New York, USA (CNN)– Warning signs of a recession are flashing around the world. Wall Street is on the brink. Central banks raise interest rates in an attempt to curb inflation. Geopolitical turmoil is exacerbating the supply chain headache that began in 2020.
Economists at Deutsche Bank warned last month that “we will face a major recession”, citing the downside on Wall Street. Bank of America, in the still bleak but lighter camp, said the mood in financial markets was “stagnation”. Goldman Sachs is among the more bullish major banks, but it’s not entirely cheerful: it recently said that a tight labor market “significantly increased downside risks”.
Meanwhile, the Bank of England on Thursday warned of double-digit inflation and a possible recession as it raised its key interest rate by a quarter of a percentage point. The Chinese economy, the world’s second largest, is slowing, threatening to derail global growth. Russia’s war in Ukraine is driving up energy and food prices to high levels in the European Union and beyond.
If history is any indication, the recent spike in inflation suggests that we will be on the verge of deflation. With one exception, every US recession since World War II has been preceded by a significant price hike, according to the Congressional Research Service.
So, what exactly is a recession, and how much do you worry about it? Let’s break it down.
What is stagnation?
First, the textbook definition: A recession is a prolonged period of economic decline, beginning when the economy reaches its peak and ending when it reaches its bottom.
Recessions are typically characterized by an economy contracting in successive quarters, usually measured by gross domestic product (aka how much we collectively buy and produce as a society). But there are exceptions to this rule, including the short and very severe recession that the United States entered during the early months of the pandemic. And this technical description doesn’t mean much to anyone who isn’t an economist.
The reality of a recession is generally bleak – think unemployment is high, the stock market is in decline, and wages are stagnating or shrinking. People often curb spending as depression sets in, giving slumps a psychological component that is difficult to shake off.
For example: Technically, the Great Recession that began in 2007 lasted only 18 months, but the impact of the crisis had an effect on consumers for much longer.
Economists call this long-term effect, especially in the labor market, a “slowdown.” The 2020 recession itself was brief, but mass layoffs and furloughs, along with a rapid shift to working from home, shattered previous assumptions about the value and meaning of work. All over the world, workers’ resentment of their employers has sparked a movement to search for something better, a phenomenon known as the “Great Resignation”.
What causes stagnation?
You could spend a career in economics researching and debating this very question. But let’s focus on the most pressing risk at the moment: the Federal Reserve’s war against inflation.
One of the quirks of the modern capitalist system in which we live is that when the economy is so strong, officials have to deliberately harm it to prevent it from derailing completely. This is exactly what the Federal Reserve is trying to do now.
On Wednesday, the Federal Reserve raised its key interest rate by half a percentage point, its largest hike in 22 years. Interest rates are the Fed’s primary tool for controlling inflation, which is currently hovering at 8.5% – the highest level since the early 1980s.
But predicting economic expansions and recessions is very difficult, and the Federal Reserve has historically been miserable at it. The bank has to raise interest rates enough to get rid of higher rates. Overdoing it, may lead to stagnation. Not doing much, may make prices continue to rise, which could also lead to a recession.
The ideal outcome is known as a “soft landing”, in which consumer prices fall and economic growth continues at a steady pace.
How should you prepare?
First, don’t panic: Even if a recession is inevitable, there’s no telling how severe it will be. But planning for the worst never hurts. Here are some of the ways financial advisors believe you can protect your money from deflation.
Get a new job now: With extremely low unemployment and plenty of job opportunities, it’s a market for job seekers. That can change quickly in a recession.
Take advantage of the housing boom: If you’re on the fence about selling your home, this might be a good time to put this on the list. Home prices in the US are up nearly 20% year over year, but mortgage rates are on the rise as well, which will eventually dampen demand.
Put some cash aside: It’s always a good idea to have liquid assets – cash, money market funds, etc. – to cover urgent needs or unexpected emergencies.
Finally, some wise advice for any market: Don’t let your emotions control you. “Stay invested, be disciplined,” certified financial planner Mary Adam says. “History shows that what people – or even experts – think in the market is usually wrong. The best way to achieve your long-term goals is to keep investing and stick to your provisions.”