Cost of living analysis: What exactly is a recession?

There's a lot of chat about a looming recession for New Zealand and the fear a shrinking economy will hit Kiwis hard.

But is there any truth to the talk? And is a recession always negative?

The Reserve Bank (RBNZ), after earlier this week raising the official cash rate by 50 basis points to 4.75 percent in an ongoing effort to tame stubbornly high inflation, said it was still forecasting a recession sometime this year and interest rates peaking at about 5.5 percent.

"While this recession is assumed to be spread over several quarters from the middle of this year, there is considerable uncertainty about the timing," the RBNZ's monetary policy statement said. "The extent of the underlying contraction may also be masked by volatility in activity due to the recovery from the severe storms throughout the North Island."

What is a recession?

By definition, a recession is when there are two successive quarters of negative GDP growth.

"GDP is 'gross domestic product' and it's the way economies try to measure their output," said Bruce O'Leary, a financial advisor from Milford Asset Management. "If you have that shrinking… After adjusting for inflation, and going backward, then there's a view that it's going to be very hard for companies to grow their earnings and make money, and there's going to be other repercussions."

That's why the markets get concerned about potential looming recessions, O'Leary told AM on Friday.

"We've just come through some of the most rapid interest hikes in over 40 years… and that's a big amount to raise in what is a relatively short space of time - and those interest rate hikes don't hit the economy immediately.

Bruce O'Leary.
Bruce O'Leary. Photo credit: AM Early

"We're still actually waiting on the economic impact of a lot of these rate hikes," O'Leary said.

He noted the RBNZ had no choice but to be aggressive with hiking interest rates because inflation was "simply too high".

But such hikes to slow demand brings with it the risk of economic contraction and, late last year, the RBNZ admitted it was deliberately trying to engineer a recession to bring spiralling inflation, sitting at 7.2 percent, under control. 

"Central banks are using their one blunt tool to try and slow down demand and that one blunt tool is interest rates and, by hiking those, they will cool off demand but they've got a fine line to walk," O'Leary said. "They don't necessarily want to cause a recession but they do need to bring inflation down - it's simply too high and it's way above where their mandates are trying to guide them to be."