A recession is a natural element of the business cycle that occurs when the economy declines for two consecutive quarters. A depression, on the other hand, is a prolonged decline in economic activity that lasts years rather than months. This makes recessions far more common: in the United States, there have been 33 recessions and only one depression since 1854.
Is a depression considered a form of recession?
- A recession and a depression are both times when the economy shrinks, but their severity, duration, and total impact are different.
- A recession is a prolonged drop in economic activity that affects all sectors of the economy.
- A depression is a more severe economic slump, and in the United States, there has only been one: the Great Depression, which lasted from 1929 to 1939.
What makes a depression different from a recession?
A recession is a negative trend in the business cycle marked by a reduction in production and employment. As a result of this downward trend in household income and spending, many businesses and people are deferring big investments or purchases.
A depression is a strong downswing in the business cycle (much more severe than a downward trend) marked by severely reduced industrial production, widespread unemployment, a considerable decline or suspension of construction growth, and significant cutbacks in international commerce and capital movements. Aside from the severity and impacts of each, another distinction between a recession and a depression is that recessions can be geographically confined (limited to a single country), but depressions (such as the Great Depression of the 1930s) can occur throughout numerous countries.
Now that the differences between a recession and a depression have been established, we can all return to our old habits of cracking awful jokes and blaming them on individuals who most likely never said them.
Is depression caused by a recession?
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):
What happens when the economy is in a slump?
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 is the cost of depression?
The term “depressed prices” refers to a period in which prices have fallen over an extended period of time. Economic depressions are defined as a country’s economic output declining for an extended period of time. Depressions, whether economic or stock-related, are frequently brought on by circumstances that reduce demand.
How long does a depression last?
A recession is a natural element of the business cycle that occurs when the economy declines for two consecutive quarters. A depression, on the other hand, is a prolonged decline in economic activity that lasts years rather than months.
How long does an economic depression 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.
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 economies 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.