It’s a grim picture out there, with the rising cost of living, record inflation and financial forecasters talking about an economic recession. We’re here to explain exactly what a recession is and how you can prepare for one.
An economic recession is when a country suffers a dip in economic activity. While unfortunate, it is considered a normal part of the business cycle, and different models exist for defining when we’re in one. Whichever model is used, we all feel the effects of a recession:
- A decline in economic activity
- Lower income levels
- Rising unemployment
- Reduced retailsales
- Industrial production levels dip
Let’s look at what causes a recession and how we define when the UK is in one.
The Technical Terms Behind an Economic Recession
The financial market is expected to fluctuate, it’s a normal part of how money works. So when do we determine an economic recession? Well, trends have to stay the same for months or years to classify as a recession. We rely on the National Institute of Economic and Social Research (NIESR) for a lot of our financial data in the UK.
These experts confirm an economic recession when a country’s gross domestic product (GDP) falls for two quarters in a row. The GDP is the total value of goods and services produced in a country over a set time, so it’s worrying to see it declining. After all, a healthy market will grow rather than shrink, so a continuous shrink strongly suggests underlining issues.
This declining GDP model has been around since 1974 when Julius Shiskin coined the term. It works when describing a country that falls into a recession but makes linear progress in getting out of it again. But, sometimes, a country can start improving and then dip again, known as a W-shaped recession. We’ve seen both of these recessions in the UK.
Why Recessions in the UK Happen
When the UK is in an economic recession, people tend to spend less money, meaning the government can’t claim as much from taxation and investors withdraw funds for fear of losing money. The combination of supply chain issues, high inflation and the impact of Covid has led to a loss of confidence from consumers and businesses alike.
In turn, businesses look for ways to cut costs or even cease trading altogether. Anyone who does keep their job is less likely to receive a pay rise, which is often critical with record inflation leading to price increases across the board. Money doesn’t stretch as far when everything costs more, yet you only have the same monthly income.
To put it into perspective, if inflation hits 10%, an item previously costing £1 will cost £1.10. It might only seem a small amount, but when this is happening with every single product in your shopping trolley, you certainly notice the difference.
With inflation increasing faster than wages, people are noticing a big hit to their purchasing power and can’t afford the luxury items they previously could. It links back to the government receiving less tax, investing less, and the vicious cycle continuing.
How to Prepare for an Economic Recession
Fortunately, recessions in the UK don’t happen overnight. We do have some warning that one’s about to happen, giving us a chance to prepare and get our finances in the best possible order. Here’s what we recommend you do:
- Review your spending
- Create budgets
- Build savings
- Avoid taking out credit
- Use money-managing apps
Let’s look at these in a little more detail.
Review Your Spending
Look back through your spending over the last few months and try to streamline it. Are there any subscriptions you can cancel or cutbacks you can make? It’s amazing how small amounts build up over time, leading to potentially substantial savings when you review them.
An economic recession is not a time to be blasé with your money. Instead, create budgets and have a plan for every penny. Work in priority order, starting with your rent or mortgage and ensuring all bills are covered. You may even choose a pot of “fun funds” to cover leisure or family activities.
Get Professional Help
For individuals concerned about how you’re going to manage, it’s worthwhile speaking to a financial advisor. They can help you get your affairs in order and see where your priorities lie.
For businesses worried about redundancies and possible restructures, we recommend getting in touch with a business consultant. They can advise on corporate strategy and finance, helping you to make informed decisions.
Savings are sensible, especially in an economic recession. Having a buffer, ideally around 3 months of expenses, protects you if the worst-case scenario happens. We understand this isn’t always feasible, but putting something into savings each month will help create a rainy day fund.
Avoid Taking out Credit
It’s a tricky time to make big purchases. If you need credit to buy something, you’re tied into monthly payments with reduced financial security. Try to save the cash in advance to give you more financial security. If you can’t, make sure you can afford any monthly repayments.
Use Money-Managing Apps
Managing your money isn’t always easy, but there are apps out there to help you. It keeps everything streamlined and accessible at a glance, so it’s worth a try if you struggle with the traditional pen and paper system.
Recession Vs Depression
A depression is a prolonged, more severe version of a recession. While there isn’t an exact definition, it involves long-term national or global economic decline with sharp rises in unemployment. Some experts say a 10% drop in GDP is a depression rather than an economic recession.
When it comes to recession vs depression, a recession is considered an undesirable yet normal part of the economy, but this isn’t the case with depressions. While we’ve had various recessions in the UK over the years, such as in 2008 and 2020, we don’t see depressions as often. Their consequences are often greater and recovery is slower.
Experts don’t have an exact definition for when one ends. Some say it’s when we see consistent economic growth, while others say we need growth to return to the level it was before the crash.
The most notable depression on record is the Great Depression of 1929. It started in America after the stock market crashed with recovery taking over 10 years.
The Bottom Line
The global economy will always experience ups and downs, with an economic recession a part of the cycle. While they’re undesirable, to say the least, there are things you can do to prepare for one. In this new post-Covid world, we’re all in uncharted territory, so stick to these tips to navigate it as best you can.