How do recessions happen?

4 min read

Money! Can’t live with it, can’t live without it!

Except you really can’t live without it. And when a recession hits your wallet? Bad times ensue.

But how do recessions happen? And what can we do to survive?

Let’s find out.

What is a recession?

First things first, let’s define a recession: A recession, generally speaking, is when GDP experiences negative growth over two quarters. In other words, it’s when an economy shrinks over more than six months. Recessions have knock-on effects which exacerbate poor economic activity: falling output, rising unemployment and decreased consumer spending.

As you can imagine, these knock-on effects have their own knock-on effects. Recessions often lead to layoffs, which therefore reduces consumer spending even more, and the whole thing snowballs into a cycle of economic slowdown. You’ll often see markets decline before the economy shows signs of recovery.

That might include lowering interest rates or providing more unemployment benefits. However, while there are measures in place to tackle recessions, there’s no simple way to determine when one can begin and end. Economists tend to analyze a number of indicators, such as employment, industrial production and retail sales. In fact, recessions tend to be recognized in retrospect after they’ve occurred.

How each individual perceives a recession is therefore different. Investors, policymakers and blue-collar workers all have their own experience depending on the timing of economic changes and where they fit in the chain of effect.

How do recessions happen?

So, how does a recession happen? We can simplify things by returning to this key fact: Recessions usually happen when people significantly reduce their spending. So, let’s think of what might trigger that decline—rising inflation, increasing interest rates or external shocks, such as war or supply chain disruptions. For example, we’re currently seeing high inflation of around 9% in the US. When you couple that with rising interest rates that make borrowing more expensive, then you’re seeing prime conditions for a recession. Not that we want to scaremonger—that’s half the problem!

Economists have different theories about how recessions start. Some point to structural changes or sharp rises in costs, like oil prices. Others focus on financial factors, such as the contraction of credit or bursting of financial bubbles, which can tighten the economy and lead to recessions. Whether driven by economic, financial or psychological factors, the effects of a recession can reach far beyond one country’s isolated economy.

How did the Great Recession happen?

Is it time to put our hard helmets on? Well, let’s get some context by zoning in on the most relevant economic downturn in recent memory: How did the 2008 recession happen?

The economic car crash happened because of risky lending practices in the US. “Subprime mortgages” destabilized the housing market without anyone really noticing. When housing prices fell, many borrowers defaulted—which promptly burst the bubble. Banks suffered huge losses and a broader financial crisis hit the rest of the world.

How often do recessions happen, and can recessions be predicted?

The good news is that recessions don’t happen all that often. For context, historical data shows there have been around 122 recessions across 21 advanced economies from 1960 to 2007. Countries spend roughly 10% of their time in recession, and recessions tend to last around a year. No two recessions are the same, but they do often share a decline of around 2% in GDP.

As to whether recessions can be predicted, let’s bear a few things in mind. There is no single indicator of a recession. However, the inverted yield curve is a reliable warning sign. Since 1955, it has preceded every U.S. recession—though not every inversion has resulted in one. Normally, long-term bonds yield more than short-term ones due to increased risk over time, creating an upward-sloping yield curve.

Beyond the yield curve, economists and investors monitor a variety of leading indicators—such as the ISM Purchasing Managers Index, the Conference Board Leading Economic Index and the OECD Composite Leading Indicator—to gauge the likelihood of a recession. They’re all useful tools, but predicting recessions is still an uncertain science.

Are we in a recession?

That’s a complicated question. Confidence has wavered in recent months, but analysts like J.P. Morgan Research, now peg the probability of a recession in 2025 at around 60%. Trump’s tariffs ushered a slowdown in global trade, though their recent easing has helped matters. The global trade environment is fragile, and the potential for retaliation, supply chain disruptions, and weakened business sentiment still looms large.

We’ve also seen big drops in banking stocks and commodities like copper and oil. That means a reassessment of future profits, with increased tariffs and trade tensions pushing costs higher and squeezing margins. But it’s important to remember that stock market declines don’t mean recession. As with everything we’ve mentioned, they figure as warning signs.

What can we do in a recession? Stay confident and trust in the economy. And buy lots of canned food.