Difference Between Recession and Depression

If you lived through the 2008 recession, you know how painful recessions can be. Even if you haven’t personally lost your job or home, you probably know more than one person who has. 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 bought a house or started a family to this day.

As bad as recessions are, depressions are even worse. The latter could generally be described as dramatic lulls in economic activity, which are much rarer. The US has experienced only one depression in its history: the Great Depression, which lasted from 1929 to 1939 when the US began to mobilize for World War II.

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

Key learning points

• The NBER pinpoints recessions by examining factors such as GDP, employment, wholesale-retail sales and real personal income minus transfers.
• Depressions are similar to recessions in definition – except they are worse, indicating a more significant lull in economic activity.
• The US is unlikely to slip into a depression thanks to federal legislation passed during and after the Great Depression surrounding policies such as deposit insurance, unemployment insurance, and the Federal Reserve.

Definition of a recession

The organization responsible for declaring recessions in the US is the National Bureau of Economic Research (NBER). A recession is often defined as two consecutive quarters of negative growth in domestic product (GDP).

The NBER does not accept this as a hard and fast rule because they do not identify economic activity solely with real GDP. Also, the depth of negative GDP growth may affect the NBER’s assessment of the economy. If GDP falls for two quarters in a row, but only marginally, they may not be talking about a recession.

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

• Unemployment: The NBER takes into account employment figures during recessions, and does so with great nuance. The Current Population Survey (CPS), a once-a-month survey of about 60,000 eligible homes nationwide, measures these numbers. An increase in unemployment sometimes means that more people have started looking for work after being unable to work, rather than ending up back in the market due to job loss.

• Non-agricultural jobs: Job creation is generally regarded as a net gain to the economy. The NBER looks at nonfarm payrolls and takes into account the amount of work available, employee hours and compensation within those positions.

• Industry Price Index (IPI): The IPI measures monthly production in the mining, manufacturing, gas and power industries. More output is a sign of a healthier economy. The government has been collecting data for the IPI since the 18th century.

• Wholesale-Retail: Growing retail sales indicate a growing economy, shrinking retail sales indicate contraction. Lower retail sales and inflationary pressures often go hand in hand. You will see in NBER articles that this data must be “adjusted for price changes” to account for fluctuating seasonal prices.

• Real personal income minus transfers (PILT): This data is reported monthly via FRED. It includes wages and excludes transfer payments from government that people may receive, such as Social Security benefits or unemployment benefits.

• GDP: Gross domestic product represents the total market value of all finished goods and services produced and sold in the US during that month. Typically, but not always, two-quarters of GDP contraction is accompanied by a recession. This measure is not used in isolation, but is part of a larger economic picture.

The NBER usually does not indicate recessions live. They wait for all the data to come in and then mark the start and end of a recession afterwards. This delay means you could be living in a recession and it won’t be recognized until months later. Or, if the NBER has already declared a recession, it may end, but not be officially declared until later.

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

The Sahm Rule

Experts often call unemployment one of the most critical recession indicators. There is a rule that the Federal Reserve uses called the Sahm rule, which means that when the three-month moving average of the national unemployment rate rises 0.50% or more from its previous 12-month low, the country is in recession. has arrived.

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

GDP vs GDI

In addition to GDP, the NBER also takes GDI (Gross Domestic Income) into account. Both measure economic activity in the US, but in slightly different ways. GDP measures the value of financial products such as goods and services, while GDI measures the money companies or people “get” for those goods and services. GDI contains data on things like wages and taxes.

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

Definition of depression

There is no single definition of depression. One of the best ways to think about them is that they’re like a recession, only worse.

The last and only depression in US history spanned the 1930s and its effects continued into the decades immediately preceding and following it. It included two recessions: one lasted an incredibly long 43 months from 1929 to 1933 and the other lasted 13 months from 1937 to 1938.

Difference between a recession and a depression

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

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

Government guarantees against depression

The US did learn and apply some lessons of the Great Depression.

Many banks went under during the Great Depression, hurting financial institutions and those who held their money with them. The policies instituted after the Depression were largely aimed at regaining public confidence in banks.

Deposit guarantee

The government created the Federal Deposit Insurance Corporation through the Banking Act in 1933. It enacted what we still know today as deposit insurance. At that time, each depositor had coverage up to $2,500. Now, the FDIC supports deposits with reliable banks up to $250,000.

Since its inception in 1934, the FDIC has ensured that not a penny of insured money was lost to bank failures.

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 involuntarily lost their jobs. This helps them to keep going have money to meet their basic needs and ensures that money can continue to circulate in the economy and in businesses.

The Federal Reserve

The banking system was not 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 created in 1913 to create a cash reserve for banks.

But the system was young in 1929. Only a third of the banks were part of the reserve system, there were frequent problems with the reserve keeping enough cash on hand, and early leaders struggled to agree about the best way forward – which in many cases means it has drifted into passivity.

During the Great Depression, this meant the situation was allowed to spiral out of control into something even worse than inflation: deflation. Between 1930 and 1933, prices fell by an average of 7% per year. The causes of deflation are low demand or oversupply, which can lead to unemployment.

Today, the Federal Reserve has a much more proactive hand in managing issues like inflation and deflation, in part because it is now a de facto independent consolidated body. Some of its responsibilities, such as insuring deposits, are outsourced to the FDIC.

Last words

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

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

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

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