Should we be worried about a recession?

Ashleay: Welcome to the “In Your Interest!” podcast from iA Financial Group, where we discuss your need-to-know economic news and how it affects your finances. All this in under 10 minutes. We've been hearing a lot lately about a recession. It seems like a good time to ask the question - should we fear a recession? What defines a recession? And above all, should we be worried? My name is Ashleay. I'm here with my colleague, Sébastien Mc Mahon, our Chief Strategist and Senior Economist here at iA Financial Group. Hi, Sébastien.

Sébastien: Hello, Ashleay.

Ashleay: So, Sébastien, what exactly is a recession?

Sébastien: Well, you may be surprised, but there is no simple and clear definition of a recession. So, when I was studying economics in university, we were taught that two consecutive quarters of contraction of the economy of a country or a province or a region constitutes a recession. So, if you have two consecutive quarterly numbers of negative GDP growth, that was a recession. But the reality is that the issue is a bit more complex. So a recession is defined as a significant slowdown in activity throughout the economy, lasting more than a few months, visible in the labour market, the industrial production numbers, household income, consumer spending and all of the typical economic indicators that come out. So we kind of ask a committee of experts to determine what's the official start and end dates of a recession. Here in Canada, the task is given to the C.D. Howe Institute, in the US, for example, it's the NBER. So, the National Bureau of Economic Research. And what may surprise you and our listeners is that when the official dates are announced, so when on the news they say that Canada or the US is officially in a recession, typically we're near the end of a recession or the recession might already be over. So that when the data confirms the recessionary state of the economy, usually we're late in the process. So, recessions are never pleasant, especially for those who lose their jobs. But they’re a necessary and essential part of any business cycle.

Ashleay: I understand. And what causes recessions?

Sébastien: Several factors can cause recessions. First would be an economic shock, like, for example, a natural disaster, a pandemic, just like we just had in 2020. A terrorist attack, just like in 2001 when we had the 9/11 attacks. Loss of consumer confidence, so when the business cycle has been going on for a while, the fact that many people start to anticipate the end of the cycle leads to caution and then to a loss of confidence which could be enough to create a recession. Rising interest rates, like, for example, it becomes more expensive for consumers and businesses to borrow money for projects when central banks are tightening monetary policy. So, raising interest rates, leading to less spending, less investment, meaning that we have a slowdown and then a recession. Another thing that's more specific to places like Japan, for example, would be deflation. So, we're talking a lot about inflation now. But in some countries, like Japan, they've been stuck with the inverse problem where the prices are typically falling year over year, meaning that households typically wait before buying what they want because prices may be lower next year, for example. So that leads to less spending, prices falling further, and you can have kind of a spiral that leads the economy into a recession. The last type, of course, everyone remembers 2000 when we had the dot-com bubble bursting or 2008 with housing. Well, the bursting of financial bubbles or any type of bubble that has an impact on the wealth of households could also be an important factor behind the recession.

Ashleay: Right. And what are the characteristics of a recession?

Sébastien: Well, according to US data, going back to the mid 19th century, the average recession lasts about 17 months. The shortest in history was the most recent in 2020. So, it lasted only two months and the longest was from 1873 to 1879, meaning that it lasted more than five years. Now, if we look at the frequency of a recession: over the last 100 years, there have been 17 recessions in the United States alone. So that's an average of one recession every about six years. So if we just look at how, you know, the movie of a recession unfolds in a typical recession, when the movie starts, you have consumer and investment spending that are the first variables that show signs of weakness, probably coming from a loss of confidence from households and from businesses. Faced with a slowdown in demand, companies begin to produce fewer goods and services. After that, that leads to, of course, job cuts, which then causes household income to fall and then the reaction of authorities, so central banks like the Bank of Canada here, the Federal Reserve in the US, they react by lowering interest rates. Fiscal policy also acts as a stabilizer by supporting households and businesses, and then at some point, confidence eventually bottoms out. We have lower borrowing costs that serve as a catalyst for the start of a new business cycle, thus ending the recession.

Ashleay: Right. And if I understand correctly, that means that if there's one every six years, many of them are not necessarily as mediatized as others would be, I imagine.

Sébastien: Of course, there's different types of recessions. Some are worse than others, and I'm sure that some of our listeners maybe don't remember that we had a short recession in the early 2000s.

Ashleay: Right, right. And what are the impacts of a recession?

Sébastien: Well, the main impact for our listeners and for the population, of course, is unemployment. So, during a typical recession, unemployment tends to increase on average by 3.6%. It could be lower than that and it could be much more, like in 2020. The rise was much worse than that. So, unemployment can create some long-term damage because not everyone gets back on their feet afterwards. Some companies fail, they go bankrupt, some new industries emerge. And some of the newly unemployed must seek new training or relocate to a different part of town, to a different province, to another country to put their skills at play in the labour market. So that's the most important aspect. Regarding markets, of course, a recession typically rhymes with a bear market, so a bear market, meaning a pull down of the stock market, that's 20% or worse, and on average, a bear market is a pull down of 30% of the stock market. So that's a significant hit to the wealth of households. So, the issue is for people who are retired or just about to retire and they need to cash out. So that means it reduces the capital that they have in an expeditious manner. So, you have to sell on the cheap. So, there might be some strategies to bypass that, like using lines of credit temporarily. But it does create some issues for the retired.

Ashleay: Should we fear a recession in Canada within the next 12 months?

Sébastien: Well, this is not our base case scenario. So, a base case would be an event that we think has more than 50% probability. But it is very possible because as of today, in August 2022, we believe the chances of a recession in Canada by the end of 2023 are about 40%. So still significant. Our labour market is a strength, as is the strength of the external sector. So, for example, oil prices are elevated, so that helps. A risk factor that we should not discard is the sensitivity of the Canadian economy to interest rates. Recently, Canadian real estate has taken up more and more room. It accounts for nearly 10% of the Canadian economy right now. It was about 7% before the pandemic, meaning that it grew in size largely during the pandemic. So, by comparison, this is twice the size of the sector in the United States, and therefore the tightening of interest rates in Canada is an important risk factor and it should not be taken lightly.

Ashleay: Right. And what about financial markets?

Sébastien: Well, the probability of a recession in the US we think is higher and the impact of a US recession, of course, would be more important on financial markets. So, to wrap this up, we think that there could be some more volatility in markets in the months to come.

Ashleay: Alright, so we'll keep an eye on that. Thank you very much, Sébastien. Loved this podcast? Want to know more about economic news? Follow our “In Your Interest!” podcast available on all platforms, visit the economic news page on ia.ca or follow us on social media.