Finance 101: what is a recession and why does it matter?

Here, we explain what a recession is and how it can affect you.

What is a recession?

A recession is when there is a sustained period of weak or negative growth in economic activity that is accompanied by a significant rise in the unemployment rate. In simple terms: it’s when the economy stops growing and starts shrinking for a prolonged period. Think of it like a cold for the economy. During a recession, businesses may earn less money, people might lose or find it much harder to obtain jobs and overall spending goes down. The most common definition of a technical recession is when there are two consecutive quarters of negative gross domestic product (GDP) growth.

Why should you care about a recession?

Recessions might sound like something only economists should worry about, but they actually affect all of us in pretty significant ways. When the economy takes a downturn, businesses can struggle, which might mean job cuts or hiring freezes, leading to the unemployment rate rising. Aussies might start tightening their belts due to weak or negative wages growth, which slows things down even more. This can potentially mess with your savings or retirement plans. 

How long do recessions last?

Some recessions last for just a few months, while some can last for years. But even if it lasts just a short while, the economy may not recover fully for a much longer period of time, depending on how governments and central banks react to it. 

Can you predict a recession?

There are some tell-tale signs that might suggest a recession is on the horizon, such as declining consumer confidence, reduced business investments, rising unemployment rates and stock market volatility. However, these indicators don't always guarantee a recession; they merely highlight potential vulnerabilities in the economy. Factors like central banks’ intervention, government policies, global events and technological advancements can all influence the economic landscape, making predictions tricky.

How would a recession affect me?

Job security: During a recession, companies might try to cut costs, which can include laying off employees. This means job security can decrease, and finding a new job might become more challenging.

Budgets: Prices for everyday goods and services might fluctuate. While some prices might drop due to lower demand, others might increase, making it harder to manage your budget.

Investments: If you have investments in the stock market or a retirement fund, their value might decrease during a recession. This can affect your savings and long-term financial goals.

Interest rates: Central banks might lower interest rates to encourage spending. This can be a good time to borrow money for things like a home, but home price appreciation tends to be sluggish in recessionary periods. It also means the interest from savings accounts might decrease.

Mental health: Financial stress can impact your mental health. Worrying about job security or paying bills can lead to anxiety or stress, affecting your overall well-being.

Can you recession-proof your life?

You can’t really prepare for a recession, but you can take a few steps to protect yourself from financial fluctuations of any cause:

1. Build an emergency fund: Try to save enough money to cover at least three months’ worth of expenses. This can help you manage if you face unexpected financial challenges like losing a job or increases in cost of living.

2. Budget wisely: Keep track of your spending and find areas where you can cut back if needed. This can help you save more and spend less during tough times. AMP’s Budget Planning Calculator can help you build a budget.

3. Stay informed: Keep an eye on economic news to understand what’s happening. This way, you can make informed decisions about your finances. Subscribe to our economist’s newsletters and listen to their podcast to keep up-to-date on financial news.

4. Focus on skills: Consider learning new skills or improving existing ones. This can make you more valuable in the job market and provide better job security.

5. Focus on the long-term: Long term investments like super can ride out the volatile waves in markets.

6. Avoid panic: It’s natural to feel worried during a recession, but avoid making hasty financial decisions like withdrawing all your investments. Talk to a financial advisor if you're uncertain. The key to weathering a recession is understanding that it's a cycle; eventually, economic activity picks up again, often leading to periods of growth and opportunity.