A double dip recession occurs when an economy enters a recovery phase from a recession, only to stumble and slide back into recession. While rare, it can happen. There have only been two instances since the Great Depression.
How Does a Double Dip Recession Work?
A double dip recession occurs when an economic shock happens during the early stages of the recovery that follows a recession. The economy is already weakened, making it susceptible to a cycle of reduced spending, high unemployment rates, and reduced credit. Consequently, it falls back into recession.
A double dip recession can also be referred to as a “W-shaped” recession. Each point in the letter “W” represents the economy at different points: a peak, followed by a decline, then another peak before a second decline. A formal recovery occurs afterward.
How Does a Recession Work?
According to the National Bureau of Economic Research, a recession is considered a “decline in economic activity that extends across the economy and lasts more than a few months.” A recession can be triggered by any number of events or economic shocks, including:
- Runaway inflation exceeding 10%, as seen in the late 1970s
- A shift in monetary policy, such as increased interest rates and tightening of available credit
- A financial system crisis, such as the subprime mortgage crisis of 2008-2009
- Pandemics
Regardless of the cause, consumers lose confidence and cut back on spending. Businesses stumble and jobs are lost. Banks tighten credit extended to companies and consumers, reducing spending and hiring, and the tragedy continues to spread throughout the economy.
Examples of Double Dip Recessions
Only two instances of double dip recessions have occurred in the past 90 years. The first was from 1937 to 1938, and the second from 1981 to 1982. Both were stimulated by changes in monetary policy.
The Double Dip Recession of 1937
The U.S. economy began recovering from the Great Depression in 1933. Over the next three years, the unemployment rate fell from 25% to 14%, and the economy grew at an annual rate of 9%. However, in 1936, the Federal Reserve became concerned about potential runaway inflation and systematically reduced banks’ ability to provide credit to businesses and consumers.
At the same time, the Social Security tax began in 1937. The veterans’ bonus was removed in 1936 (a stimulus for spending). High taxes, reduced credit, and diminished spending were enough to halt the recovery from the Great Depression.
The end result was a double dip recession that lasted from May 1937 to June 1938. The unemployment rate rose to 19% and GDP declined by 4.5%.
The Double Dip Recession of 1982
A brief recession from January 1980 to July 1980 was caused by a sharp rise in oil prices and persistently high inflation, peaking at 14.6% in the spring of that year. As the economy began to recover, the Federal Reserve significantly raised interest rates in an attempt to control inflation.
The explosive interest rates, which peaked at 21.5% in December 1980, pulled the economy back into recession, which lasted for most of 1982. Mortgage rates were over 18% in October 1981, making home ownership nearly impossible for most first-time buyers.
What Does a Double Dip Recession Mean for Investors?
During both double dip recessions in the nation’s modern history, the stock market declined, dropping 35.34% in 1937 and 4.7% in 1981. Both recovered sharply the following year.
Historically, stocks have performed well during periods of expansionary monetary policy when the Federal Reserve used interest rates and open market operations and reserve requirements to stimulate economic activity.
The potential for a double dip recession is a good reason to reassess your investment plan if you haven’t already. Make sure you are comfortable with your risk levels and allocations of stocks, bonds, and other assets. Do you have the financial ability to weather a market downturn, if it happens?
Examine
The companies in your portfolio of stocks, mutual funds, and exchange-traded funds. Are they financially strong? Do your investment strategies need adjustment to accommodate a potential downturn?
If you don’t have an investment plan, it’s always the right time to build one. Consider getting help from a financial professional to balance future uncertainty with your overall investment goals.
Frequently Asked Questions (FAQs)
What are the causes of a double-dip recession?
Generally, monetary policy has been the driving force behind double-dip recessions in past years.
When was the last double-dip recession in the United States?
The most recent double-dip recession occurred from 1980 to 1982. Before that, the last double-dip recession happened in the 1930s.
Source: https://www.thebalancemoney.com/what-you-need-to-know-about-double-dip-recessions-5084424
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