The main distinction between a recession and a depression is that the former refers to a short-term economic downturn, whilst the latter refers to a long-term drop in economic activity. The duration of each event varies in general.
There have been 50 recessions in the United States’ history. The Great Depression of the 1930s was the only time there was a depression.
Continue reading to understand more about a recession, how it differs from a depression, and a snapshot of our present financial situation.
How do you tell the difference between a recession and a depression?
What’s the difference between a recession and a depression, and how do you tell the two apart? A depression is the popular word for a severe recession, which is defined as six consecutive months of decreasing real GDP. A peak is the point at which a recession begins, while a trough is the point at which a recession’s output stops declining.
A recession or a depression: which is worse?
That is an excellent question. Unfortunately, there isn’t a standard answer, however there is a well-known joke about the difference between the two that economists like to tell. But we’ll return to that eventually.
Let’s start with a definition of recession. As previously stated, there are various widely accepted definitions of arecession. Journalists, for example, frequently define a recession as two consecutive quarters of real (inflation adjusted) gross domestic product losses (GDP).
Economists have different definitions. Economists use the National Bureau of Economic Research’s (NBER) monthly business cycle peaks and troughs to identify periods of expansion and recession. Starting with the December 1854 trough, the NBER website tracks the peaks and troughs in economic activity. A recession, according to the website, is defined as:
A recession is a widespread drop in economic activity that lasts more than a few months and is manifested in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins when the economy reaches its peak of activity and concludes when it hits its lowest point. The economy is expanding between the trough and the peak. The natural state of the economy is expansion; most recessions are temporary, and they have been uncommon in recent decades.
While there is no universally accepted definition for depression, it is generally said to as a more severe form of recession. Gregory Mankiw (Mankiw 2003) distinguishes between the two in his popular intermediate macroeconomics textbook:
Real GDP declines on a regular basis, the most striking example being in the early 1930s. If the period is moderate, it is referred to as a recession; if it is more severe, it is referred to as a depression.
As Mankiw pointed out, the Great Depression was possibly the most famous economic slump in US (and world) history, spanning at least through the 1930s and into the early 1940s, a period that actually contains two severe economic downturns. Using NBER business cycle dates, the Great Depression’s first slump began in August 1929 and lasted 43 months, until March 1933, significantly longer than any other contraction in the twentieth century. The economy then expanded for 21 months, from March 1933 to May 1937, before experiencing another dip, this time for 13 months, from May 1937 to June 1938.
Examining the annual growth rates of real GDP from 1930 to 2006 is a quick way to highlight the differences in the severity of economic contractions associated with recessions (in chained year 2000dollars). The economy’s annual growth or decrease is depicted in Chart 1. The gray bars show recessions identified by the National Bureau of Economic Research. The Great Depression of the 1930s saw the two most severe contractions in output (excluding the post-World War II adjustment from 1945 to 1947).
In a lecture at Washington & Lee University on March 2, 2004, then-Governor and current Fed Chairman Ben Bernanke contrasted the severity of the Great Depression’s initial slump with the most severe post-World War II recession of 1973-1975. The distinctions are striking:
Between 1929 and 1933, when the Depression was at its worst, real output in the United States plummeted by over 30%. According to retroactive research, the unemployment rate grew from roughly 3% to nearly 25% during this time period, and many of those fortunate enough to have a job were only able to work part-time. For example, between 1973 and 1975, in what was likely the most severe post-World War II U.S. recession, real output declined 3.4 percent and the unemployment rate soared from around 4% to around 9%. A steep deflationprices fell at a rate of about 10% per year in the early 1930sas well as a plunging stock market, widespread bank failures, and a spate of defaults and bankruptcies by businesses and households were all aspects of the 1929-33 fall. After Franklin D. Roosevelt’s inauguration in March 1933, the economy recovered, but unemployment remained in double digits for the rest of the decade, with full recovery coming only with the outbreak of World War II. Furthermore, as I will show later, the Depression was global in scale, affecting almost every country on the planet, not just the United States.
While it is clear from the preceding discussion that recessions and depressions are serious matters, some economists have suggested that there is another, more casual approach to describe the difference between a recession and a depression (recall that I promised a joke at the start of this answer):
In economics, what does depression mean?
In economics, a depression is a significant downturn in the business cycle marked by sharp and sustained declines in economic activity, high rates of unemployment, poverty, and homelessness, increased rates of personal and business bankruptcy, massive stock market declines, and significant reductions in international trade and capital movements. A depression can also be characterized as a particularly severe and long-lasting kind of recession, with the latter being defined as a period of at least two consecutive quarters of real (inflation-adjusted) GDP, or gross domestic product, in relation to a national economy. A recession, according to the National Bureau of Economic Research, is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales,” while a depression is “a particularly severe period of economic weakness” that is “commonly undetectable in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
What stage does a recession or depression lead to quizlet?
The business cycle is divided into four stages: prosperity, recession, depression, and recovery. Prosperity is a high point in the economy. The economy is slowing down. A severe economic downturn that lasts several years and impacts the whole economy.
Can a downturn become a depression?
Although the following definition is bleak and detailed, its dullness serves to emphasize the fact that the recession/depression question is not so easy to solve. The Federal Reserve Bank of San Francisco attempted to come to a conclusion in 2007 – What is the difference between a recession and a depression? They agreed with the National Bureau of Economic Research’s definition of a recession:
A recession is defined as a major drop in economic activity across the economy that lasts more than a few months and is reflected in real GDP, real income, employment, industrial output, and wholesale-retail sales. A recession starts when the economy reaches its peak of activity and concludes when it hits its lowest point. The economy is expanding between the trough and the peak. The typical state of the economy is expansion; most recessions are brief and have been uncommon in recent decades.
And I turned to Gregory Mankiw to help me understand the difference between two types of economic contraction:
Real GDP has been falling for many years, the most striking example being the early 1930s. If the period is moderate, it is referred to as a recession; if it is more severe, it is referred to as a depression.
Despite the Federal Reserve’s best efforts, the simpler and more widely recognized definition of a recession is a drop in GDP for two consecutive quarters. However, there is little agreement when it comes to depressions; the two most prevalent descriptions are:
While the two meanings are not mutually exclusive, they do differ significantly. The distinction between a recession and a depression, in my opinion, is more complex. A recession is an unavoidable component of the business (or credit, as the case may be) cycle. A depression, on the other hand, entails the physical ruin of the economy: enterprises are irrevocably damaged, job possibilities are obliterated, and investment must be completely written off.
Examining prior Great Depressions is an alternative technique. Unfortunately, this strategy is also inconclusive. The Great Depression of the 1930s, for example, is widely thought to have lasted from 1929 to 1941, yet as the graph below shows, there were only two separate phases of decreased GDP growth between 1930 and 1933, and again between 1937 and 1938:
Despite my more practical definition above, I prefer the two-year-plus definition to the one based on a dramatic drop in GDP. Some aspects of the economy are harmed during a recession. Depression is becoming more common.
A rise in the unemployment rate is another element frequently linked to recessions and depressions. Historically, increased unemployment has preceded the commencement of recessions, and recessions have only been labeled depressions after they have lasted for a long time.
Another factor to consider is the absolute degree of inflation. In general, central banks respond to rising inflation by boosting short-term interest rates. This aids in the cooling of overheated economies. However, if they tighten too quickly, they risk triggering a recession by forcing the credit cycle into a rapid contraction. A depression, on the other hand, is frequently accompanied by an absolute drop in the price level, which is produced by an excessive amount of domestic or corporate debt.
Why does a depression definition matter to you as an investor? Because financial markets are anticipatory. If investors believe the recovery from the Covid-19 pandemic will be ‘V’-Shaped, even a 20% drop in GDP, combined with zero interest rates, price support for government bonds, and fiscal expansion on a scale not seen since FDR’s ‘New Deal,’ will result in a steeply rising stock market. If, on the other hand, it becomes evident that a tsunami of creative destruction is sweeping entire industries away, even the most sumptuous of New Deals may not be enough to stem the flood of stock liquidation as investors flee to the safety of cash.
So far, the official policy response has been enough to persuade investors that a slump will not occur. If you scratch the surface of the S&P 500, though, you’ll see a very different image. The graph below depicts the market’s performance through the end of May. Since then, the S&P 500 index has been driven by the same five technology stocks:
The most successful industry has been technology. One rationale for such high valuations is that the pandemic has hastened a wide range of technological advancements, resulting in the possibility of considerably faster profits. The net present value of future technology cash flows has been shifted forward by several years, according to some analysts. It’s no surprise, they say, that these equities have shattered new all-time highs and will continue to rise.
The broader stock market has been riding the coattails of tech since May (at the time of writing, the MSCI World Index is up 1.73 percent YTD). For the time being, hope wins out over fear, although vaccines are still months away from becoming publicly available. Meanwhile, autumn is approaching in the Northern Hemisphere, bringing with it fears of a second wave of diseases.
The scenario is even worse for emerging markets. In Foreign Affairs The Pandemic Depression, Carmen and Vincent Reinhart wrote:
Despite being labeled a “global financial crisis,” the 2008 downturn was mostly a banking crisis in 11 advanced economies. Emerging economies were remarkably immune to the volatility of the recent global crisis, thanks to double-digit growth in China, strong commodity prices, and lean balance sheets. The current economic downturn is unique. Because of the worldwide nature of this shockthe new coronavirus knows no national bordersa bigger percentage of the global society is in recession than at any point since the Great Depression. As a result, the recovery will be slower and less robust than the downturn. Finally, the fiscal and monetary policies implemented to combat the contraction will alleviate rather than erase economic losses, implying that the global economy will take a long time to recover to where it was at the beginning of 2020.
According to the World Bank, more than 60 million people will be forced into extreme poverty globally. Meanwhile, in wealthy countries, bankruptcies that have been postponed due to government involvement may experience personal epiphanies as fiscal generosity is abruptly withdrawn. The demise of broad swaths of sophisticated market economies has just been postponed unless the lockdown limitations are relaxed and people feel safe, both medically and financially, to venture out and spend.
We will have had two quarters of reduced growth by next month, indicating that we are already in a serious recession. Large swaths of the economy have been irreversibly transformed, increasing the likelihood of a slump. Millions of workers have been displaced, and retraining them will take far longer than a few months. It will be difficult for new and existing businesses to grow and hire new staff without the consumer demand from these former employees.
Fiscal spending will have to be done on a far larger scale and for much longer than previously anticipated. Since 1850, it has taken an average of eight years for per capita GDP to recover to pre-crisis levels in all major financial crises. The G20 response to the epidemic is estimated to have cost $11 trillion so far. The majority of these actions have been described as “temporary” or “short-term.” It is becoming increasingly evident that the disruption to employment, business, and economic sectors will be lengthy and, in many cases, permanent.
According to the IMF, the deficit-to-GDP ratio in advanced nations will grow from 3.3 percent in 2019 to 16.6 percent this year. The ratio is predicted to rise from 4.9 percent last year to 10.6 percent in 2020 for emerging nations, where budgetary expansion is more limited. While borrowing rates in established economies have stayed low, they have increased in emerging markets. The burden of fiscal stimulus will invariably fall most heavily on the advanced economies’ treasuries.
Conclusion
This isn’t the conclusion of the story. This isn’t even the start of the end. But it’s possible that this is the end of the beginning.
Individual economic needs are still important in Western (and other) aging civilizations. Governments in developed countries are fortunate in that they can borrow at lower rates than at any other period in history. While it goes against my Austrian, free-market principles, I have to admit that fiscal policy is the least painful weapon available to resist the pandemic’s economic catharsis. There will be a significant cost in terms of economics, but the alternative is a deadly mix of political fragmentation and polarization.
The goal of securing consistent real income for investors remains difficult. High-yielding private debt and asset-backed lending carries both default and liquidity risk. Financial repression is rampant across the credit spectrum, as shown in the chart below, which looks at some of the public market options:
High-income stocks may be a viable option, but no matter how ‘blue-chip’ the name, there is no certainty. Growth stocks, in general, are benefiting from the historically low-interest environment, but there will be a higher number of failures because the cost of speculative capital is also at an all-time low. Active management has been out of favor for at least a decade, but in the future, capital preservation will be more important than reaping large returns.
In June, I published a piece called A Brave New World for Value Investing, in which I concluded that:
Since late March, the stock and corporate bond markets have restored most of their stability. The repercussions of the global economic slowdown have been mitigated by central banks and governments. As the dust settles, the financial markets will adjust to a new environment, one in which value-based stock and bond market analysis will be an invaluable tool for navigating the waters.
The simultaneous supply and demand shocks, as well as their impact on global supply networks, have heightened the geopolitics of trade policy, which was already a source of conflict before the epidemic arrived. Supply networks will become shorter and more diverse. In the months and years ahead, robustness, not efficiency, will be the watchword. This shift in the global economy’s functioning will not come without a price. It will manifest itself in higher pricing or lower corporate profits. In this brave new world, value-based investment analysis will be the finest guidance.
An additional approach, a momentum overlay, would be added to the investment toolbox. Capital flows will be a formidable arbiter of investment return as fiscal and monetary policy continue to support economies as they transition to the new world order. By most conventional measures, technology companies appear to be overvalued, yet the trend is undeniable. After all, financial market liquidity flows like a tide, so don’t be like Cnut The Great and follow Brutus’ advice in the opening statement.
How long do economic downturns last?
A recession is a long-term economic downturn that affects a large number of people. A depression is a longer-term, more severe slump. Since 1854, there have been 33 recessions. 1 Recessions have lasted an average of 11 months since 1945.
What causes economic downturns?
An economic depression is primarily caused by a decline in consumer confidence, which leads to a drop in demand and, finally, the closure of businesses. When customers stop buying items and paying for services, businesses must make budget concessions, which may include laying off employees.
But let’s take a closer look at some of the other elements that contribute to economic downturn.
Is depression linked to inflation?
Is it, however, too early for such pessimism? The magnitude of this shock is undeniable – the magnitude and speed of the drop in output is unprecedented and terrifying. If economies do not recover to their previous growth trajectory or rates, the coronavirus will leave a structural macroeconomic legacy. A macroeconomic shock even a severe one is a long way from a structural regime disruption, such as a depression or a debt crisis.
The key to a positive macroeconomic regime is price stability, therefore keep an eye on it. A break in the economy, such as a depression or a debt crisis, is characterised by a change to excessive deflation or inflation, and hence a disruption of the economy’s normal functioning. The US economy has enjoyed declining, low, and steady inflation for the previous 30 years, which has resulted in low interest rates, longer business cycles, and high asset valuations. However, if price stability is lost, the real and financial sectors will suffer greatly.
The Four Paths to a Structural Regime Break
Between a serious crisis and a systemic regime breakdown lie policy and politics. Failure to stop the negative trajectory of a crisis-ridden economy is due to persistently poor policy measures, which are anchored either in incompetence or political unwillingness. We’ve charted four stages that lead to a structural regime break, each shown with historical examples.
1. Error in Policy
The first step toward depression happens when politicians and policymakers attempt to identify and treat the problem theoretically. The Great Depression is a quintessential example of policy failure, as it was an enormous policy failure that aided not only the depth but also the length and legacy of the crisis. There were two conceptual misunderstandings:
- Errors in monetary policy and the banking crisis: Between 1929 and 1933, a lack of oversight of the banking sector, tight monetary policy, and bank runs resulted in thousands of bank collapses and massive losses to depositors. The collapse of the banking system stifled the flow of credit to businesses and individuals. Despite the fact that the Federal Reserve was established in 1913 to presumably combat such crises, it stood by as the banking system imploded, assuming that monetary policy was stable. In actuality, it was mired in a logical blunder.
- Politicians also stood by and let the economy bleed for far too long. The New Deal arrived too late to avoid the slump, and it offered insufficient relief. In 1937-38, when fiscal policy was tightened anew, the economy crashed once more. World War II eventually put an end to the Great Depression by dramatically increasing aggregate demand and even restoring economic output to pre-depression levels.
As a result of these policy errors, there was severe deflation (price level collapse) of well over 20%. While unemployment remained high, the nominal value of many assets fell substantially, while the real weight of most loans rose sharply, leaving households and businesses fighting to get back on their feet.
2. Political Determination
When the economic diagnosis is evident and the cures are recognized, but politicians stand in the way of a solution, the second path from a profound crisis to a depression occurs. More than understanding and thinking, it’s a problem of willingness.
We don’t have to search far to see an example of this danger: When the US Congress couldn’t agree on a way ahead in the global financial crisis in 2008, a lack of political will pushed the economy dangerously near to a deflationary depression.
Bank capital losses were building up by late 2008, causing a credit bottleneck that crippled the economy. The potential of a deflationary depression with a shaky financial system was genuine, as seen by collapsing inflation expectations throughout the crisis.
The most perilous moment occurred on September 29, 2008, when the House of Representatives rejected TARP, a $700 billion rescue package designed to recapitalize (or bail out) banks. The resulting market crash lowered the political cost of opposing TARP, and the bill was passed a few days later, on Oct. 3.
In effect, political will came together at the last possible moment to prevent a structural regime break and limit the structural legacy to a U-shaped shock. While the US economy recovered its growth rate after a few years, it never returned to its pre-crisis growth path, which is what a U-shaped shock is.
3. Policy Requirements
When policymakers lack operational autonomy, authority, or economic resources, a third possible path from acute crises to depression emerges. This occurs in countries or territories that lack monetary sovereignty, or central bank autonomy in other words, they can’t use the central bank to maintain a healthy credit flow even if their currency is stable in times of crisis. Internal depression, or price and wage deflation, is the only method for such economies to rebalance and overcome monetary dependence’s restrictions.
Greece’s relationship with the European Central Bank during the global financial crisis is perhaps the best example of such dependence. Because it was unable to obtain finance from the ECB, Greece was forced to enter a slump marked by significant deflationary pressures.
Rejection of Policy
The fourth option, unlike the previous three, leads to a debt crisis rather than a depression. In this instance, policymakers know what to do and have the political will to do it, but they are unable to generate the necessary real resources because the markets are rejecting their efforts. This path differs from the others in that it leads to high inflation rather than deflation.
What effect does depression have on the economy?
The significant prevalence of depression and its related impairment has gained international awareness. Major depressive disorders were the most common chronic diseases in the previous year in nations where workers were studied. The expenditures of screening, treatment, maintenance, and support for people with depression are all included in the economic costs of depression. Costs associated with depression’s effects on absenteeism, presenteeism, and long-term impairment are also included. Workplaces have a lot of promise for preventing depression, diagnosing depression in its early and severe phases, enhancing depression care off-site or on-site, in person or online, and improving the outcomes of those efforts. There are evidence-based programs for lowering depression costs. Clinically and economically, technological advancements and a growing interest in funding experimental programs for people with depression provide promising results.