Depressions and recessions differ in their severity, duration, and overall impact. Here's what you need to know.
recessionand a depressiondistinguish periods during which the economy shinks, but they differ in severity, duration, and overall impact.
- A recession is a decline in economic activity spread across the economy that lasts more than a few months.
- A depression is a more extreme economic downturn, and there has only been one in US history: The Great Depression, which lasted from 1929 to 1939.
Economic downturns are a lousy time for everyone. You may be worried about losing your job and footing your bills, or alarmed at the sight of your investment funds losing money.
While you've probably heard the terms "recession" and "depression" tossed around, you may not know what they actually mean. And more importantly, what the difference is between the two.
To help you better understand and prepare for the twists and turns of an economic crisis, here's what you need to know about the difference between a recession and a depression.
What is a recession?
An economic recession is often defined as a decline of real gross domestic product (GDP) for two consecutive quarters — but it's not that simple.
The National Bureau of Economic Research (NBER), the century-old nonprofit that determines the start and end dates of recessions in the US, takes a broader view. The group defines recessions as "a significant decline in economic activity spread across the economy, lasting more than a few months," with indicators including:
- Decline in real GDP
- Decline in real income
- Rise in unemployment
- Slowed industrial production and retail sales
- Lack of consumer spending
The NBER's view of recessions takes a more holistic outlook of the economy, meaning recessions are not necessarily defined by one single factor.
There have been almost 50 recessions in history, from the Copper Panic of 1789 to the 2008 Great Recession. Throughout the 19th and early 20th centuries, recessions were quite common.
Between 1945 and 2001, there were only 10 recession cycles, which is far fewer than we had seen in similar periods of time in the past. Some economists use this as evidence that the business cycle has become less volatile.
Although they're more or less a regular occurrence, and indicative of a cyclical business cycle, the duration, economic impact, and triggers of recessions can vary greatly.
The inverted yield curve: A trusted recession predictor
There are many indicators experts use to predict when a recession may occur, and the most reliable is an inverted yield curve.
Typically, interest rates for short-term loans are lower than rates of long-term loans. That's partly because a short-term loan is seen as a riskier investment for the lenders and partly because inflation is built into the interest rates.
For example, $1,000 today is not going to be as valuable as $1,000 in 10 years, and higher interest rates seek to mend that. When this model is inverted, it can be a sign of a worsening economy, because it shows that there is less confidence in the long-term than there is in the short-term.
An inverted yield curve worries the market because it means "an expectation of low inflation, which comes with economic downturns" says Laura Ullrich, regional economist with the Federal Reserve Bank of Richmond, adding that inverted yield curves signal that people are "searching for safer places to put their money."
Since 1955, an inverted yield curve has predicted each recession, and it should be noted that the curve did invert in 2019. Ullrich warns that there were other economic forces abroad that caused the most recent inversion.
"We're in a situation where it's going to look like it predicted it again, but the economic crisis we're in right now is from a totally different place," Ullrich says. "I wouldn't necessarily give much credence to the fact that the inverted yield curve last year predicted what's happening right now."
What is a depression?
An economic depression is typically understood as an extreme downturn in economic activity lasting several years, but the exact definition and specifications of a depression are less clear.
"The way people think about it is a depression is a more widespread and severe recession," Ullrich says, "but there is no clear-cut moment where we can say 'we hit X unemployment rate or Y GDP growth — we're now officially in a depression.'"
The NBER notes that economists differ on the period of time that designates a depression. Some experts believe a depression lasts only when economic activity is declining, while the more common understanding is a depression extends until economic activity has returned to close to normal levels.
The difference between a recession and a depression
Recessions and depressions have similar indicators and causes, but the biggest differences are severity, duration, and overall impact.
A depression spans years, rather than months, and typically sees higher unemployment and a sharper decline in GDP. And while a recession is often limited to a single country, a depression is usually severe enough to have global trade impacts.
Because economists do not have a set definition for what constitutes a depression, the general public sometimes uses it interchangeably with the term recession. But in the U.S., there has only been one depression: The Great Depression of the 1930s, which spanned 10 years.
What caused the Great Depression?
The Great Depression was one of the most severe economic downturns in history lasting from 1929-1939. It started in America in 1929 as a recession before expanding globally, most notably in Europe.
As with any long-term economic crisis, there wasn't just one event that led to the Great Depression, but rather a series of events including the stock market crash of 1929 and the severe drought of the Dust Bowl in the 1930s.
The economy was already trending downward over the summer before the crash, with unemployment rising and manufacturing declining, leaving stocks significantly overvalued. Then on October 24th, known as "Black Thursday," investors sold off almost 13 million shares of stock, signaling to consumers that they had been right about their lack of confidence. Spending came to a halt, debt increased, homes were foreclosed, and banks began failing.
The stock market crash in October of 1929 kicked off a panic that resulted in a severe drop in consumer spending and
The current financial landscape
Between 1929 and 1939, president Franklin D. Roosevelt passed numerous pieces of legislation aimed at stabilizing the economy. He established the FDIC to protect consumers' bank accounts. The SEC was created to regulate the stock market, and the Social Security Act guaranteed pensions to Americans and set up an unemployment insurance program.
The programs and reforms put in place in response to the Great Depression were established in hopes that an economic downturn of parallel magnitude would unlikely be repeated.
So could we be heading into another depression? With the COVID-19 pandemic sending the US into a recession, the next phase could be anyone's guess. However, there have been troubling signs.
In July 2020, data relased by the Commerce Department revealed that the US economy experienced its worst quarterly slump ever. US GDP fell a historic 33% annualized rate in the second quarter of 2020, with no other downturn in history (including the Great Depression) causing as sharp of a decline in the economy.
That said, there's reason to be hopeful, according to Ullrich:
"2007-2009 was different because much of the crisis began in financial institutions. That sector was heavily impacted immediately, and because of some of that, it couldn't respond in the ways the economy needed it to … The good news is that the financial system, the fundamentals of the economy were strong coming into the current crisis we're facing."
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