What is a recession and how can I be better prepared for it?

A pandemic, a cost of living crisis, war in Ukraine, and now a looming global recession. It certainly feels like those of us hoping for more settled times in 2023 could end up rather disappointed.  

That’s the assessment of the New Zealand Treasury, at least, which has officially forecast the economy to shrink in 2023, bringing with it higher unemployment and all the other undesirable side effects of a downturn. 

But it’s not all bad news. Unlike the world's recent experience of spike proteins and invading armies, we can see this particular adversary coming. And that means when (or if) a recession actually arrives, we can be ready.  

What is a recession?

Going by the textbook definition, a recession occurs when an economy’s GDP declines by at least 1.5% for at least two consecutive quarters. Or as economist Shamubeel Eaqub told Radio NZ, it’s “the economy going backwards for six months.”

The technical definition is probably less useful to us than the practical, real-world impacts that generally arise in a recession – fewer businesses hire people and unemployment rises; fewer consumers spend their money and more people end up in hardship.  

This can be scary, but it’s important to remember that recessions are a normal part of the economic cycle. They happen for a variety of reasons, and while there’s no denying that some people will be caught in the crossfire, not even the shrewdest economist among us can accurately predict how severe this one might be or how long it could last.

What is causing this recession? 

In a word, inflation. The pandemic and the war in Ukraine have sent economic shockwaves worldwide, creating major imbalances in supply and demand. These have combined to push up prices, which in turn have kicked off the cycle of high inflation that’s now painfully obvious every time we fill up our cars or check out at the supermarket. 

Getting inflation under control is critical to addressing the cost of living crisis and returning stability to the economy. Simply put, we all have to reduce our spending, and it’s the job of the Reserve Bank and its counterparts in other countries to make sure we do that.

This is why we’ve seen interest rates jump so much in the last few months. By making it more expensive to borrow and incentivising people to save more, these central banks are decreasing demand. In doing so, they’re reducing pressure for prices to rise and lowering inflation. Unfortunately, this will come with a side-serve of economic pain for some of us.  

Who will be most affected by a recession? 

One consequence of all this belt-tightening is that unemployment is likely to rise as fewer of us go out for meals, update our wardrobes or choose to buy a house. 

While anyone can be affected by a recession, economists usually cite retail, hospitality, real estate, construction and manufacturing as the riskiest industries in these times. There’s already evidence of this happening, with a recent New Zealand Herald article pointing to a drop-off in inquiries for new builds and suggesting tough times ahead for builders. 

There’s also evidence that young people are disproportionately affected by recessions. The recession which followed the Global Financial Crisis in 2008 had particularly negative and persistent consequences for the youth labour market in New Zealand. More recently, the short but sharp economic downturn which followed the COVID lockdowns saw an effective shutdown of our hospitality sector, which has a high proportion of younger workers.

How to survive a recession

There is no shortage of advice out there about preparing for a recession. Whether you’re talking to a financial adviser or scrolling through videos on your phone – the consensus from experts is largely the same: build up your emergency savings, pay off as much credit card or other high-interest debt as you can, and brush up on your employability skills. 

There’s new research showing that young people are already taking this advice. The latest Workforce Confidence Index from LinkedIn indicates around 78% of Gen Z adults in the US are starting to prepare for a potential recession by delaying big purchases and cutting back on their spending. Millennials are only slightly behind them at 74%.  

In many ways, the prospect of a recession is a wake-up call that having a buffer for bad times isn’t a ‘nice to have.’ It has been suggested that younger workers have a greater fear of the recession because they have never experienced one in their working lives, and their willingness to prepare well for it could put them on a better footing than older generations.  

Is there a silver lining anywhere in this? 

Actually, yes. As mentioned earlier, the driver for this recession is high interest rates designed to combat inflation, rather than a meltdown of the global financial system which caused the 2008 recession that followed the Global Financial Crisis. Back then, hundreds of New Zealand households were losing their homes every month. While an increase in mortgagee sales is predicted in 2023, property economists are cautiously optimistic the numbers won’t be as high this time around.  

Business confidence has sunk to a 52-year-low according to the New Zealand Institute of Economic Research’s quarterly survey of business opinion released in January 2023, suggesting New Zealand will enter a fast and deep recession this year. But rather than panic, it’s best to plan for what might lie ahead to help you ride out the downturn.

It can also be prudent to invest during a recession. After all, Warren Buffett once famously said we should be "fearful when others are greedy, and greedy when others are fearful."  Regardless of your investing approach or appetite for risk, it’s a good time to reevaluate things like what kind of KiwiSaver scheme fund you have, and a good opportunity to talk to a MAS Adviser about any other questions or concerns you may have.

KEY TIPS TO WEATHER A COMING RECESSION

1. Focus on building your emergency fund 
2. Prioritise paying off high-interest debt
3. Sharpen your employability skills
4. If you have savings to invest, be savvy about it