Differences between depression and recession

DEPRESSION vs. RECESSION

What is the Difference between a Depression and a Recession

What is the difference between depression and a recession?

What is the difference between depression and a recession?

The current state of the economy is often referred to as a financial crisis and it has many concerned about where it may lead. There is much debate over the situation, particularly whether or not we should be using the terms recession or depression. These terms are often used interchangeably due to what appears to be a lack of clear understanding as to what differences exist between them. One thing that can be agreed upon is that both are representative of an economic downturn, the severity of which may be a key factor in determining which term is most appropriate.

One of the basic criteria for determining whether a situation is a recession or a depression is to measure the degree of economic decline. A recession has been defined by the National Bureau of Economic Research (NBER) (2010) as a considerable slowing in activity throughout the economy that lasts more than a couple of months and is evident in Gross Domestic Product (GDP), income, employment, industrial production, and retail sales. A recession can be identified by factors such as rising unemployment rates and the falling of investment rates (Lapidos, 2008). Some have quantified this into two consecutive quarters of declining output (Ramirez, 2008) while others have furthered this as being a drop in inflation-adjusted gross domestic output (Adams, 2008).

The accepted definition is not without its opponents. For example, it is believed that the focus on gross domestic product alone will not adequately reflect economic changes, such as unemployment rates, credit availability, consumer confidence, or increasing interest rates (Lapidos, 2008). This explanation of a depression also makes it challenging to identify the beginning and end of a recession, a task that is already quite difficult (Lapidos, 2008).

A recession has been viewed as a business cycle that is directly impacted by monetary conditions (Newman, 1990). The beginning of this cycle is commonly referred to as its peak and the end when the economy bottoms out (Newman, 1990). It is a short-term occurrence, lasting a few months to a year. It dampens the economy through the increase in interest rates and inflation of other costs (Newman, 1990). Newman (1990) reports that this situation can typically be reversed or improved by changes in fiscal and monetary policies at the federal government level.

Interestingly when looking at the history of our country, one quickly realizes that recessions are a fairly common occurrence. According to the NBER (2010), the economy has experienced several recessions in the last few decades. One occurred between March 2001 and November 2001, as well as from July 1990 until March 1991. In addition, during the 1980s the economy took a downturn twice (Lapidos, 2008). There is fairly consistent cyclical nature that recessions appear to occur in which ebbs and flows with some dips deeper than others.

On the other hand, the term depression is one that is widely understood despite the fact that no single agreed upon definition appears to exist. A definition that is frequently utilized is that of a prolonged recession that has a larger impact on the business economy (Lapidos, 2008). Further, a depression is a period of time during which the GDP declines by more than 10 percentage points (Lapidos, 2008). This practical approach allows one to quantify the differences between the two phenomenons.

It is important to determine whether an economic downturn is a recession or a depression due to the fact that each will require a different response from the federal government in order to improve the outcome. If it is a recession, since it is caused by monetary conditions, it can be aided through the lowering of interest rates. However, the large changes to fiscal policies such as tax cuts or government spending plans will not be very effective (Adams, 2009). A depression, on the other hand, is the direct result of an asset bubble being burst and therefore changes to economic policies, such as stimulus packages may significantly impact this situation. Depressions can range in severity from mild to severe and the best course of action is an economic policy to address the shortfalls (Adams, 2009).

The last two depressions in the U.S. were both in the 1930s. The first was from August of 1929 to March 1933, where GDP declined by roughly 33% (Ramirez, 2008). The economy did make a recovery after this time, yet severe economic decline occurred from 1937 to 1938, this depression was not quite as severe as the previous one (Ramirez, 2008). All other economic downturns since that time have been qualified as recessions and the safeguards that are in place are designed to ensure that things do not decline to the level of depression in the future.