What is a recession, and is the U.S. headed for a recession

Younger generations often associate the word “recession” with catastrophe—and for good reason.

From December 2007 to June 2009, the Great Recession led millions of Americans to lose their homes and livelihoods. It was the worst economic downturn since the Great Depression of the 1930s, and it traumatized several cohorts that left college or graduate school with little hope of finding a good job as the labor market took nearly a decade to fully recover.

For a significant percentage of the population, 2008’s collapse is the only true recession they’ve ever experienced—if you don’t count 2020’s short-lived COVID-induced downturn. As a result, when Americans see dire predictions of impending economic doom or a “major” recession from billionaires and investment banks, most tend to freak out.

The reality is, however, that recessions are a normal part of business cycles, and even as expert predictions of an “everything bubble” or a global economic meltdown abound, not every economist foresees a worst-case scenario.

A recession is far from guaranteed, experts including Harvard economist Jason Furman point out; and even if one does come, most economists agree the likelihood of it turning out to be a once-in-a-lifetime all-out collapse like 2008 is slim.

“Recessions, they’re an unavoidable fact of economic life,” Stephen Miran, the cofounder of Amberwave Partners and a former senior adviser at the U.S. Department of the Treasury, told Fortune. “We were fortunate in the previous cycles to have gone a pretty long time without a recession. But actually, you know, recessions happening has been the norm throughout most of economic history.”

Miran argues that it’s more likely the U.S. economy will fall into what he calls a “garden variety recession,” rather than a financial crisis like was seen in 2008.

Not every recession is 2008

It’s important to remember that not every recession is created equal: While they all bring terrible hardship and involve widespread job losses—disproportionately hurting the low end of the income distribution—some are worse than others.

And despite the stock market’s recent turbulence and the rising odds of a recession, there are plenty of reasons to remain upbeat about the prospects of the U.S. economy, even if growth comes to a halt for consecutive quarters.

“We’re a little more optimistic than doom and gloom for sure,” Kelly Bouchillon, a senior partner at Sound View Wealth Advisors in Savannah, Ga., told Fortune. “Corporate America has never had more cash on its balance sheets. Bank surveys show that the consumer is not overladen with consumer debt. And there’s a lot of cash in people’s checking accounts. So there seems to be a fair amount of spending power.”

“I think that the doom and gloom side of this may have led the equity markets to possibly overshoot to the downside,” he added.

Miran explained that, while every economic downturn is different, the U.S. economy has experienced two main types of recessions since the end of World War II.

The first is the “garden-variety” recession, where the economy “overheats,” causing inflation to rise. This leads the Federal Reserve to increase interest rates and “crush demand to try to crush inflation,” and a recession ensues.

It’s the most common type of recession that the U.S. has seen in postwar history, Miran says, but there’s another, much more dangerous type of recession called a “balance-sheet recession.”

That’s when a “debt bubble” emerges, leading households and consumers to spend a significant portion of their income paying down debt instead of spurring economic activity. The aftermath of this type of recession is a slow recovery and mass unemployment. Sound familiar?

“It typically takes about 10 months from the low in unemployment to recover to pre-recession employment levels in a typical recession,” Miran said. “For the dot-com [bubble] and the global financial crisis, it took about three times that amount, about 32 months, to recover to pre-recession unemployment levels.”

Miran added that he believes we are more likely headed for the former than the latter.

“It’s the cascading defaults that come out of too much debt that we don’t have right now,” he explained.

Bouchillon agrees that a recession like what was seen in 2008 is unlikely to be the outcome for the U.S. economy, and he’s not even sure we will experience a recession at all.

“The big thing in 2008, remember, what happened was really borderline fraud in the economy because you had all these people that were borrowing money [to buy homes] that really couldn’t afford it,” he said.

The bad debt floating around the financial system in 2008 led to an “implosion,” but since then, there have been a number of changes to the banking system, chief of which was the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The legislation introduced a number of measures designed to regulate the financial sector and protect consumers, including the establishment of the Consumer Financial Protection Bureau, a whistleblower program, and stress test requirements for banks that helps determine whether these institutions have enough capital to withstand an economic crisis.

While some of the Dodd-Frank act was rolled back under President Donald Trump, protections against debt bubbles today are still more robust than they were in 2008.

In Bouchillon’s view, these measures, and much stronger household balance sheets, will help prevent a 2008-style collapse. The greater threat to the U.S. economy, he argues, is stagflation, where economic growth slows, but inflation remains elevated.

But don’t discount rising risks

While many experts contend that the U.S. economy is unlikely to experience the type of recession that was seen in 2008, there are still a number of mounting risks that investors and consumers should consider.

First, the personal savings rate—or the percentage of consumers’ disposable income that is saved each month—fell to 4.4% in April, its lowest level since September 2008, when Lehman Brothers went bankrupt. For comparison, from 1959 to 2019, the personal savings rate averaged 11.8%, according to research from the St. Louis Federal Reserve.

Second, inflation remains near four-decade highs, and the Federal Reserve is set to continue raising interest rates until, as Fed Chair Jerome Powell puts it, there is “clear and convincing” evidence that inflation is under control.

Bouchillon noted that the central bank has struggled to prevent a recession in the past when raising interest rates.

“The track record of the Federal Reserve trying to get to target inflation by hiking rates, is, I think close to 80% of the time we wind up in what you would call a technical recession. So I think there’s a chance that’ll happen,” he said.

Marc Goldwein, senior vice president and senior policy director for the Committee for a Responsible Federal Budget, told Bankrate in April that even if the Fed doesn’t instigate a recession as it attempts to fight rising consumer prices, “there’s going to be pain that we create.”

“That is a reality, but inflation is too painful. You can’t juice the economy forever and expect that it’s sustainable. You have to rip off the Band-Aid before it gets even worse,” he added.

Finally, investment banks continue to sound the alarm about the increasing risk of a recession and its potential impact on employment and the stock market.

While most aren’t outright calling for a recession, many are warning that the risk of a recession has risen, and some noted bulls have recently changed their tune when it comes to the potential for an economic downturn.

Mark Haefele, UBS Global Wealth Management’s chief investment officer, has for months now brushed off fears of a recession, advising in a May 13 note, for example, that investors should avoid “a hasty exit from markets” as the firm’s “central scenario” is that “a recession will be avoided over the next 12 months.”

In a Friday research note, Haefele took a different stance when discussing the Fed’s attempt to secure a “soft landing” for the U.S. economy—where inflation is reined in without instigating a recession.

“The path to achieving this is narrow. If Fed policymakers underestimate the strength of the US economy, we face an extended period of above-target inflation. If they overestimate it, we face a recession. And we can’t know with great conviction which path we’re on,” he wrote.