What is a recession and how will it affect you?
The UK economy is heading towards a recession, according to economists. But what is a recession, and what does it mean for your money?
According to research by MoneySuperMarket, as many as 4.2 million people in the UK don’t know what a recession is and how it will affect them, although the figure is much higher among those who’ve never seen one before.
Around 14% of 18-24 year olds don’t know what a recession is while the figure is far lower for those over 65. In fact, over-65s were nearly four times as likely to report being “unaffected” by the approaching recession as 18-24 year olds.
So, what is a recession and how will it affect you?
What is a recession?
A recession is a period of economic decline, typically defined as a decline in a country's gross domestic product (GDP) for two consecutive quarters or six months.
This is typically accompanied by high unemployment and a decrease in business activity and consumer spending. Recessions are a normal part of the economic cycle, but they can have severe consequences for individuals and businesses.
The size of the economy is measured in terms of GDP, which aims to take into account all the economic activity that goes on in the country.
According to the Office for National Statistics (ONS), GDP is made of three main components:
- The value of all goods and services produced by the economy
- The country’s overall spending, including business, personal and government spending
- Income across the country, including wages, business profits and international trading income
As you might guess, the ONS does not have all of these figures to hand all of the time. So it uses estimates based on surveys and government spending data to come up with its GDP figures.
Still, GDP is seen as a reliable indicator of the size of a country’s economy. The ONS publishes its estimates on the size of the economy once a quarter and these are used by economists to determine the health of the economy.
If GDP declines it means the economy is contracting and economic activity is slowing. If it grows, it means the economy is expanding, more money is changing hands and the country is generally getting richer.
But if GDP shrinks for two quarters in a row, economists define this as a recession, a sign that the economy is in trouble.
The health of an economy can be measured by a variety of indicators, including GDP, unemployment, and inflation. A healthy economy is typically characterised by strong economic growth, low unemployment, and low inflation.
Overall, the health of an economy is determined by a combination of these and other factors. A healthy economy is one that is growing, with low unemployment and stable prices, and that is able to provide opportunities for individuals and businesses to thrive.
Is the UK heading for a recession?
The Bank of England, which has a network of economists and data researchers plugged into the plumbing of the UK economy, believes the country is going to slump into a recession over the next few months and will be “in a recession for a prolonged period”.
The latest figures from the ONS seem to support this view.
According to the BoE’s projections, the economy is expected to remain in a recession for 2023 and the first half of 2024.
Policymakers are blaming inflation, the war in Ukraine and political uncertainty for the slump.
However, as is the case with all economic projections, these are just forecasts. There’s a lot that can change over the next two years which could affect the UK’s economic position.
For example, if the war in Ukraine reaches an uneasy stalemate, commodity prices could fall and take the edge off inflation, giving consumers more spending power and driving economic growth.
Why is a recession bad news?
Recessions are bad news because they mean people and businesses are spending less. If people are spending less, companies might decide to stop hiring new staff or even let existing staff go to offset declining sales.
This can have a knock-on effect on the rest of the economy. Companies lay staff off because sales are falling, which means these consumers will have less money to spend, which means companies will see sales decline, which means they’ll have to cut costs, and so on.
Just the talk of a recession can send a chill through the business community. No one wants to commit to a large investment project if they think demand is about to drop due to a recession.
And when combined with the threat of higher interest rates, this combination of factors could lead to tight financial conditions - a situation in which it is difficult for individuals and businesses to access credit or to obtain financing for their activities.
Tight financial conditions can have negative effects on the economy, as they can make it difficult for businesses to invest and expand, and they can reduce consumer spending. This can lead to a decrease in economic growth and potentially higher unemployment.
What does a recession mean for you?
A recession can have a number of impacts on individuals, depending on their circumstances.
For some, a recession may mean losing their job or seeing their hours reduced, leading to a decrease in income and difficulty paying bills. It can also mean that businesses may be less likely to hire new employees or invest in new projects, which can make it harder for individuals to find new job opportunities.
On the other hand, a recession may also mean that interest rates are lowered, making it cheaper to borrow money and potentially benefiting those with outstanding loans.
Overall, a recession can be a difficult time for many people, but the specific impacts will vary depending on a person's individual situation.
Indeed, the term recession itself is pretty hit-and-miss as it only measures the state of the economy as a whole, and does not take into account specific regions and markets.
For example, in the fourth quarter of 2021, the UK economy as a whole grew 1.3% year-on-year. However, London’s economy expanded 3.1% while economic activity in Yorkshire and the Humber shrank -0.8%.
There are also sector differences. The latest figures from the ONS show that despite the overall decline in GDP between the second and third quarter, the construction sector continues to and the services sector is treading water.
Recessions can also have different effects on people in different income brackets. Those on benefits or fixed incomes such as retirees are more likely to struggle especially in the current cost of living crisis.
Graduates and school leavers may find it harder to get their first job, and companies might be more reluctant to give promotions or pay rises.
It’s always sensible to keep at least three months' spending in a cash savings account if you can to act as a cushion against disaster.
And it could be worth taking a look at your current spending. Inflation is driving the price of everything higher, and it might make sense to cut back spending in some areas to make sure your outgoings do not exceed your income.
Searching out other ways to earn an income, or getting a better deal on your mobile bills, savings accounts and other expenses such as car or home insurance could also help you improve your financial position ahead of a downturn.