What Is the Relationship Between Recessions and Unemployment?

Economies go through ups and downs, just like we do. When they are hot, workers are needed to fulfill the demands of consumers. When they cool down, people start losing their jobs.

In fact, increasing unemployment rates can be an important indicator to predict if our economy is headed for, or already in, a recession.

Let’s take a closer look at how recessions can impact the job market and employment rates.

A recession is defined as “significant decline in economic activity that is spread across the economy and lasts more than a few months,” according to the National Bureau of Economic Research (NBER), a nonprofit organization that investigates and analyzes major economic issues.[1]

Since the Great Depression, the U.S. economy has gone through 14 recessions. While the Great Depression lasted 43 months and is the longest recession on record, the average length of a recession since then has been around 12.5 months. The shortest recession our economy has ever experienced lasted only two months and took place in 2020 during the COVID pandemic.[2]

Maybe, maybe not. No one really knows for sure.

Persistent inflation, supply chain chaos and the Russian invasion of Ukraine are disrupting economies left and right. The U.S. economy also shrank by an annualized rate of 1.4% in the first quarter of 2022, a leading indicator that things aren’t as good as they seem.[3,4]

But we simultaneously have low unemployment and a record number of jobs that aren’t being filled, which usually doesn’t happen in a recession.

That said, from singer Cardi B to JPMorgan Chase Chief Executive Officer Jamie Dimon, many people are expressing concern that a recession is looming.[4]

Definitions are varied, but experts in the financial industry “look for slowdowns in the economy,” says Danene Cronin, a financial advisor and vice president of wealth management at Morgan Stanley. “When we see higher energy costs, higher housing costs, higher food costs (14 consecutive months of increases), we see signs of inflation.”

“Energy alone is up significantly this year, taking money out of people’s pockets, taking money away from living expenses,” she says. “The impact on individuals directly correlates to the pressure businesses also face, with tightening economic conditions and potential slowdowns in goods, services and the economy.”

Determining if we’re officially in a recession is ultimately down to the NBER’s Business Cycle Dating Committee. The NBER's definition emphasizes that a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months.[4] NBER analyzes real-time economic reports by Federal agencies, looking closely at a number of key factors, including: unemployment rates and income, consumer spending, manufacturing production levels and gross domestic product (GDP), the value of goods and services produced in a country.[1,4,5]

If you lose your job, you are officially unemployed. However, if you decide against looking for a new job and choose to stay home (which doesn’t mean you’re not working, we know) you are no longer unemployed. By the government’s definition you’re not part of the labor force anymore, and do not count as employed or unemployed.

These definitions are some 80 years old, and the world of work has obviously changed significantly, with the gig economy among the reasons. Such newer nuances are not necessarily captured in the unemployment figures the government puts out every month. However, for the purposes of this explainer, these are the definitions used by the government.

The Bureau of Labor Statistics (BLS) is the federal organization that measures unemployment rates and issues a monthly report that is closely watched for signs of things to come.[10]

Unemployment rates can be indicative of economic health, particularly when it comes to recessions. In fact, employment data from the BLS is one of the key factors used by the NBER’s Business Cycle Dating Committee to track economic trends that may foreshadow the beginning or end of a recession. [1,2,4]

As of May 2022, unemployment rates are holding steady at 3.6%, which is among the lowest ever. It’s an odd place to be given that inflation is at 40-year highs. Normally, you’d see layoffs starting to happen, but the demand for workers continues to remain at near-record highs. That said, if inflation persists, we could see hiring dry out and layoffs pick up.[4,6]

When we’re in a recession, there tends to be a dip in overall consumer spending. This can create less demand for products and the employees needed to make and sell them. Companies don’t want to hold onto expensive staff without enough revenue coming in to pay their salaries, and they start laying people off. Unemployment rates go up, people ease up on spending and the economy goes down.[6] That can create a cycle that’s difficult to break.

“It’s a vicious circle,” says Cronin. “In a recession, consumer confidence and spending decreases, leading to businesses cutting jobs which contributes to the increase in unemployment.”

In April 2020, during the most recent (and shortest) recession, unemployment skyrocketed to 14.8%, the highest rate on record since the Great Depression’s more than 25%. The rate came down to 5.4% by July 2021.[1,6,7]

The Federal Reserve, the U.S. central bank, is the superhero in times of recession. Or, at least, that’s what it’s supposed to be. It sometimes missteps, but don’t we all?[8,9]

The Fed was created in 1913 to smooth out boom-and-bust cycles in the economy. Among its super powers:

• Adjusting reserve requirements: how much banks have to hold to make sure it can meet the need if we all go demanding our money back immediately

• Buying bonds: by buying bonds, the Fed increases the money supply in the economy

• Targeting interbank lending rates: the Fed can lower the rate banks use to lend to each other, making it cheaper

It all boils down to nudging interest rates lower to boost the economy by encouraging spending and lending.

There’s more that can be done. The government can give us money to help get things started.

For example, during the pandemic, the CARES Act was passed, providing $4.6 trillion in emergency assistance–remember those stimulus checks? During the Great Recession in the 2000’s, the American Recovery Act and Reinvestment Act of 2009 provided $800 billion to stimulate economic activity and create jobs through infrastructure projects and more.[8,9]

It’s clear that recessions and unemployment are linked. Unusual combinations of factors seen in 2022, however, with low unemployment and high inflation, make those ties harder to interpret.