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Difference Between Recession and Depression | Entrepreneur

If you lived through the 2008 recession, you know how painful recessions can be. Even if you didn’t personally lose your job or home, you likely knew more than one person who did. The effects of that recession lasted long after the period was declared over. Many Millennials cite its knock-on effects as the reason they haven’t purchased a home or started a family, even to this day.

As bad as recessions are, depressions are even worse. You could generally describe the latter as dramatic pauses in economic activity, and they’re much rarer. The U.S. has only experienced one depression throughout its history: the Great Depression, which lasted from 1929 to 1939 when the U.S. began mobilizing for World War II.

Today, we’ll look at the key features that define a recession and a depression and at specific examples of their orders of magnitude.

Key Takeaways

  • The NBER designates recessions by examining factors like GDP, employment, wholesale-retail sales, and real personal income less transfers.
  • Depressions are similar to recessions in definition – except they’re worse, indicating a more significant pause in economic activity.
  • The U.S. is unlikely to go into a depression thanks to federal legislation passed during and after the Great Depression surrounding policies like deposit insurance, unemployment insurance, and the Federal Reserve.

Definition of a recession

The organization in charge of declaring recessions in the U.S. is the National Bureau of Economic Research (NBER). You’ll often hear a recession defined as two consecutive quarters of negative growth domestic product (GDP) growth.

The NBER does not accept this as a hard rule because they don’t identify economic activity solely with real GDP. Also, the depth of negative GDP growth can influence the NBER’s assessment of the economy. If GDP declines for two consecutive quarters, but only marginally, they may not call a recession.

Instead of the “two consecutive quarters” rule, the NBER relies on various economic indicators. Some of the most relevant data points include the following.

  • Unemployment: The NBER considers employment numbers during recessions, and it does so with great nuance. The Current Population Survey (CPS), a survey of roughly 60,000 eligible houses nationwide conducted once a month, measures these numbers. An uptick in unemployment sometimes signifies more people have started looking for jobs after being unable to work rather than ending up back on the market due to job loss.
  • Non-farm jobs: Creating jobs is generally considered a net win for the economy. The NBER looks at non-farm payrolls and considers the amount of available work, employee hours, and compensation within those positions.
  • Industrial price index (IPI): The IPI measures monthly output across mining, manufacturing, gas, and electric industries. More output is a signifier of a healthier economy. The government has collected data for the IPI since the 18th century.
  • Wholesale-retail sales: Growing retail sales indicate a growing economy, while shrinking retail sales indicate a contraction. Lower retail sales and inflationary pressure tend to go hand-in-hand. You’ll see in NBER articles that this data has to be “adjusted for price changes” to account for fluctuating seasonal pricing.
  • Real personal income less transfers (PILT): This data is reported monthly via FRED. It includes wages and excludes government transfer payments people might receive, like Social Security payments or unemployment compensation.
  • GDP: Gross domestic product represents the total market value of all finished goods and services produced and sold within the U.S. for that month. Typically – though not always – two-quarters of contraction in GDP accompany a recession. This metric is not used in isolation but is one component of a larger economic picture.

The NBER doesn’t typically designate recessions in real-time. They wait for all the data to come in, then designate the beginning and end of a recession after the fact. This delay means you could live in a recession and not have it acknowledged until months later. Or, if the NBER has already called a recession, it could end but not be officially declared over until later.

Recessions are considered a natural and unavoidable part of the economic cycle. They’re much more common than depressions. There have been 14 recessions since the Great Depression.

The Sahm Rule

Experts often cite unemployment as one of the most critical recession indicators. There’s a rule the Federal Reserve uses called the Sahm Rule, which holds that when the three-month moving average of the national unemployment rate rises by 0.50% or more relative to the previous 12-month low, the country has entered a recession.

Economists also see unemployment as one of the most significant indicators of economic depression. As shown in the table below, unemployment rates during the Great Depression reached over 20%, whereas unemployment rates during the 2008 recession peaked at 10%.

GDP vs. GDI

The NBER considers GDI (gross domestic income) in addition to GDP. Both measure U.S. economic activity but in slightly different ways. GDP measures the value of financial products like goods and services, whereas GDI measures the money companies or people “get” for said goods and services. GDI includes data on things like wages and taxes.

GDI is another reason the NBER doesn’t stick by the “two quarters of negative GDP growth” rule, as they weigh the two equally. The difference between GDP and GDI, also known as the statistical discrepancy, is caused by differences in survey techniques and ways of accounting for seasonal price fluctuations. GDP estimates (and GDI estimates) are revised multiple times after publication, making it even more critical for the NBER to consider a broader range of data before calling a recession.

Definition of a depression

There is no singular definition of a depression. One of the best ways to think about them is that they’re like a recession – but worse.

The last and only depression in U.S. history spanned across the 1930s, with its effects spilling over into the decades immediately preceding and following it. It included two recessions: one lasting an incredibly long 43 months from 1929 to 1933 and the other lasting 13 months from 1937 to 1938.

Difference between a recession and a depression

The main difference between a recession and a depression is severity. Here’s a comparison of key metrics during the 2008 recession and the same metrics throughout the Great Depression.

Economic Period GDP Loss Peak Unemployment Industrial Production Loss Duration
Great Depression 29% from 1929-1933

10% from 1937-1938

25% peak in 1933

20% between 1937 and 1938

47% from 1929-1933

32% from 1937-1938

43 months

13 months

2008 Recession 4.3% 10% 10% 18 months

GDP loss, industrial production loss, and unemployment rates were much higher during the Depression than they were in 2008. And the Great Recession was the longest recession the country has experienced since the 1940s.

Governmental safeguards against depressions

The U.S. did learn and apply some lessons from the Great Depression.

Many banks went under during the Great Depression, hurting financial institutions and those who kept their money with them. Policies instituted post-Depression largely centered around winning back public trust in banks.

Deposit insurance

The government created the Federal Deposit Insurance Corporation through the Banking Act in 1933. It made effective what we still know today as deposit insurance. At the time, every depositor had coverage for up to $2,500. Now, the FDIC backs deposits at trustworthy banks up to $250,000.

Since its founding in 1934, the FDIC has made sure not a cent of insured money was lost due to bank failure.

Unemployment insurance

This was another direct response to the Great Depression. Established with the passage of the Social Security Act of 1935, this program provides partial wages to those who have recently lost their jobs involuntarily. This helps them continue to have money to meet their basic needs and allows money to keep circulating in the economy and into businesses.

The Federal Reserve

The banking system wasn’t particularly strong before the Great Depression. Bank failures and subsequent bank runs were not uncommon. 1929 took the situation to a new level. Because bank failures were such a concern, the Federal Reserve was founded in 1913 to create a cash reserve for banks.

But the system was young in 1929. Only one-third of banks were part of the Reserve’s system, there were frequent problems with the Reserve keeping enough cash on hand, and early leaders had difficulty agreeing on the best path forward – meaning in many cases it erred towards inaction.

During the Great Depression, that meant the situation was allowed to spin out of control into something even worse than inflation: deflation. Between 1930 and 1933, prices dropped an average of 7% annually. The causes of deflation are low demand or excess supply, which can lead to unemployment.

Today, the Federal Reserve has a much more proactive hand in controlling issues like inflation and deflation, partially because it is now an effectively independent consolidated body. Some of its responsibilities, like insuring deposits, have been outsourced to the FDIC.

Final words

We may or may not be living through a recession currently. We won’t know until the NBER decides when or if one started, which can be months later. Still, analysts are constantly speculating whether or not we’re in a recession, and the relevant data considered by the NBER is publicly available. You can research it yourself to understand the country’s economic situation.

A depression, on the other hand, would be much easier to spot. Its severity would make it undeniable. The low demand, high unemployment, and sinking costs would be evident even if government agencies took a few months to catch up with official diagnoses.

One thing still holds true whether the economy is on its way down or up. Historically, the market as a whole has always gone up over long time horizons.

The post Difference Between Recession and Depression appeared first on Due.

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