low debt, good cash flow, and strong balance sheets. Contrarily, steer clear from companies that are significantly leveraged, cyclical, or speculative.

How Close Are We to Total Economic Collapse?

Economic expansions begin at the trough of a business cycle – its lowest point – and end at its peak after which the economy begins to contract, kicking off an economic recession.

Oct, 1945Nov, 194837
Oct, 1949Jul, 195345
May, 1954Aug, 195739
Apr, 1958Apr, 196024
Feb, 1961Dec, 1969106
Nov, 1970Nov, 197336
Mar, 1975Jan, 198058
Jul, 1980Jul, 198112
Nov, 1982Jul, 199092
Mar, 1991Mar, 2001120
Nov, 2001Dec, 200773
Jun, 2009Feb, 202012

Recession and Depressions:

Based on the NBER, there have been 34 recessions in the United States since 1854 up to the most recent recession in 2020. Since 1980, there have been five such periods of negative economic growth that were deemed recessions. Common examples of recession and depression include the worldwide recession after the 2008 financial crisis and the Great Depression of the 1930s.

Depression is a deep and continuing recession. With no particular criteria existing to declare depression, unique characteristics of the Great Depression included a decrease of 33% in the number of goods and services produced in the U.S, an 80% loss of value in the stock market, and an unemployment rate that briefly got to 25%. Simply put, depression is a significant downturn that lasts for several years.

Economic Indicators of a Recession:

What is used to indicate a recession? You see, the most important indicator used to determine recession is real GDP. That consists of everything produced by businesses and people in the U.S. it is called “real” because the effects of inflation are removed.

When the real GDP growth rate first turns negative, it could mean a recession. However, sometimes, growth will be negative and suddenly appear positive in the next quarter. Other times, the Bureau of Economic Analysis might take another good look at the GDP estimate in its next report. It is hard to determine if you are in a recession judging from GDP alone. And that is why the NBER measures the following statistics. This gives a good estimate of economic growth. When these economic pointers fall, so will GDP. These are the indicators to look at if you want to know whether the economy is in a recession.

  1. Real Income:

Real income measures personal income adjusted for inflation. Transfer payments, like Social Security and welfare payments, are discarded. When real income falls, so do consumer purchases and demand.

  1. Employment:

Employment and real income together tell the commissioners about the economy’s general health.

  1. Manufacturing:

The commissioners study the health of the manufacturing sector, as measured by the Industrial Production Report.

  1. Wholesale-Retail Sales:

Manufacturing and wholesale-retail sales, adjusted for inflation, tell commissioners how companies are reacting to consumer demand.

  1. Monthly GDP Estimates:

The NBER also studies monthly estimates of GDP given by Macroeconomic Advisers. Remember that the stock market isn’t an indicator of a recession. Stock prices show the potential earnings of public companies. Investors’ assumptions are sometimes over-optimistic or too pessimistic, increasing the stock market’s volatility even more than the economy.

When a recession occurs, the stock market could enter a bear market, indicated by a drop of 20% or more over a minimum of two months. A stock market decline could also result in a recession as many investors lose trust in the economy.

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Warning Signs of a Recession:

When a recession occurs, a quarter of negative growth could take place, accompanied by positive growth for many quarters and then another quarter of negative growth. A recession is short-term, lasting for around nine to 18 months, but its effects can be long-lasting.

The first sign of an imminent recession happens in one of the leading economic indicators like manufacturing jobs. Manufacturing receives large orders months in advance, measured by the durable goods order report. If that falls over time, so will factory jobs. When manufacturers stop hiring, other sectors of the economy will slow down.

A reduction in consumer demand is normally the culprit behind dwindling growth. As sales reduce, businesses stop growing. Soon later, they stop hiring new workers. By that time, the recession is underway.

How a Recession Affects You?

Recessions are devastating in that they normally create widespread Unemployment, which is why so many are normally affected when they happen. As the unemployment rate increase, consumer purchases reduce even more. Businesses can go bankrupt.

In many recessions, individuals lose a lot (such as their homes), especially when they cannot keep up with mortgage payments. Young people can’t get a good job even after graduating from school. The result? A stagnant career.

Historical Recessions:

The Great Recession started in December 2007 and ended in June 2009. Real GDP experienced a downturn in the first, third, and fourth quarters of 2008 and the first quarter of 2009. The recession began when GDP was reduced by 2.3%. The economy lost 17,000 non-farm jobs in January 2008.

When measured by duration, only the 30-month employment decline from February 2001 to August 2003 was longer than the most recent decline. That is another sign that the recession was already in progress. Unlike most recessions, demand for housing slowed first. As a result, most experts thought it was just the end of the housing bubble, not the beginning of a new recession. The NBER declared the Great Depression over in the third quarter of 2009. It was the worst recession since the Great Depression, with five quarters of economic contraction, four of them consecutive, in 2008 and 2009. It was also the longest since the Great Depression, lasting 18 months.

Another good example was the 2001 recession. It didn’t meet the textbook definition of recession, as there were not two consecutive quarters of contraction, but the NBER reported that it remained from March 2001 to November 2001. GDP shrunk in the first and third quarters of 2001.

Advantages of Recessions:

Of course, recessions have a benefit. The only good thing about depression is that it helps combat inflation. The Federal Reserve must always attempt to stall the economy enough to stop inflation without causing a recession.

Usually, the Federal Reserve does that without the assistance of fiscal policy. Politicians, who are in charge of the federal budget, try to stimulate the economy as much as possible by reducing taxes, spending on social programs, and disregarding the budget deficit. That is how the United States debt accumulated to $10.5 trillion before even a penny was spent on the 2009 Economic Stimulus Package, known previously as the American Recovery and Reinvestment Act.

Worse Case of Recession:

The recession of 1873 was regarded as the Great Depression until the 1929 recession came. The recession started with a financial panic in 1873 with the failure of Jay Cooke and Company, a major bank. The event resulted in a chain reaction of bank collapses across the country, and the collapse of a bubble in railroad stocks, The New York Stock Exchange shut down for 10 days in response. The recession lasted until 1877.

How does Unemployment React to Recession?

During inflation, Unemployment reduces. Is this the same for a recession? Definitely not! Unemployment increases like an ascending plane and falls like a shooting star. At the beginning of a recession, as companies try to handle the dwindling demand, reducing profits, and increased debt, many start to lay off workers to reduce costs.

As the number of unemployed workers increases while demand and output reduce further, as a result, newly unemployed workers find it difficult to find new jobs, and the average length of unemployment rises. Increasing Unemployment is one of a number of indicators that define a recession, and it worsens the decline.

Why Does Unemployment Increase During a Recession?

Since a recession means a decline in economic activity and labor is an important economic input, including the capital, it stands to reason that employment must decrease as output falls. The direct causal relationship between employment and output growth has been regular enough to enter the economic canon as Okun’s Law, named after the economist who first documented it, Arthur Okun. A related rule of thumb suggests that the economy must experience upturn two percentage points faster than its potential growth rate to cut the unemployment rate by one percentage point a year.

Potential GDP is an estimate of output an economy would have produced had its workforce and capital been used at a max sustainable rate. Potential GDP is determined by the size of the labor force and the pace of productivity growth, including capital investment. Because potential GDP is a theoretical construct that isn’t directly measurable, different modeling approaches tend to yield divergent estimates.

When Okun’s Law is a useful summary of the relationship between employment and economic growth, challenges in estimating potential GDP and the natural rate of unemployment restrict the rule’s utility to policymakers.

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