What is a recession? Definition, what does it mean for economy, and is UK going into a recession in 2022

With the cost of living crisis forcing consumers to cut back on spending, supply chain issues and record interest rates, businesses are struggling to operate

The UK appears set to fall into a recession in the coming months, with economic growth already stalling and gloomy forecasts growing more numerous by the day.

It comes against a tough backdrop for people and businesses up and down the UK. The cost of living crisis - which is being driven by record inflation rates - is making it harder to spend money.

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Household resources have been further squeezed by a real-terms drop in wages and rising unemployment. Meanwhile, big name businesses have already been going bust due to the major financial pressures they face.

As if these issues were not bad enough, interest rates have been rising throughout the year - spiking in the wake of the inflationary mini budget delivered by the Liz Truss government in September. While the situation has been steadied by Rishi Sunak since he became Prime Minister, the consequences of Truss’s premiership are likely to be with us for some time.

During his autumn statement on 17 November, the Chancellor Jeremy Hunt laid bare the major economic headache facing the country - although his solutions have not been welcomed by everyone. The austerity-lite budget he has delivered means we are all likely to be paying higher taxes for some time yet.

So, with dark economic clouds gathering overhead, what is a recession - and what happens when one hits?

There are growing fears the UK is headed for another recession (Pic: Getty Images)

What is a recession?

A recession is when a country experiences economic decline. The UK’s wealth is calculated by its GDP. When the GDP rate falls below zero, it means the economy is shrinking.

If the GDP declines for two quarters in a row (a period of six months), this is defined as a recession. A recession is problematic for a country because it means consumers and businesses are likely to be spending less cash. It therefore means the government is unlikely to be able to generate as much money from taxation.

The Bank of England plays a key role alongside the government in making the UK economy work (image: AFP/Getty Images)

Is the UK going into a recession?

A recession has been on the cards for several months. The economy has been struggling to grow much throughout 2022, growing by just 0.4% in the first quarter of the year, according to the ONS. It has declined marginally in recent months.

The UK’s economy is faltering because of record inflation, staff shortages and supply chain issues - all of which have created an environment of low consumer and business confidence. If these two groups that drive the economy don’t feel optimistic, they will spend less and, in the case of businesses, could reduce activity.

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The Bank of England has predicted that the UK will enter a recession in late 2022 and says it could be the longest on record. It expects the economy will decline by between 0.1% and 1% in each quarter until at least 2024.

In a recession, money is less likely to move around the economy (image: PA)

The UK central bank has also predicted that real-terms household income will fall back by 1.75% over the next 12 months, before recovering by 2025, and households will spend around 1.5% less over the next two years. While these numbers do not sound significant, they will likely translate into a major fall in tax receipts.

Meanwhile, business investment is expected to have fallen back by 10% by the end of 2024. Businesses borrow money to invest in their current operations or expand, so - when it becomes more expensive to borrow, as it has done this year - the private sector’s output tends to diminish.

The general public also borrows money to fund things like house purchases. Given stamp duty is one of the biggest income streams for the UK treasury, any slowdown in this market is likely to either reduce public spending or increase government borrowing.

Currently, all the signs are that the Bank of England’s predictions of a recession will come true. At the start of October, the services and manufacturing sectors both reported slowdowns in output.

UK economic output is expected to reduce across the economy (image: Getty Images)

For services, the S&P Global and CIPs index (based on a survey of thousdands of UK businesses) showed the sector stagnated for the first time in 18 months. Inflationary pressures have increases supply costs, while some companies have also had to freeze recruitment.

In manufacturing, the same index showed the sector contracted for its third month in a row. Rising economic uncertainty, inflation and the cost of living crisis had all forced customers to postpone or cancel orders, the survey said.

What happens in a recession?

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When economic growth turns into economic decline, businesses tend to look for ways to save money. Some companies go out of business altogether.

This activity means investment is likely to be reduced, jobs are cut and, ultimately, the government receives less money through taxation. In the last major recession in 2008, unemployment levels peaked at 10%.

In the recession we’re expecting, The Bank of England expects unemployment will rise from around 3.5% to just under 6.5% by mid-2025 - although its worst case scenario says it could climb to just short of 9%.

For consumers who hold onto their jobs, they are less likely to receive pay increases - something which can severely dent their purchasing power when inflation is high. This in turn means they are unlikely to spend money on anything other than basics, such as food, fuel and household costs.

A direct consequence of all of this reduced spending is that house prices tend to drop. In turn, this means the Treasury struggles to raise as much tax through stamp duty - one of its major income streams.

How long does a recession last?

The length of time a recession lasts depends on the measures the government put in place to help revive the economy. According to Forbes Magazine, the average recession in the USA lasts for 11 months.

After the 2008 recession, it took the UK five years to get its economy back on to the size it was before the fallout. This current recession could last for 2 years, the Bank of England says.

Staff from Lehman Brothers leave their offices in London, 2008 (Pic: Getty Images)

When was the last UK recession?

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The last time the UK entered a recession was August 2020. Due to the Covid-19 pandemic, businesses closed with many people losing their jobs and GDP fell by 20.4%.

The most famous recession to hit the UK was the crash of 2008. Dubbed the great recession, it was caused by rising energy prices and the collapse of the housing market.

This recession lasted for five quarters and was the longest one on record since the second world war. The downturn of 2008 was global, impacting all of the G7 countries.

High inflation means consumers are likely to spend less money on products and services they don’t deem to be essential (image: Getty Images)

What happens when there are high rates of inflation?

Recession is more likely when inflation is high. The current rate of inflation in the UK is 11.1% - the highest it’s been for more than 41 years.

As most wages have not kept pace with this level of inflation, consumers are likely to be experiencing a hit to their purchasing power. This scenario means they are unlikely to be spending money on anything beyond basic items or services, which, in turn, dents companies’ sales.

Given businesses have also been hit by rising costs, they are likely to be reducing investment. Ultimately, this chain of events leads economic growth to decline or stall completely.

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