What is an Economic Recovery
An economic recovery is a stream of improved business activity indicating the end of a recession. Much like a recession, an economic recovery is not always easy to recognize until at least several months after it has begun. Economists use a variety of indicators, including gross domestic product (GDP), inflation, financial markets and unemployment to analyze the state of the economy and determine whether a recovery is in progress.
BREAKING DOWN Economic Recovery
An inextricable feature of a free market economy is its ebb and flow. The economy grows and contracts in alternating periods as it constantly strives to find equilibrium. The economic cycle measures these ever-present gyrations in the economy.
The Economic Cycle
The economic cycle, or business cycle, features four phases: expansion, peak, contraction and trough. Recessions occur during the contractionary phase, though not every period of contraction is severe enough for designation as a recession. In the United States, the most widely accepted measure of a recession is two consecutive quarters of GDP decline.
When the economy hits rock bottom in a recession, a trough is signaled. The recovery that follows coincides with the expansionary phase. Common features of economic recovery and expansion include GDP growth, stock market gains, declining unemployment and higher consumer confidence.
The final phase, the peak, occurs when the economy has grown as much as possible in a given cycle. Following the peak, a new period of contraction sets in — which may or may not trigger a recession — and the economy absorbs the excesses generated during expansion.
Economic Recovery and Leading vs. Lagging Indicators
Some confusion commonly results from the use of both leading and lagging indicators in analyzing whether an economic recovery is in progress. Leading indicators, such as the stock market, often rise ahead of an economic recovery. This is because future expectations drive stock prices. On the other hand, employment is typically a lagging indicator. Unemployment often remains high even as the economy begins to recover because many employers will not hire additional personnel until they are confident there is a long-term need for new hiring.
Leading and lagging indicators work both ways. For example, prior to the Great Recession of 2007-2009, the Dow Jones Industrial Average (DJIA) peaked in October 2007 before pulling back in advance of the recession, which began in December 2007. The unemployment rate, by contrast, remained at 5%, a level associated with full employment, until April 2008, five months into the recession, and did not exceed 6% until August 2008.
Economic Recovery Example
The economic recovery from the Great Recession began in June 2009. Real GDP, which had contracted by 5.4% in the first quarter of 2009 and 0.5% in the second quarter, began growing again in the third quarter of 2009. The DJIA, a leading indicator, had already been rising for four months after bottoming out in February 2009. However, the unemployment rate, a lagging indicator, continued to spike until October 2009, at which point it peaked at 10% before abating as the recovery gained strength.