Will COVID-19 Cause an Economic Recession?

Point of Interest

Understanding the actual definition of a recession and looking at past indicators can help people better prepare for the financial impacts of the coronavirus (COVID-19)

As the coronavirus (COVID-19) pandemic continues to have a dramatic effect on the health of the world, it also is having a dramatic effect on the U.S. economy. According to MarketWatch, the Dow Jones Industrial Average is on pace for its worse month since the Great Depression. As the health of the stock market is often looked to as a measure of the U.S. economy’s health, it begs the question: Is a recession coming?

The first step in answering that question is defining what a recession is. According to many journalists, it’s “two consecutive quarters of declines in quarterly real (inflation-adjusted) gross domestic product (GDP).” While this definition is not technically wrong, it is somewhat incomplete based on the definition taken from the economics community.

The National Bureau of Economic Research (NBER) defines it as  “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough.” Based on this definition, it’s too early to tell if we’re in a recession in the U.S.

Regardless of whether the country enters into a recession or not, the financial effects of the coronavirus (COVID-19) on the economy and families will be felt. It’s important to understand the effects that the virus may have on your family’s financial picture, and how best to prepare.

Signs of a recession

1. A continued decrease in GDP

The country’s last recession was in 2008 following the subprime mortgage lending crisis. Over the third and fourth quarter of 2008, GDP fell by 0.54% and 2.16%, respectively. The fall continued into the first two quarters of 2009, and revised estimates show the drops were far worse than originally thought.

Gross domestics product is the monetary measure of the market value of all the final goods and services produced in a specific time period. To determine if the country is entering a recession, GDP will need to be monitored. The current downturn may be reactionary to the events, and may spring back as soon as the virus is under control and industry is allowed to open again. GDP will be a significant indicator of whether it’s a sharp downturn or a recession.

2. A continued increase in the unemployment rate

As outlined by the NBER, the unemployment rate is another indicator of a recession. Before the COVID-19 outbreak, unemployment rates in the country were at all-time lows. However, many people now find themselves out of work. Again, monitoring what happens to these unemployment rates when industries are allowed to open again will be critical.

3. A continued decrease in retail sales

While some online retailers are doing well through COVID-19, most brick and mortar and traditional retailers are not. It’s difficult to sell anything when you’re not allowed to be open. The question will be how people choose to spend when stores reopen. If consumers aren’t confident and hold onto their money, the country could see a recession. If the government is able to drive the economy through actions like lowering the interest rate, the drop in sales could be short-lived, and a recession could be avoided.

All of these indicators of an economic recession need to be monitored collectively. Ultimately, a recession is something that happens over time to the whole economy. Yes, some industries will fare easier during a recession, but not all. However, all areas mentioned in the NBER’s definition of a recession would be affected to satisfy the definition.

Prediction of COVID-19’s impact

According to a survey of economic experts conducted by the University of Chicago Booth School of Business, 62% of the U.S. panel and 82% of the European panel agreed with the statement that “a major recession is a likely consequence of the pandemic.” While the majority of U.S. panel members selected “agree,” only 18% of the total surveyed strongly agreed, and 44% marked agree. Furthermore, 31% said they were uncertain, and 8% disagreed.

Also, remember the statement was whether they agree that it is likely, not that they believe it will definitely happen. It’s still a cause for some concern, but not a reason to panic.

Additionally, the NBER provides several new studies worth mentioning. These include a study on the lessons learned from the influenza (Spanish flu) pandemic of 1918-1920, the tradeoff between the severity and timing of suppression of the disease, and a study on the macroeconomics of epidemics.

The effects this will have on a microeconomic level to things like your mortgage, student loans, personal loans and savings accounts remain to be seen. The Fed lowering the interest rate does offer the opportunity to refinance mortgages and other loans to better rates. However, lenders struggling to keep up with the demand ended up raising their rates on refinancing, which may or may not be temporary. As the cost to borrow money for banks has gone down, APY rates on savings accounts may also trend downwards.

What you can do

If coronavirus does cause a recession (and even if it just causes a sharp downturn), there are steps you can take to financially protect yourself and your family.

  1. Finding additional work – Although finding additional work may not be possible for everyone, it’s a great place to start if you find yourself in need for extra cash. Look into companies hiring for work-from-home jobs right now.
  2. Utilizing credit cards – Some credit cards have 0% balance transfer offers that can help you save money on interest payments. All depends on how quickly you want to pay off your debt, since this tactic may leave you with some less time than taking out a personal loan.
  3. Adjusting your budget – The first thing to do is begin limiting spending on unnecessary items and developing a revised budget. However, completely shutting down and buying nothing is not the way to go, especially from local businesses who will experience the brunt of the effects. Look into cutting out some luxury spending if it does not fit with your revised budget.
  4. 401(k) hardship withdrawals – 401(k) hardship loans could be a viable option, and if you qualify, you can avoid the 10% early withdrawal penalty. You will have to demonstrate an immediate financial need, and you will be limited to only taking the amount necessary to meet that need. Full details can be found on the IRS website.
  5. Personal loans – A personal loan can help people that are struggling now more than ever to pay their debt and want to consolidate it with a lower-interest loan.

Some of these steps may help you unlock a few extra funds, and you can start to build out an emergency fund if you don’t already have one. According to Vanguard, having 3 to 6 months’ worth of living expenses is the right target. During a recession, though, you may look to add a few months to this, especially if you’re in an industry heavily affected by recessions and economic downturns. According to Brookings research, the industries most at risk from COVID-19 are mining, transportation, employment services, travel arrangements and leisure and hospitality. If you look at the areas most people might be trimming their expenses, it will most likely line up with this list.

The final word

Continuing to follow the social distancing guidelines laid out by the CDC and the White House will be important. The quicker the virus is brought under control, the lesser the impact on the economy. Remember, social distancing is different than a quarantine. With a quarantine, you can’t go anywhere. With social distancing, you can still engage in the economy, but you do so while employing health best practices and standing further apart from individuals if you have to go out in public, the CDC recommends six feet of distance between you and other people.