With a Bloomberg survey reporting around a 50 percent recession chance within a year, many Americans are wondering, "How would a recession affect me?" Since a recession usually involves unemployment issues, business slowdowns and less spending, you could face being laid off, your retirement savings falling or a struggle to cover expenses. In addition, you can experience different effects related to the housing market and interest rates. Understanding these effects will help you prepare for the next recession.
The Business Cycle and Recessions
Before looking into the specific effects of a recession on consumers, it helps to understand the business cycle. It's normal and natural for economic activity to speed up and slow down in terms of output rates, consumer expenditures and labor participation rates. For example, the economy will expand until it peaks and then it will contract until it reaches a trough. Economists look at detailed data to determine where the economy is at in the business cycle.
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While an economic downturn can happen at any time, the National Bureau of Economic Research looks at whether the decline has been significant and long lasting to determine if the economy has fallen into a recession. For example, if the country's gross domestic product (GDP) has fallen for two quarters straight, this could indicate a recession, but just two or three months of slowed economic activity probably wouldn't be enough evidence.
The Congressional Research Service explains that many conditions can lead to a recession occurring. For example, the Fed's recent actions to aggressively raise interest rates to try to slow down the overheated economy and cool down inflation has some Americans fearing a resulting recession. Recessions can also occur as a result of bubbles in certain industries like the housing market or when there's a bear market. As seen during the coronavirus pandemic, major shocks to the economy can also trigger a recession.
Since a recession usually involves unemployment issues, business slowdowns and less spending, you could face being laid off, seeing your retirement savings fall or struggling to cover expenses.
Recessions and Labor Market
Looking at previous recessions, such as the Great Recession, and the pandemic-related recession of 2020, you'll find that the labor market normally suffers from a higher unemployment rate from job losses and less hiring. As companies struggle with less demand for their products and services but still have plenty of bills to pay, they decide to cut costs by laying off workers or giving fewer hours to those they keep.
Southern New Hampshire University notes that some industries are more recession-proof than others. As customers are less willing to spend money on nonessential purchases, retailers, restaurants, hotels and entertainment venues can especially have job losses. On the other hand, essential businesses like health care facilities, grocery stores and accounting or technology services firms tend to be more resilient.
If you work in a vulnerable industry and get laid off, you could find yourself tapping into your emergency fund or relying on credit to cover your everyday bills and needs. In addition, you face the challenge of trying to find a new job or side gig in a market less favorable for new opportunities. This could mean spending more time finding a new job or needing to take a less ideal one just to have income.
Recessions and Interest Rates
When a recession begins, the Federal Reserve (Fed) looks into monetary policy actions that can help the economy expand and correct issues such as low customer spending and high unemployment rates. To encourage people to spend rather than save their money, the Fed can lower the federal funds rate at which banks lend money to each other overnight. These adjustments can also affect your finances for the better or worse.
Federal funds rate decreases usually lower the interest rates for everything from mortgages and car loans to credit cards and lines of credit, and the intent is to encourage borrowing and spending. This can be a good thing if you need a new loan or have a variable-rate credit product since it means paying less to borrow money. However, you won't benefit if you have an existing fixed-rate product unless you opt to refinance, which can come with extra costs.
At the same time, federal funds rate drops affect your savings since they'd lower the return you get on investments like your savings account or bonds. This happens since the government intends to discourage people to save and to spend instead. Unfortunately, this means you'll see your money not grow as quickly as you'd like, so you might opt for other investment opportunities that could come with more risk.
Recessions and Consumer Spending
Whether you end up laid off or just want to conserve money in a rough economy, you'll likely find your willingness to spend money decreasing and your consumer confidence down, explains the Bank of America Institute. This might mean forgoing luxuries and entertainment and opting for cheaper alternatives. But at the same time, you face the challenges of still paying your bills even if you encounter financial hardship. Unfortunately, this can create added costs if you need to rely on credit cards due to less cash flow.
In addition, North Carolina State University mentions that high inflation can lead up to a recession. While the Fed's actions are designed to lower inflation and improve the U.S. economy, you can still find yourself paying more, at least early during the recession. Eventually, businesses usually lower their prices to encourage people to buy from them. You'll need to adjust your budget accordingly in response to price changes during a recession.
Recessions and the Housing Market
If you're a homeowner, know that a recession can affect the housing market in a few ways. A recession usually decreases demand for housing as fewer people seek to move or buy properties, and this can mean your property's value falls. Not only does this affect your home's equity, but it would disadvantage you if you did need to sell your property soon. On the other hand, if you have an adjustable-rate mortgage, the economic downturn could give you a lower rate.
Chase explains that recessions can provide opportunities if you're looking for a home since a less competitive market drives prices down, and you might find that you get more of a home for your money. In addition, recessions usually mean falling interest rates for borrowers, and this can advantage you when you need a mortgage. However, you could also face stricter criteria from the lender and find getting approved more challenging.
Recessions and Your Retirement Plans
An economic recession also creates labor issues that can affect your retirement decision and timing. You might find yourself retiring early if you're laid off and don't find satisfying work again. In that case, you could end up with less saved for retirement than you expected and experience the related financial challenges from that. But if you're employed and plan to retire soon, the Population Reference Bureau suggests that you might feel tempted to stay employed longer as you see unemployment rates going up.
In addition, the financial markets are particularly volatile during a recession as the stock market is usually in a bear market. This means you can find your retirement savings going down, especially if you opt for riskier investments like stocks over bonds, cautions the Auditor of the State of Indiana. The good news is that performance improves after the recession, and having a diversified portfolio and waiting for the market to improve will help.
- Chase: The Effects of Recessions on Mortgages
- Southern New Hampshire University: Which Industries Will be Most Affected by a Recession?
- Federal Reserve: Why Do Interest Rates Matter?
- Bank of America: Changing Consumer Spending Habits During Recessions
- Population Reference Bureau: Effects of the Great Recession on Older Americans' Health and Well-Being
- Auditor of the State of Indiana: What Is Market Volatility
- Bloomberg: Odds of US Recession Within Next Year Near 50%, Survey Shows
- North Carolina State University: Inflation Is Healthy for the Economy – But Too Much Can Trigger a Recession
- National Bureau of Economic Research: Business Cycle Dating
- Congressional Research Service: What Causes a Recession?
- How to Survive a Recession