Graph of the Month, February 2008, Business Forecasting Center, Eberhardt School of Business, University of the Pacific

What Happens During a Recession?

A recession represents a significant decline in the economic activity that lasts more than a few months.  Most U.S. recessions are characterized by two consecutive quarters of decline in real GDP (Gross Domestic Product) -- a gauge of the value of the outputs produced in a region.  No matter what causes it, a recession will eventually spread through all the industrial sectors, and the impact will be felt throughout the economy.  Yet, the extent of the impact is not the same across the board as it should depend on the type of shocks that trigger the recession.

If we focus our attention on the fluctuations of the major components of GDP, we will see some patterns of fluctuation during recessions.  Four major components make up region’s GDP including Consumption, Private Investment, Government Expenditures, and Net Export-Import.  Of these four components, the first two are the most fluctuating, thus strongly affecting the ups and downs of GDP.  Learning the two fluctuations of these two can help us predict which industries could be most affected by future recessions.

The figures below show the fluctuations of the two volatile GDP components during the last U.S. recessions occurring in the mid 1970s, early 1980s, early 1990s, and early 2000s.  The first figure shows that during these recessions real GDP experiences negative or near zero growth.  The component most affected by the recession is Private Investment, which shrinks from over -7.0% to nearly -18.0%.  On the other hand, while slowing considerably, Consumption still increases most of the time.

The second figure shows that of the Total Private Investment, most affected by the recession is Investment for Residential (except in the 2001 recession).  Investment for Non-Residential (which includes investment for structures and equipment and software) also shrinks considerably but at milder rates.  These patterns suggest that when recessions happen, construction and manufacturing sectors will most likely be highly affected.

On the consumption side, Consumption for Durable goods is the most affected by the recession, followed by Consumption for non-durable goods but at milder rates.  The declines in both consumptions will hurt the Retail-trade and Wholesale-trade sectors.  On the other hand, Consumption for Services still sees positive, although mild growth.  The Services sectors, primarily Professional and Business Services, will still be affected by the recession.  The effect, however, is considerably less than the effect on the production sectors.

On a side note, the 2001 recession, which was triggered by the collapse of the dot-com bubble and the 9-11 terrorist attack, was known as the mildest among these recessions.  It was also a special case of recession as its impact seemed to be localized in the non-residential investment.

For questions, please contact Dr. Christiadi at cchristiadi@pacific.edu or 209-946-2623.