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What Is An Economic Depression?

Market observers have repeatedly thrown around the word "depression" to describe a severe economic downturn. However, when it comes to pinning down a specific definition of this term, there is no consensus. This article will explore the aforementioned concerns, reviewing varying definitions and the different ways to measure the severity of a downturn.

What Is The Difference Between A Depression And A Recession?

One good way to explain a depression is to differentiate it from a recession, which is a less intense contraction. The National Bureau of Economic Research (NBER), which has historically declared U.S. recessions[2], has defined such downturns as follows:[3]

"A recession 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. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades."

Length

While the NBER describes a recession as being a short-lived contraction, depressions go on for years.[4] The Great Depression, for example, managed to continue for approximately a decade. More precisely, the aforementioned contraction actually comprised two recessions, including one that took place between August 1929 and March 1933 (43 months), and a second that began in May 1937 and ended in June 1938 (13 months).

Severity

Another way of differentiating between a recession and a depression is that the latter is more intense. N. Gregory Mankiw, a highly esteemed professor who teaches at Harvard, has spoken to this matter.[5] His textbook, Macroeconomics, states that:

"There are repeated periods during which real GDP falls, the most dramatic instance being the early 1930s. Such periods are called recessions if they are mild and depressions if they are more severe."

An article in The Economic Times also weighed in on this subject, stating that "depression is defined as a severe and prolonged recession."[6] "The level of productivity in an economy falls significantly during a depression," the piece added. "Both the GDP (gross domestic product) and GNP (gross national product) show a negative growth along with greater business failures and unemployment."

As an example, we can look at the decline in economic output that took place during The Great Depression. During 1930, 1931, and 1932, GDP decreased 8.5%, 16.1%, and 23.2%, respectively.[7]

Measuring The Severity Of Downturns

There are several ways that economists and market observers can measure the severity of a contraction when evaluating whether it is in fact a recession or a depression. One quick way to measure the intensity of a downturn is to look at the figures for GDP.[5]

Ben Bernanke, who previously served as the Chairman of the Federal Reserve, commented on this during a 2004 speech, in which he stated that:[5]

"During the major contraction phase of the Depression, between 1929 and 1933, real output in the United States fell nearly 30 percent. During the same period, according to retrospective studies, the unemployment rate rose from about 3 percent to nearly 25 percent, and many of those lucky enough to have a job were able to work only part-time."

He added that "for comparison, between 1973 and 1975, in what was perhaps the most severe U.S. recession of the World War II era, real output fell 3.4 percent and the unemployment rate rose from about 4 percent to about 9 percent."

The National Bureau's Business Cycle Dating Committee, which keeps a history of the economy's expansions and contractions, looks at employment data and personal income data when determining whether the U.S. is in a recession or a recovery.

Summary

One easy way of describing an economic depression is that it is a particularly intense contraction. More specifically, a depression is similar to a recession, except it is more severe in nature and also lasts longer. A perfect example is The Great Depression, which took place during a period of approximately 10 years.

As for how long, or how dire, a recession must be in order to be considered a depression, not everyone has the same point of view. Past that, people look at different variables to determine whether an economy has entered a depression.

While some stress changes in GDP, others look at less general economic indicators such as personal income figures and unemployment data.