What Is a Double-Dip Recession?

How Does a Double-Dip Recession Work?

Double-dip recessions occur when there is an economic shock during the early stages of a recovery that follows a recession. The economy is already weakened, leaving it vulnerable to the cycle of reduced spending, rising unemployment, and reduced credit. Therefore, it falls back into a recession.

Double-dip recessions can also be called W-shaped recessions. Each point in the "W" represents the economy at different points: It's high, then low, then on the rise again before dipping a second time. Then, there's an official recovery.

How Do Recessions Work?

According to the National Bureau of Economic Research, a recession is a "decline in economic activity spread across the economy that lasts more than a few months." Recessions can be triggered by any number of events or economic shocks, including:

Runaway inflation in excess of 10%, as in the late 1970s

• Monetary policy change, such as increasing interest rates and reducing available credit
• Crisis in the financial system, such as the subprime mortgage crisis of 2008-2009
• Pandemics

Whatever the reason, consumers lose confidence and reduce spending. Businesses falter, and jobs are lost. Banks extend less credit to businesses and consumers, which further reduces spending and employment, and the misery continues to spread across the economy.

How Do Recoveries Work?

A recovery is the process of returning from a recession to previous levels of economic activity and growth. Conditions become favorable for businesses to begin hiring. Unemployment declines, consumers gain confidence and begin spending, banks resume extending credit, and the recovery (ideally) takes off, leading to an economic expansion.

Examples of Double-Dip Recessions

Only two double-dip recessions have occurred in the last 90 years. The first was from 1937 to 1938, the second from 1981 to 1982. Both of them were triggered by changes in monetary policy.

The Double Dip of 1937

The U.S. economy began to recover from the Great Depression in 1933. For the next three years, unemployment fell from 25% to 14%, and the economy grew at an annual rate of 9%. But in 1936, the Federal Reserve became concerned about potential runaway inflation and systematically reduced the capacity of the banks to provide credit to business and consumers.

At the same time, the Social Security payroll tax took effect in 1937. The veterans' bonus of 1936 (a spending stimulus) was removed. Higher taxes, reduced credit, and reduced spending were enough to interrupt the recovery from the Great Depression.

The end result was a double-dip recession lasting from May 1937 until June 1938. Unemployment rose to 19% and gross domestic product (GDP) fell by 4.5%.

The Double Dip of 1982

The short recession of January 1980 through July 1980 was brought on by the sharply increased price of oil and prolonged high inflation, which peaked at 14.6% in the spring of that year. As the economy began to recover, the Fed dramatically increased interest rates in an effort to bring inflation under control.

Skyrocketing interest rates, peaking at a prime rate of 21.5% in December 1980, pulled the economy back into a recession, which lasted through most of 1982. Mortgage rates were over 18% in October 1981, making homeownership virtually impossible for most first-time buyers.

What Does a Double-Dip Recession Mean for Investors?

During both double-dip recessions in the county's recent history, the stock market pulled back, dropping 35.34% in 1937 and 4.7% in 1981. Both recovered sharply in the following year.

In the past, stocks have done well during periods of expansionary monetary policy when the Fed has used interest rates, open market operations, and reserve requirements to increase economic activity.

The possibility of a double-dip recession is a good reason to review your investment plan if you haven’t already. Make sure you are comfortable with your risk levels and allocations to stocks, bonds, and other assets. Are you financially positioned to withstand a market downturn, should one occur?

Examine the companies in your stock, mutual fund, and exchange-traded fund (ETF) portfolio. Are they financially strong? Do your investment strategies need to be adjusted to accommodate a possible downturn?

If you don’t have an investment plan, it's always a good time to build one. Consider getting help from a financial professional to balance the uncertainty of the future with your overall investment goals.

Frequently Asked Questions (FAQs)