Investing

Need more time to file taxes? Fill out IRS extension Form 4868

Reviewed by Lea D. Uradu
Fact checked by Vikki Velasquez

Taxpayers unable to file their federal income tax return by the filing deadline can apply for an extension with the Internal Revenue Service (IRS) Form 4868: Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. 

The extension does not extend the time to pay taxes owed but only extends the deadline to fill out and submit the paperwork.

Key Takeaways

• Form 4868 gives taxpayers a six-month extension to file federal income tax returns.
• An extension for federal income tax returns due on April 15 delays the submission until Oct. 15.
• Filing the IRS extension form doesn’t extend the time to pay owed taxes, which are still due by April 15.
• Those who need an extension must submit Form 4868 by the normal April tax filing deadline.

Reasons to Request an Extension

By obtaining the extension, taxpayers avoid any late filing penalties. A late filing penalty of 5% of the amount due for each month or part of the month is incurred if the return has missed the April filing deadline. For returns more than 60 days late, the minimum penalty is $510 or the balance due, whichever is smaller.

Some reasons taxpayers may need additional time to file income taxes include:

• Missing a Schedule K-1 from a trust in which the taxpayer is a beneficiary.
• Self-employed individuals may need additional time to set up and fund a simplified employee pension (SEP) retirement plan.
• Taxpayers who are living or working out of the country.

Note

Certain taxpayers may file their federal tax returns online for free directly with the IRS through the Direct File program. This service is available to people who lived in the following states in 2024:

Alaska, Arizona, California, Connecticut, Florida, Idaho, Illinois, Kansas, Maine, Maryland, Massachusetts, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Oregon, Pennsylvania, South Dakota, Tennessee, Texas, Washington state, Wisconsin, Wyoming

Tax filers must submit state tax returns separately. Refer to the IRS website to see if you qualify.

Download Form 4868

All versions of Form 4868 are available on the IRS website.

Note

Depending on the U.S. state, filing Form 4868 may also provide an automatic extension for the state income tax filing deadline.

Who May File Form 4868?

Taxpayers who want more time for any reason to file federal income tax returns may use Form 4868, which includes extensions for Form 1040: U.S. Individual Tax Return, Form 1040-SR: U.S. Tax Return for Seniors, Form 1040-NR: U.S. Nonresident Alien Income Tax Return, Form 1040-PR: Self-Employment Tax Return-Puerto Rico, and Form 1040-SS: U.S. Self-Employment Tax Return.

What Information Is Required on Form 4868?

Taxpayers must provide their name, address, Social Security number, and their spouse’s Social Security number if applicable. An estimate of final taxes is required, and if the taxpayer expects to owe taxes, they need to pay the balance with the form.

Does Form 4868 Give Filers More Time to Pay Taxes?

No, a taxpayer’s payment is still due on the original due date, usually April 15. When submitting Form 4868 to the IRS, taxpayers should send in a payment of the estimated balance due. The IRS allows individuals to skip filling out Form 4868 entirely if they pay their estimated income tax due online or by phone using Direct Pay, EFTPS, or a credit or debit card and indicate that the payment is for an extension.

Do Taxpayers Living Abroad Need to File an Extension?

A two-month filing extension is automatically given to a U.S. citizen or resident who lives outside of the U.S. or Puerto Rico, whose place of work is outside of the U.S. or Puerto Rico, and those in the military or naval service on duty outside the U.S. or Puerto Rico.

The Bottom Line

Form 4868 is available to any U.S. taxpayer needing extra time to file their federal tax return. By completing and sending it to the IRS, they will receive a six-month tax return due date extension into October. Although the paperwork deadline is extended, owed taxes are still due by the April filing date.

Reviewed by Charlene Rhinehart
Fact checked by Vikki Velasquez

Tier 1 capital, under the Basel Accord, measures a bank’s core capital. The Tier 1 capital ratio measures a bank’s financial health, its core capital relative to its total risk-weighted assets (RWA). Under Basel III, banks and financial institutions must maintain a minimum Tier 1 capital ratio to ensure against unexpected losses such as those that occurred during the financial crisis of 2008.

Key Takeaways

• Tier 1 capital is a bank’s core capital, including common stock, disclosed reserves, and certain other assets.
• The Tier 1 capital ratio compares a bank’s equity capital with its risk-weighted assets. It is used to measure the bank’s capital adequacy.
• Under the rules of the Basel III framework, banks should maintain a minimum tier 1 capital ratio of 10.5%.

Tier 1 Capital Explained

Tier 1 capital includes a bank’s shareholders’ equity and retained earnings. Risk-weighted assets are a bank’s assets weighted according to their risk exposure. For example, cash carries zero risk, but there are various risk weightings that apply to particular loans such as mortgages or commercial loans. The risk weighting is a percentage that’s applied to the corresponding loans to achieve the total risk-weighted assets. To calculate a bank’s tier 1 capital ratio, divide its tier 1 capital by its total risk-weighted assets.

6%

The minimum Tier 1 capital ratio. 4.5% of that must be common equity tier 1 capital (CET1).

Tier 2 Capital

Tier 2 capital is composed of any supplementary capital the bank has, such as loan-loss and revaluation reserves and undisclosed reserves. Tier 2 capital is considered separately in bank risk analysis because it is usually less secure than Tier 1 capital.

Tier 1 Capital Requirements

The Tier 1 capital ratio can be expressed as all of a bank’s core capital or as the Tier 1 common capital ratio or CET1 ratio. The CET1 ratio excludes preferred shares and non-controlling interests from the total Tier 1 capital amount; therefore, it is always less than or equal to the total capital ratio.

Under the Basel Accords, banks must have a minimum capital ratio of 8% of which 6% must be Tier 1 capital. The 6% Tier 1 ratio must be composed of at least 4.5% of CET1.

The Basel III requirements were fully implemented in 2019, requiring banks to have a mandatory “capital conservation buffer” of 2.5% of the bank’s risk-weighted assets, which brings the total minimum CET1 to 7% (4.5% plus 2.5%). If there is high credit growth, banks may need an additional buffer of up to 2.5% of risk-weighted capital composed of CET1 capital.

Loans are Assets for Banks

Although it appears counterintuitive, loans are considered assets for banks because banks earn revenue from loans in the form of interest from borrowers. On the other hand, deposits are liabilities since the bank pays interest to deposit holders.

Example of Tier 1 Capital Ratio Calculations

Regulators use the tier 1 capital ratio to determine whether a bank is well capitalized, undercapitalized, or adequately capitalized relative to the minimum requirement.

For example, bank ABC has shareholders’ equity of $3 million and retained earnings of $2 million, so its tier 1 capital is $5 million. Bank ABC has risk-weighted assets of $50 million. Consequently, the bank’s tier 1 capital ratio is 10% ($5 million/$50 million), and it is considered to be well-capitalized compared to the minimum requirement.

On the other hand, bank DEF has retained earnings of $600,000 and stockholders’ equity of $400,000. Thus, its tier 1 capital is $1 million. Bank DEF has risk-weighted assets of $25 million. Therefore, bank DEF’s tier 1 capital ratio is 4% ($1 million/$25 million), which is undercapitalized because it is below the minimum tier 1 capital ratio under Basel III.

Bank GHI has tier 1 capital of $5 million and risk-weighted assets of $83.33 million. Consequently, bank GHI’s tier 1 capital ratio is 6% ($5 million/$83.33 million), which is considered to be adequately capitalized because it is equal to the minimum tier 1 capital ratio.

What’s the Difference Between Tier 1 and Tier 2 Capital?

Tier 1 capital represents a bank’s core capital, consisting of common stock and retained earnings. The tier 2 capital consists of supplemental capital including undisclosed reserves, revaluation reserves, and subordinated term debt. When tier 1 capital represents less than 6% of the banks risk-weighted assets, the bank may not have enough capital to absorb unexpected losses.

What’s the Difference Between Tier 1 Capital and CET1 Capital?

CET1, or common equity tier 1, is a subset of tier 1 capital that comprises the bank’s common equity stock and cash. There is also a separate category, additional tier 1 capital, comprising instruments that can be readily converted to CET1 capital. Together, CET1 and additional tier 1 make up the bank’s Tier 1 capital.

What Is Basel III?

Basel III is an international regulatory accord designed to increase the resiliency of the global financial sector. It was established by a consortium of central banks after the 2008 financial crisis, and established minimum standards for capital adequacy in the banking sector to reduce the impact of future crises.

The Bottom Line

The tier 1 capital ratio is used to measure a bank’s financial health. It is calculated by dividing the bank’s core capital—the value of its common stock and retained earnings—divided by the bank’s risk weighted assets. In the event of a financial crisis, this figure reflects the bank’s ability to absorb losses without causing losses to its depositors.

Reviewed by Andy Smith
Fact checked by Vikki Velasquez

Financial Accounting: An Overview

Financial accounting is the process by which an organization’s revenue, receivables and expenses are collected, measured, recorded and finally reported in financial statements.

The objectives of financial accounting are to:

• Accurately reflect business and financial activity
• Help companies meet legal, fiscal and statutory requirements
• Present financial accounts to business owners
• Allow for in-depth financial analysis
• Facilitate efficient resource allocation
• Allow third parties, such as auditors, investors, and financial analysts, to assess the activities and value of a company

Broadly, financial accounting is an important tool that companies can use to avoid financial risks and achieve success.

Structuring Financial Accounting

Companies have two basic ways that they can structure their business’s accounting policy.

Publicly traded companies must use the accrual accounting method which is standardized by generally accepted accounting principles (GAAP).

The accrual method reports revenues as they are accrued as opposed to when they are received. Expenses are reported as they are incurred rather than when they are paid.

Many private companies use GAAP to guide their accounting but they are not required to do so. Private companies also have the option to use the cash accounting method.

Key Takeaways

• The objectives of financial accounting include recording business and financial activities for analysis by management and third parties, such as investors and investment analysts.
• Companies that review their financial statements throughout the year can see their progress and make informed decisions about current and future operations.
• Shareholders and creditors have financial stakes in companies and great interest in their financial statements.
• Responsible financial accounting promotes trust in companies.
• It helps a company meet its tax and compliance obligations, as well.

Understanding Financial Accounting

In a practical sense, the main objective of financial accounting is to accurately prepare a business’ financial accounts for a specific accounting period.

Once the company’s financial activities are recorded, they can be reported by its financial statements. Primary financial statements include the income statement, the balance sheet and the statement of cash flows.

A company’s financial statements serve several purposes:

1. They are used internally by management to manage both the current operations and future activities of the firm.
2. They provide important information to shareholders and creditors, each of which has a financial stake in a company.
3. In addition, investors and analysts use a company’s financial statements to analyze, through the use of financial ratios and other analytic tools, how successful the company has been at earning revenue, building profits, and increasing its value.

The Benefits of Financial Accounting

The work involved in financial accounting has enormous benefits for a company, its stakeholders, and potential investors. Here are some of them:

1. It provides the foundation for accurate financial statements that are available to the public. Supposedly, anyone seeking a transparent view of a company’s financial health can turn to its financial statements.
2. It can build trust for management, investors, creditors, and others in how a company operates and its value.
3. That transparency and trust can open up access to credit opportunities and attract more investors.
4. Data offered by financial accounting can help companies make their operations more effective, increase revenues, cut costs, and build profits.
5. Reliable financial accounting enables companies to meet their tax and compliance obligations.
6. By studying their financial statements, companies can detect and reduce instances of fraud, and other financial risks.
7. Consistent financial accounting can help to ensure a company’s ongoing financial stability and longevity.

Important

Formal financial accounting standards became a focus after the 1929 stock market crash and during the Great Depression when the Securities Act of 1933 and the Securities Exchange Act of 1934 mandated that public companies had to be audited to ensure the accuracy of their financial statements.

Financial Reporting Standards

In the United States, financial reporting standards are set forth by the Financial Accounting Standards Board (FASB) and required under GAAP for publicly traded companies.

The FASB is contracted by the Securities and Exchange Commission (SEC) to control the approved methods and applications of financial accounting.

Following these reporting standards makes it easier for individuals to understand the financial statements of various companies, as they are presented in the same manner and therefore easier to follow.

Financial accounting is normally performed by those individuals who have studied the methods, concepts, history, and laws related to its practice. In the U.S., these individuals are referred to as certified public accountants (CPA).

The SEC requires that public companies annually report their financial statements and that this reporting is done by an impartial third party, which is where CPAs come in to play.

This ensures that the financial statements have been properly created under all required policies.

The American Institute of Certified Public Accountants (AICPA)

The American Institute of Certified Public Accountants (AICPA) is an industry-leading organization in the area of financial accounting. It has over 597,000 members worldwide.

The AICPA is a leading source of research and alerts on topics of interest in the accounting profession. The AICPA is also responsible for developing and grading the Uniform CPA Exam.

In 1973, the AICPA released a study entitled “The Objectives of Financial Statements.” The study was pivotal for the accounting industry, with objectives adopted by the FASB.

The study was also released the same year that the FASB was created, which replaced the work of the AICPA in developing accounting standards for the accounting industry.

Today financial accounting standards and objectives can be found through the FASB’s website.

Who Uses a Company’s Financial Accounting?

The management of the company itself uses its financial accounting. So do lenders, vendors, investors, regulatory agencies, and auditors.

What Financial Statements Report a Company’s Financial Accounting?

Financial statements can differ from company to company. But four main statements are the balance sheet, the income statement, the statement of cash flows, and the statement of retained earnings (also called the statement of shareholder’s equity).

How Do I Know That Financial Accounting Is Correct?

A company’s financial accounting is governed by recognized standards and principles of accounting, such GAAP. Usually, it’s prepared by one or more CPAs who uphold proper accounting standards. And financial statements that report the financial accounting of public companies are audited for truth and accuracy. However, financial accounting can be manipulated to deceive auditors and the public.

The Bottom Line

Financial accounting is meant to help companies track and monitor their revenues, income, and expenses so that they can run their businesses more effectively for their own benefit and that of other stakeholders.

Accurate, transparent financial accounting allows for better decision-making by company management, potential and existing investors, vendors, creditors, auditors, and regulators.

The funds hold special-issue U.S. government securities, redeemable as needed

Reviewed by Ebony Howard
Fact checked by Vikki Velasquez

Social Security trust funds are accounts managed by the U.S. Treasury. The two funds take in Social Security payroll taxes from workers and their employers and pay out benefits to Social Security recipients. They invest any surplus in special issue U.S. government debt securities.

Key Takeaways

• Social Security trust funds receive payroll taxes, pay out benefits, and invest any surplus in special government securities.
• In contrast to publicly traded U.S. government debt, these securities can be redeemed at face value at any time to pay fund obligations.
• The interest rate on new securities acquired by the trust funds is the average of market yields for traded U.S. government debt with terms of more than four years.
• In 2021, Social Security costs exceeded total income, including interest, for the first time.
• A 2024 analysis revealed that the trusts are expected to be able to pay full benefits only until 2035.

What Are the Social Security Trust Funds?

The Social Security trust funds are used by the U.S. government to manage surplus contributions to the Social Security system. They are funded through a withholding tax that deducts a set percentage of pretax income from each paycheck. If contributions made by workers and employers exceed what’s needed to fund benefits payments to retired and disabled workers, the funds invest the surplus in U.S. government debt.

Important

Employees and employers pay 6.2% apiece in payroll taxes on income below an annual cap, set at $168,600 for 2024 and $176,100 for 2025. If you’re self-employed, you pay the full 12.4%.

How the Social Security Trust Funds Work

Social Security relies on two legally separate trust funds: the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund. The OASI Trust Fund is used to pay benefits to retired workers and their families, as well as to the families of deceased workers. The DI Trust Fund covers benefits for disabled workers and their families.

The OASI trust fund receives 10.6% of employee earnings covered by Social Security payroll taxes, and the DI trust fund the other 1.8%. Otherwise, the two funds work similarly.

Whenever workers and employers pay more money into the Social Security system than it needs at the same time to pay benefits to the current beneficiaries, those “excess” contributions are invested in special U.S. government securities. That allows the federal government to borrow money from the trust funds for purposes other than Social Security, while the trust funds earn investment income with the lowest possible risk.

What Securities Do the Trust Funds Own?

The Social Security trust funds are limited by law to investing their reserves in U.S. government debt. Although the funds have held marketable securities in the past, they typically and currently own only special U.S. debt issued expressly for use by the trust funds. In contrast to the Treasury securities sold to the public, which are only guaranteed to return face value when redeemed at maturity, the special issue debt held by the trust funds may be redeemed at face value at any time if needed to meet current obligations.

The special government securities come in two types: short-term certificates of indebtedness, which mature on the following June 30, and bonds with a term of one to 15 years. The short-term certificates and bonds issued to the Social Security trust funds are not traded in the bond market or available to the public. Like other Treasury securities, however, they are backed by the full faith and credit of the U.S. government.

The interest rate on the special issues is set by a formula established in 1960 through amendments to the Social Security Act. For special issue debt issued to the trust funds in a given month, the interest rate is the average market yield on the last day of the prior month for marketable U.S. government debt securities not due or callable for more than four years, rounded to the nearest one-eighth of a percentage point.

In 2024, the trust funds earned an effective interest rate of 2.5%, while the average of the 12 monthly rates for the debt they purchased that year was 4.3%. In March 2025, the interest rate for new special issue debt bought by the Social Security trust funds was 4.25%.

$2.54 trillion

OASI asset reserves at the end of 2024.

Current Social Security Finances

The 2024 annual report from the Social Security and Medicare Boards of Trustees updated the financial projections for the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund.

Combined OASI and the Disability Trust Funds

The OASI and Disability Insurance (DI) trust funds had combined asset reserves of $2.79 trillion at the start of 2024. For both, the trustees projected 2024 Social Security expenditures of $1.48 trillion, exceeding the expected income of $1.38 trillion. The Hospital Insurance (HI) Trust Fund was expected to increase reserves in 2024.

The OASI Trust Fund

The trustees’ 2024 report predicted the OASI Trust Fund’s reserves will run out in 2033, same as predicted in the previous year’s report. Once the fund is depleted, ongoing payroll tax receipts will cover 79% of the scheduled Social Security benefits for retirees, their families, and survivors.

The Disability Insurance (DI) Trust Fund

The DI reserves are now projected to be sufficient over the next 74 years, with the 2024 report stating DI reserves will be able to pay out 100% of benefits through 2098. The DI Fund is legally separate from OASI, so transferring money from it to allow the payment of full retirement benefits before those reserves were also exhausted would require action by Congress.

Demographics and Taxes

For the 75-year projection period, the actuarial deficit is 3.5% of taxable payroll (down from 3.61% the previous year). In other words, Social Security taxes would need to increase by 3.5% to fix the problem for at least 75 years.

The Baby Boomer generation, whose older members have begun collecting Social Security benefits, is much larger than the cohorts of the youngest workers replacing it in the workforce. With the U.S. population growing older on average and fewer workers left to support each retiree than previously, Social Security’s long-term financial prospects are unlikely to improve meaningfully without reform no matter how well the economy is performing.

182.8 million

The number of people who paid Social Security taxes in 2023. About 58.6 million received monthly Social Security benefits, while an additional 8.5 million received DI benefits.

The Future of the Social Security Trust Fund

Social Security is a pay-as-you-go system, with tax receipts pooled and immediately available to pay benefits to retired workers and others. For many years, the payroll tax income funding Social Security was more than sufficient to cover the benefits being paid out. Over time, the two Social Security trust funds accumulated combined reserves that peaked at $2.9 trillion at the start of 2020.

However, the program’s benefits payouts exceeded tax receipts in 2021, and deficits are expected to widen in the coming years as the ranks of beneficiaries grow faster than the workforce supporting them. The OASI Trust Fund’s $2.6 trillion in reserves at the end of 2023 is expected to run out in 2033 unless Congress acts to shore up the system’s funding.

How Much Money Is in the Social Security Trust Fund?

At the start of 2024, the Social Security trust funds had $2.79 trillion dollars for OASI and DI. This was a decrease in reserves from roughly $2.83 trillion in 2023 due to an annual deficit. Another annual deficit was forecast for 2024 for both OASI and DI.

Who Owns the Social Security Trust Fund?

The Social Security trust funds are owned by the U.S. Department of the Treasury. There are two trust funds: The Old-Age and Survivors Trust Fund (OASI) and the Disability Insurance (DI) Trust Fund. The securities in the funds are all issued by the U.S. federal government.

What Happens to the Money Once It Goes Into the Social Security Trust Fund?

Once money goes into the Social Security trust funds, it is invested in government securities. All funds are on the books of the Treasury. When Social Security benefits need to be paid, these securities are redeemed for cash and paid out to the beneficiaries.

The Bottom Line

The two Social Security Trust Funds—the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund—are managed by the U.S. Department of the Treasury. The accounts are funded through payroll taxes on working individuals, and the money is invested in U.S. securities. At the start of 2024, the funds had approximately $2.79 trillion in assets with the expectation that the trust funds combined would not have enough money to pay out full benefits by 2035.

Fact checked by Vikki Velasquez

Gaining residency and moving to a new country can be the dream of a lifetime and you can do just that in Golden Visa programs available in countries around the world. It won’t be cheap, however.

Golden Visa programs require a significant economic investment into the country where you’ll be living, but they can be a great way to live abroad if you can afford it.

Key Takeaways

• A Golden Visa allows you to gain residency in a country in exchange for making a large economic investment there.
• A Golden Visa investment can be real estate, a bank deposit, investment funds, or government bonds.
• More than 100 countries offer Golden Visa programs.
• President Trump has announced a $5 million Golden Card program for the United States.

What Is a Golden Visa?

A Golden Visa allows you to gain residency in a country after making a large investment in the country’s economy. The amount of the investment varies by country.

Golden Visa investment options include real estate, business development, a bank deposit, government bonds, and investment funds.

Many Golden Visa programs include family members so you’re free to include them on your application.

What Countries Have Golden Visas?

More than 100 countries around the globe offer Golden Visa programs and more than 60% of EU member countries have active programs. Countries with popular Golden Visa programs include Greece, Portugal, Italy, Malta, Canada, the United Kingdom, and Australia.

Important

You’re unfortunately out of luck if you’re looking to obtain a Golden Visa into Spain. The country is ending its Golden Visa program on April 3, 2025.

How Much Do Golden Visas Cost?

The price of an investment into a Golden Visa program varies by country. Portugal’s Golden Visa program comes with a price tag as high as $500,000 Euros, Italy and Greece require investments of 250,000 Euros in their Golden Visa programs.

President Donald Trump announced a $5 million Golden Visa program for the United States in February 2025, called a Gold Card.

How Do I Apply for a Golden Visa?

If you want to apply for a Golden Visa, you must first decide on an investment in the country where you’re looking to gain residency. Will you buy real estate, make a business investment, or purchase government bonds?

You’ll also have to provide several documents, including a passport, health insurance, proof of your investment, and proof that you can support yourself financially. You’ll have to go through a series of background checks.

How long do you have to wait after submitting your Golden Visa application? You’ll receive a response within six months or less from most programs. Some applications are processed as quickly as a couple of months.

Not every country is swift with managing Golden Visa applications, however. Wait time for applicants to Portugal stretches to about two years.

The Bottom Line

An international retirement may be within your reach if you qualify for a Golden Visa and receive residency in the country where you’d like to live. You’ll have to spend a good deal of money, however. Golden Visas require making investments into the country that can range from hundreds of thousands of dollars to millions depending on the country you choose.

The investment can be real estate, government bonds, a bank deposit, or investment funds. A Golden Visa program may be just the way to gain residency in another country if this is something you can financially handle.

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration in an industry. It measures the market concentration of the 50 largest companies in a particular industry to determine if that industry should be considered competitive or as close to being a monopoly.

Market concentration in an industry is determined by examining the number of companies that manufacture or market a particular product or line of products, along with the relative distribution of market share in terms of sales for each company within the industry. Economists consider the concentration of market share to be an important determinant in the viability of market competition and consumer choice.

Key Takeaways

• The Herfindahl-Hirschman Index, or HHI, looks at the market concentration in an industry to determine if the industry provides healthy competition or is veering close to being a monopoly.
• Federal regulators consider the HHI when they are debating whether to approve a corporate merger, as they want to promote healthy competition and avoid the creation of monopolies.
• The HHI is calculated by taking the sum of the squared market shares of the 50 biggest companies in an industry.
• The simplicity of the calculation is both its biggest advantage and disadvantage—it’s easy to calculate but so basic that it doesn’t account for the nuances and complexities of certain markets.

Advantages and Disadvantages of the Herfindahl-Hirschman Index

The primary advantages of the Herfindahl-Hirschman Index (HHI) are the simplicity of the calculation necessary to determine it and the small amount of data required for the calculation. The primary disadvantages of the HHI stem from the fact that it is such a simple measure that it fails to take into account the complexities of various markets in a way that allows for a genuinely accurate assessment of competitive or monopolistic market conditions.

The basic simplicity of the HHI carries some inherent disadvantages, primarily in terms of failing to define the specific market that is being examined in a proper, realistic manner. For example, consider a situation in which the HHI is used to evaluate an industry determined to have 10 active companies, and each company has about a 10% market share. Using the basic HHI calculation, the industry would appear highly competitive. However, within the marketplace, one company might have as much as 80% to 90% of the business for a specific segment of the market, such as the sale of one specific item. That firm would thus have nearly a total monopoly for the production and sale of that product.

Another problem in defining a market and considering market share can arise from geographic factors. This problem can occur when there are companies within an industry that have roughly equal market share, but they each operate only in specific areas of the country, so that each firm, in effect, has a monopoly within the specific marketplace in which it does business.

Pros

• Provides a simple calculation for the level of competitiveness in an industry.

• Does not require extensive data, aside from market shares.

Cons

• Does not account for the complexities of various markets.

• Does not account for situations where a single company has market dominance over specific geography or p

Note

The HHI does not account for nuances, such as the fact that while there may be a number of companies active in an industry, implying healthy competition, one company might control the majority of the business for the sale of one specific product, which suggests a potential monopoly.

How the Herfindahl-Hirschman Index Is Calculated

The calculation for the HHI is the sum of the squared market shares of the 50 largest companies in an industry. The calculation for the HHI is simple and straightforward, requiring only basic market data, which is the primary advantage of using the HHI.

The HHI value can range anywhere from near 0 up to 10,000. A higher index value means that the industry is considered to be closer to monopoly conditions. Generally, a market with an HHI value of under 1,000 is considered to be competitive.

The U.S. Justice Department and the Federal Trade Commission (FTC) are wary of any mergers that would result in an HHI value over 1,000 and are likely to disapprove any merger that would result in an HHI value over 1,800.

Example of HHI Risk

Imagine a hypothetical industry of fifty companies, each with about 2% market share nationwide. Using only the formula and the available data, the Herfindahl-Hirschman index for that industry is 50*2²=200, suggesting a highly competitive market.

However, the Herfindahl-Hirschman index does not account for regional variations of market dominance. It is possible (however unlikely) that each of the fifty companies each have monopolistic market dominance in one of the fifty U.S. states. In that case, the healthy-seeming market would be much less competitive than the index calculation suggests.

Important

A market with an HHI of less than 1,000 is seen as competitive, while one with an HHI of over 1,000 is seen as being at risk for veering toward a monopoly; regulators are likely to shoot down any merger requests that result in an HHI value above 1,800.

How Do You Calculate the Herfindahl-Hirschman Index?

The Herfindahl-Hirschman index is calculated by adding up the squared market shares of the top fifty companies in a given industry. For example, imagine an industry where two market leaders control 26% of the market each, and 48 smaller companies have a market share of 1% each. The Herfindahl-Hirschman Index for that industry is 26²+26²+48*(1²)=1,400.

Because it is significantly higher than 1,000, this would be considered a highly concentrated industry.

What Does the Herfindahl-Hirschman Index Tell You?

The Herfindahl-Hirschman index is a measure of the amount of competition in an industry. A high Herfindahl-Hirschman index indicates a near-monopolistic level of control by a handful of companies, while a low index indicates a more competitive playing field.

Who Uses the Herfindahl-Hirschman Index?

The Herfindahl-Hirschman index is used by regulators to predict how policy changes would affect the level of competition in an industry. If a proposed merger or acquisition would result in an unacceptably high index level, regulators would be likely to reject the proposed corporate action.

The Bottom Line

The Herfindahl-Hirschman index is a convenient way to measure the competitiveness in an industry or market sector. Although it is computationally simple, it does not always account for all of the differences between companies and products.

Reviewed by Marguerita Cheng
Fact checked by Kirsten Rohrs Schmitt

Cyclical vs. Non-Cyclical Stocks: An Overview

The terms cyclical and non-cyclical refer to how closely correlated a company’s share price is to the fluctuations of the economy. Cyclical stocks and their companies have a direct relationship to the economy, while non-cyclical stocks repeatedly outperform the market when economic growth slows.

Investors cannot control the cycles of the economy, but they can tailor their investing practices to its ebb and flow. Adjusting to economic transitions requires an understanding of how industries relate to the economy. There are fundamental differences between companies that are affected by broad economic changes and those that are virtually immune to them.

Key Takeaways

• Cyclical stocks are volatile and tend to follow trends in the economy.
• Non-cyclical stocks outperform the market during an economic slowdown.
• Companies of cyclical stocks sell goods and services that many buy when the economy is doing well but cut during downturns, such as luxury goods.
• Non-cyclical companies sell staple goods like food and clothing and household consumables like soap and toothpaste.
• Cyclicals tend to go up and down with the economy, while non-cyclical stocks are steady earners in good times and bad.

Cyclical Stocks

Cyclical companies follow the trends in the overall economy, which makes their stock prices very volatile. When the economy grows, prices for cyclical stocks go up. When the economy turns down, their stock prices will drop. They follow all the cycles of the economy from expansion, peak, and recession all the way to recovery.

Cyclical stocks represent companies that make or sell discretionary items and services that are in demand when the economy is doing well. They include restaurants, hotel chains, airlines, furniture, high-end clothing retailers, and automobile manufacturers. These are also the goods and services that people cut first when times are tough.

When people delay or stop buying anything dispensable, the revenues of the companies that produce and sell them fall. This, in turn, puts pressure on their stock prices, which start to drop. In the event of a long downturn, some of these companies may even go out of business.

Investors may find opportunities in cyclical stocks hard to predict because of the correlation they have to the economy. Since it’s hard to predict the ups and downs of the economic cycle, it’s tricky to guess how well a cyclical stock will do.

Note

Cyclical industries make or sell products that we can live without or delay buying when times are tough. Examples include luxury goods, non-business travel, and new construction.

Non-Cyclical Stocks

Non-cyclical stocks repeatedly outperform the market when economic growth slows. They may also be known as consumer staples since they are always in demand as basic needs.

Non-cyclical securities are generally profitable regardless of economic trends because they produce or distribute goods and services we always need, including things like food, power, water, and gas. The stocks of companies that produce these goods and services are also called defensive stocks because they can defend investors against the effects of an economic downturn. They are great places in which to invest when the economic outlook is sour.

For example, non-durable household goods like toothpaste, soap, shampoo, and dish detergent may not seem like essentials, but they really can’t be sacrificed. Most people don’t feel they can wait until next year to lather up with soap in the shower.

A utility company is another example of a non-cyclical. People need power and heat for themselves and their families. By providing a service that is consistently used, utility companies grow conservatively and do not fluctuate dramatically.

This is a key fact about non-cyclical stocks. They provide safety, but they are not going to skyrocket in price when the economy grows.

Investing in non-cyclical stocks is a good way to avoid losses when highly-cyclical companies are suffering.

Example of Cyclical vs. Non-Cyclical Stocks

Below is a historical example that uses a chart showing the performance of a highly-cyclical company, the Ford Motor Co. (F), and a classic non-cyclical company, Consolidated Edison Inc. (ED). This chart clearly demonstrates how each company’s share price reacts to downturns in the economy.

Notice that the downturn in the economy in 2020 drastically reduced Ford’s share price, whereas Con Ed’s share price barely blinked at the slowdown. However, as the economy recovered, Ford once again began to outperform, while the utility remained stable.

This is because cars are considered discretionary goods that are cyclical to the economy. When there is a recession, people choose not to spend on a new car in order to save money for basic needs. Moreover, more people will be unemployed, and those people may search for a used car instead.

On the other hand, regardless of one’s employment or the state of the economy, people still need water and electricity in their homes. That means people will still pay their utility bills, even when they begin to struggle financially.

What Are Some Examples of Cyclical Stocks?

Cyclical stocks tend to be for expensive durable goods, luxury, or leisure. Therefore, stocks in the automotive industry, consumer durables, airlines, luxury goods makers, and hospitality stocks would be prime examples.

What Are Consumer Cyclical Stocks?

Sometimes analysts break down cyclical stocks into consumer and non-consumer. A non-consumer cyclical would be a company that sells to businesses, governments, or large organizations and which is also sensitive to the state of the economy. A consumer cyclical would be a cyclical stock that markets to individuals or households.

What Types of Stocks Are Non-Cyclicals?

Non-cyclical stocks are companies from which people will continue to consume their products even during an economic downturn. These often include consumer staple goods, food, gasoline, utilities, and pharmaceuticals/healthcare.

The Bottom Line

Cyclical companies follow the trends in the overall economy, and therefore their stock prices are volatile. Non-cyclical companies produce consumer staples that are always in demand regardless of the state of the economy. Therefore, non-cyclical stocks can be profitable regardless of economic trends, and they can outperform the market when economic growth slows.

Investing in non-cyclical stocks is considered to be safer than investing in cyclical stocks. During economic turndowns, non-cyclical companies won’t produce the losses that highly-cyclical companies do. But for the same reason, when the economy grows, non-cyclical stocks won’t surge in price either.

Reviewed by David Kindness
Fact checked by Vikki Velasquez

In 2013, the U.S. Bureau of Economic Analysis announced a change to the way it estimates gross domestic product (GDP). Going forward, it was going to include intangible assets in its calculations of investments in the economy.

The change significantly boosted economic growth calculations, adding nearly $560 billion to GDP. Now that intangible assets are considered long-lived assets in the economy, accountants will have to amortize their amount over time when preparing financial statements.

Amortization is an important concept not just to economists, but to any company figuring out its balance sheet.

Key Takeaways

• Amortization is an accounting method that calculates the expenses incurred by an intangible asset resulting from regular use and then systematically deducts these expenses from its value over time.
• Unlike depreciation, which accounts for the reduction in the value of tangible assets, amortization is only used for intangible assets, which can’t be seen, touched, or felt.
• While amortization appears in the balance sheet as a reduction in an asset’s carrying value or book value, it appears in the income statement as an expense.

How Amortization Works

Amortization refers to capitalizing the value of an intangible asset over time. It’s similar to depreciation, but that term is meant more for tangible assets.

Amortization occurs when the value of an intangible asset, such as research and development (R&D) or a trademark, is reduced over a specific time period, usually the asset’s estimated useful life.

A good way to think of this is to consider amortization to be the cost of an asset as it is consumed or used up while generating value for a company or government. Along with the useful life, major inputs into the amortization process include residual value and the allocation method, the last of which can be on a straight-line basis.

A more specialized case of amortization occurs when a bond purchased at a premium is amortized down to its par value as the bond reaches maturity. When a bond is purchased at a discount, the discount is reduced each period in a process known as accretion. The concept is again referring to adjusting value over time on the balance sheet, with the amortization amount reflected in the income statement.

Generally speaking, an asset can be amortized if its benefits will be realized over a period of several years or longer. With a shorter duration, such as days or months, it is probably best and most efficient to expense the cost through the income statement and not count the item as an asset at all.

Yet, companies often amortize one-time expenses, classifying them as capital expenses on the cash flow statement and paying off the cost over time. Doing this allows companies to report increased net income in the fiscal quarter or year that the expense occurred, as the cost is spread over multiple quarters or years instead of all at once.

Examples of Intangible Assets

Tangible assets are physical assets, such as land, machinery, vehicles, or inventory. In contrast, intangible assets assets can’t be seen or touched. Examples include customer lists and relationships, licensing agreements, service contracts, computer software, and trade secrets (such as the recipe for Coca-Cola). Goodwill is another major intangible asset. It used to be amortized over time but now must be reviewed annually for any potential adjustments.

A good example of how amortization can impact a company’s financials in a big way is the purchase of Time Warner in 2000 by AOL during the dot-com bubble. AOL paid $162 billion for Time Warner, but AOL’s value plummeted in subsequent years, and the company took a goodwill impairment charge of $99 billion. In previous years, this amount would have been amortized over time, but it must now be evaluated annually and written down if, as in the case of AOL, the value is no longer there.

GAAP vs. IFRS

Firms must account for amortization as stipulated in major accounting standards. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) both have similar definitions of what qualifies as an intangible asset, but there are differences in how their values must be adjusted over time.

For instance, development costs to create new products are expensed under GAAP (in most cases) but capitalized (amortized) under IFRS. GAAP does not allow for revaluing the value of an intangible asset (except for certain marketable securities), but IFRS does. This means that GAAP changes in value can be accounted for through changing amortization schedules or potentially writing down the value of an intangible asset, which would be considered permanent. Finally, GAAP stipulates that advertising expenditures be expenses as incurred, but IFRS does allow recognizing a prepayment of these expenses as an asset, which would be capitalized or amortized as they are used at a later date.

What’s the Difference Between Depreciation and Amortization?

The difference separating depreciation and amortization lies in the types of assets they cover. While depreciation is used for tangible assets, like machinery and inventory, amortization is used for intangible assets, such as intellectual property or computer software.

Where is Amortization Found on the Balance Sheet?

Typically, amortization is classified as a contra-asset account on the balance sheet. You can often find this information below the line for the unamortized intangible asset.

What is an Amortization Schedule?

The amortization schedule shows the allocation of an intangible asset’s cost over its useful life. For a loan, the amortization schedule details the breakdown of each payment toward the loan principal and interest.

The Bottom Line

Amortization reflects the fact that intangible assets have a value that must be monitored and adjusted over time. The amortization concept is subject to classifications and estimates that need to be studied closely by a firm’s accountants and auditors, who must sign off on financial statements.

Reviewed by Margaret James
Fact checked by Vikki Velasquez

Fighting Food Inflation: An Overview

American consumers are paying 23.6% more for food today than they did in 2020, based on the Consumer Price Index.

It’s not a problem that is going away soon. In 2025, food prices overall are projected to rise another 3.4%. There’s no relief to be found even in egg prices. The USDA expects their cost to rise another 41.1% in 2025.

Unless your income has increased at an equally rapid rate, your budget is under stress.

Here are 22 ways to relieve the burden.

1. Eat at Home

Dining out is an expensive proposition. Many of the meals that you pay for in a formal restaurant can be made at home for a fraction of the price. Even good coffee is cheaper to make if you do it yourself.

One study prices a home-cooked meal at an average of $4.31 per person compared to $20.37 for a restaurant meal. Those increasingly popular home meal kits cost an average of $12.53.

Fast-food restaurants were excluded from the study. While high-calorie, low-quality food can be had at bargain prices, the impact on your long-term health overrides the benefit of short-term savings.

2. Shop With a Plan

If you wheel around the grocery store and fill your cart with everything that catches your eye, you’ll spend more than if you had prepared a shopping list in advance. Plan your meals for the week ahead and make careful note of the ingredients you need to prepare those dishes.

Purchase only the items on the list and avoid impulse buys.

3. Put On Blinders

Grocery stores are designed to lead you through a maze to get to the most basic items you need. It’s intended to encourage a few impulse purchases along the way.

If you keep to your planned list of foods, you won’t be tempted when you get forced down the junk food aisle to get to the milk.

Most necessities and basic cooking items are found along the outside perimeter of the store. Start there and work your way around the edge of the store, only stepping into the maze to grab any leftover items on your list.

4. Eat Before You Shop

When you are hungry and you walk into a building full of food, there’s a high likelihood that you are going to fill your cart with unnecessary and expensive purchases that appeal more to your taste buds than your budget. To keep your costs down, eat first and shop on a full stomach.

5. Avoid Prepared Foods

Our fast-paced society encourages convenience, and the food industry has capitalized on this trend.

Ready-made meals are easy to buy but come with a premium price tag. Instead of putting that rotisserie chicken and macaroni salad in your cart, buy the ingredients and prepare the meal yourself.

The same concept applies to frozen entrees, baked goods, ready-made sandwiches, ready-to-nuke meal kits, and any other prepared food.

6. Skip the Bottled Water

If you have reservations about the water that comes out of your tap, buy a water filter. The per-gallon cost is significantly less than the cost of bottled water.

The math is compelling: Tap water costs about 2 cents per gallon, while a 16-ounce bottle of water is about $1.50. A simple faucet-mounted water filter can be bought for under $35, with much more elaborate filtration systems costing $100 and up.

7. Shop Without the Kids

Hungry, tired, and cranky kids increase the cost of grocery shopping. Every extra minute that you spend in the store increases the likelihood of you buying more—including toys and snacks meant to keep the kids quiet while you try to focus on finding some bargains.

Supermarkets target kids, too. There’s a reason the sugary cereals are displayed at a kid’s eye level.

8. Buy in Bulk

Bulk buying can save you a lot. Pay attention to the posted unit prices and pick up the family-size package, if the per-unit cost is lower and you have a place to store it.

Shopping at big-box bulk retailers like Sam’s Club and Costco can also save on your bill if you shop there enough to cover the membership dues.

However, pay attention to your spending habits. The prices at the big boxes are not necessarily a bargain compared to the regular sales and discounts at other stores. Their family-size packaging also could lead you to buy more than you need, driving up your grocery bill.

9. Use Store Reward Cards

If the store that you visit most frequently has a rewards card, sign up. Some stores raise their prices for shoppers who don’t use reward cards.

If the card offers other benefits, such as a ham for the holidays or a discount on gasoline, maximize your benefits by paying attention to the cutoff dates and cashing in your points before they expire.

10. Use Coupons

Coupons provide an easy way to save money. Whether you use the old-fashioned paper coupons or find them online, grab them and cash them in. Pay extra attention to stores that double the value of manufacturers’ coupons.

Get into the habit of checking both the major online coupon sites and apps and the sites of supermarkets where you shop. A few minutes of online browsing can make a difference.

11. Buy Locally

Locally grown or produced food is usually available for less because you’re not paying transportation or middleman costs.

Farmers’ markets, fairs, and the local aisle at your grocery store are all game for deals on high-quality fresh food.

12. Look Down

Supermarkets often place the most expensive items at eye level. To find less expensive choices, look down.

Also, looking around your brand-name food can find you a cheaper generic alternative. Generic label products are often identical to name-brand goods and are often produced in the same factory, so don’t pay extra for the name-brand packaging.

13. Avoid End Caps and Checkout Extras

The displays placed at the end of aisles and near the checkouts often feature premium brands.

Walk down the aisle. Chances are good that you’ll be rewarded with a less expensive option. Many grocery stores now offer checkout lines that don’t display candy. Use these lanes and you can save money and avoid impulse buys.

14. Compare Prices and Stores

Comparing brands and prices at your local stores is an easy way to shave a few cents off your purchases.

The store that has the lowest average prices in your area is often the best place for routine shopping, but a higher-priced competitor may run sales on specific items that undercut the cost at your usual venue.

15. Shop for Sales

Sales can be a great incentive to switch stores, but only if you need the items on sale.

Pay attention to sales on necessity items and stock up on non-perishables and freezer goods. Keep an eye on the regular prices so that you know when a sale price is a small saving or a significant discount.

16. Watch for Expiration Discounts

You are virtually guaranteed a discount on products that are close to their “sell by” or “best before” date approaches. If the “sell by” date hasn’t passed, the product is fine.

For example, grocery stores lower prices as meat gets close to its expiration date, so ask the butcher when the meats get marked down. Most stores follow a fairly regular schedule.

When you get a good deal, stock your freezer so you can avoid buying when the price is high. If you plan on freezing the food, “best before” dates aren’t a concern.

17. Substitute Recipe Items

If you have a higher-priced item that reoccurs in your favorite recipes, it may be time to shake up your taste buds. Often a lower-priced alternative can be found.

For instance, if you bake with olive oil and you see that the price has skyrocketed, a switch to applesauce is a great cheap and low-fat substitution for many recipes.

18. Keep Your Kitchen Stocked

A well-stocked kitchen means that you won’t run out of staple items and need to buy them on the spur or the moment. Knowing what you have in the cabinet means that you can wait to make your purchases until these items are on sale.

19. Shop Infrequently

Reducing the number of trips that you make to the store each week or month reduces the odds of unnecessary purchases and minimizes the amount of gasoline you use getting there.

20. Time the Sales

Weekly sales often run from mid-week to mid-week. Hold off on your shopping until after you’ve had a chance to grab the week’s coupons.

Shopping during the evening or early morning helps you avoid the rush.

21. Pay in Cash

When you put groceries on your credit card and don’t pay off the card in full each month, you’re adding heavy interest charges to your food bills. To avoid this extra cost, pay in cash when you shop and keep these regular charges off of your credit cards.

22. Check Your Bill

Electronic scanners make the shopping experience faster and more convenient, but scanners aren’t perfect. Be sure to take a look at the receipt to make sure your coupons and discounts were properly credited.

Why Have Food Prices Been Rising So Rapidly?

Food prices began climbing unusually rapidly in 2020. This was explained as a result of the COVID-19 pandemic. The pandemic disrupted the global food supply chain, leading to shortages in many products. Food prices rose 3.5% that year, but peak food price inflation hit in 2022. Food prices rose 9.9% that year, the worst increase since 1979.

Food prices are leveling off now, but that doesn’t mean they’re declining to pre-COVID levels. They’re just increasing at a slower pace. Another 3.5% increase is projected for 2025.

What Foods Have Been Hardest Hit by Inflation?

In 2025, consumers can expect above-average price increases on eggs, sugar and sweets, nonalcoholic beverages, and fresh fruit, according to the USDA.

Egg prices are under pressure for a reason quite separate from the Covid pandemic. More than 150 million birds have been slaughtered since early 2022 in an effort to control the avian flu epidemic.

How Much Have Food Prices Risen Lately?

Between 2020 and 2024, U.S. food prices rose by a whopping 23.6%, based on the Consumer Price Index.

Other categories were hard hit during the same period. Transportation costs were up 34.4%. Housing costs rose 23%.

The Bottom Line

It takes a little time, patience, and effort to reduce your food bill, but it will have a substantial impact on your budget every month.

Reviewed by Somer Anderson
Fact checked by Vikki Velasquez

The National Bureau of Economic Research (NBER) defines a recession as a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale retail trade. It is caused by a chain of events in the economy, such as disruptions to the supply chain, a financial crisis, or a world event.

A recession can also be triggered after an inflationary period. When inflation increases, central banks raise interest rates to slow the economy with the goal of bringing down inflation. With higher interest rates, the probability of a recession increases, leading to layoffs, fewer jobs, and decreased consumer and corporate spending, among other effects found in a slowing economy.

As companies and consumers become anxious about the economy, they hold onto their money and cut spending. Businesses are forced to reallocate resources, scale back production, limit losses, and lay off employees as the economic downturn intensifies. Trends during a recession include an increase in the unemployment rate and a decrease in gross domestic product (GDP) for two consecutive quarters.

Key Takeaways

• A recession is a trend of simultaneously slowing business and consumer activity, leading to negative growth as measured by gross domestic product (GDP) and other data, such as the unemployment rate, wage growth, and the like.
• Financial, psychological, and real economic factors can cause recessions, such as supply chain disruptions or a financial crisis.
• The recession in 2020 was affected by COVID-19 and the preceding decade of extreme monetary stimulus that left the economy vulnerable to economic shocks.
• Though the economy has grown since 2022, some economists say a recession is still possible by the end of 2025.

Signs of a Recession

The standard macroeconomic definition of a recession is two consecutive quarters of negative GDP growth. When this occurs, private businesses often scale back production and try to limit exposure to systematic risk. Measurable levels of spending and investment are likely to drop, and a natural downward pressure on prices may occur as aggregate demand slumps. GDP declines and unemployment rates rise because companies lay off workers to reduce costs.

At the microeconomic level, firms experience declining margins during a recession. When revenue—whether from sales or investment—declines, firms look to cut their least efficient activities. For example, a firm might stop producing low-margin products or reduce employee compensation. It might also renegotiate with creditors to obtain temporary interest relief. Unfortunately, declining margins may force businesses to reduce employment to cut costs further.

Important

A range of financial, psychological, and real economic factors are at play in any given recession.

Causes of a Recession

There are financial, psychological, and fundamental economic factors that can lead to the cascade of business failures that constitute a recession. Some theories look at long-term economic trends that lay the groundwork for a recession in the years leading up to it. Others look only at the immediately visible factors that appear at the onset of a recession. Many or all of these various factors may be at play in any given recession.

Financial Factors of a Recession

Financial factors can contribute to an economy’s fall into a recession, as during the 2007–2008 U.S. financial crisis. The overextension of credit and debt on risky loans and marginal borrowers can lead to an enormous buildup of risk in the financial sector. The expansion of the supply of money and credit in the economy by the Federal Reserve and the banking sector can drive this process to extremes, stimulating risky asset price bubbles.

Artificially suppressed interest rates during the boom times leading up to a recession can distort the structure of relationships among businesses and consumers. It happens by making business projects, investments, and consumption decisions that are interest rate-sensitive, such as buying a bigger house or launching a risky long-term business expansion, appear much more appealing than they ought to be. The failure of these decisions when rates rise to reflect reality constitutes a major component of the rash of business failures that make up a recession such as that of 2007–2008.

Psychological Factors of a Recession

Psychological factors are also frequently cited by economists for their contribution to recessions. The excessive exuberance of investors during the boom years brings the economy to its peak. The reciprocal doom-and-gloom pessimism that sets in after a market crash, at a minimum, amplifies the effects of real economic and financial factors as the market swings.

Moreover, because all economic actions and decisions are always forward-looking to some degree, the subjective expectations of investors, businesses, and consumers are often involved in the inception and spread of an economic downturn.

Interest Rates

Interest rates are a key link between the purely financial sector and the real economic preferences and decisions of businesses and consumers.

Economic Factors of a Recession

Real changes in economic fundamentals, beyond financial accounts and investor psychology, also make critical contributions to a recession. Some economists explain recessions solely due to fundamental economic shocks, such as disruptions in supply chains, and the damage they can cause to a wide range of businesses.

Shocks affecting vital industries such as energy or transportation can have such widespread effects that they cause many companies across the economy to retrench and cancel investment and hiring plans simultaneously, with ripple effects on workers, consumers, and the stock market.

There are economic factors that can also be tied back to financial markets. Market interest rates represent the cost of financial liquidity for businesses and the time preferences of consumers, savers, and investors for present versus future consumption. In addition, a central bank’s artificial suppression of interest rates during the boom years before a recession distorts financial markets and business and consumption decisions. All of these factors may cause a recession over time.

In turn, the preferences of consumers, savers, and investors place limits on how far such an artificially stimulated boom can proceed. These manifest as economic constraints on continued growth in labor market shortages, supply chain bottlenecks, and spikes in commodity prices (which lead to inflation). When not enough resources can be made available to support all of the business investment plans, a rash of business failures may occur due to increased production costs. This situation may be enough to tip the economy into a recession.

Impact of COVID-19 Pandemic on the Economy

In February 2020, the National Bureau of Economic Research (NBER) announced that, according to its data, the United States was in a recession due to the economic shock of the widespread disruption of global and domestic supply chains and direct damage to businesses across all industries. These events were caused by the COVID-19 epidemic and the public health response.

Some of the underlying causes of the two-month recession (and economic hardship) in 2020 were the overextension of supply chains, razor-thin inventories, and fragile business models.

The pandemic-related recession, according to NBER, ended in April 2020.

Are There Any Risks of a Recession as of March 2025?

As of March 2025, a number of economic data points are positive, including:

• A rate of inflation down to 2.8% as of February 2025
• Fourth quarter (4Q) 2024 GDP growth of 2.3%
• A strong job market in which jobs are still rising
• Low unemployment at 4.1% as of October 2024

The Fed slowed the pace of its interest rate increases in 2023, aiming for an upper limit final Fed funds target rate of 5.5%, also referred to as the terminal rate. As of February 2025, the effective federal funds rate was 4.33%.

Higher interest rates make everything from home mortgage rates to credit card rates rise, which eats away at consumer spending, ultimately the key driver of U.S. economic activity. By easing interest rates while inflation and unemployment remain low, the Fed hopes to deliver a soft landing (lower inflation and a minor slowdown in the U.S. economy), rather than a hard landing (where inflation comes down at the expense of economic growth and employment). A hard landing would be likely to result in a recession.

Economists will continue to pay special attention to the state of consumer spending, unemployment, and job creation as the main bellwethers of a recession.

What Is a Recession?

A recession is when economic activity turns negative for a sustained period of time, the unemployment rate rises, and consumer and business activity are cut back due to expectations of a weak growth environment ahead. While this is a vicious cycle, it is also a normal part of the overall business cycle, with the only question being how deep and long a recession may last.

Is the Fed Still Raising Interest Rates?

The Fed raised rates in July 2023, to a range of 5.25% and 5.5% after a pause. As of December 2024, however, the rate has decreased to a range of 4.25% to 4.50%.

Do Prices Go Down in a Recession?

Prices often go down in a recession because people are buying less, which means businesses lower prices to encourage consumer spending. Not all prices decrease, however. Some items, such as food and gas, may see price increases, especially if there is a decreased supply or increased demand.

The Bottom Line

Recessions are caused by a multitude of factors, with higher interest rates usually cited as the primary cause of a recession. To combat inflation, the Fed and other central banks aggressively raised interest rates to bring inflation down to their target of around 2%. However, this trend has seemed to slow down.

The hope is for a soft landing, where interest rates reach a level to bring down inflation and avoid a recession. The alternative is a hard landing, where the Fed raises rates too much and triggers a recession.