Depression (economics)

The stock market crash of 1929 marked the start of the Great Depression, the most widespread in modern history, with effects felt until the start of World War II

In economics, a depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe economic downturn than a recession, which is a slowdown in economic activity over the course of a normal business cycle.

A depression is an unusual and extreme form of recession. Depressions are characterized by their length, by abnormally large increases in unemployment, falls in the availability of credit (often due to some form of banking or financial crisis), shrinking output as buyers dry up and suppliers cut back on production and investment, large number of bankruptcies including sovereign debt defaults, significantly reduced amounts of trade and commerce (especially international trade), as well as highly volatile relative currency value fluctuations (often due to currency devaluations). Price deflation, financial crises and bank failures are also common elements of a depression that do not normally occur during a recession.

Definitions

In the United States the National Bureau of Economic Research determines contractions and expansions in the business cycle, but does not declare depressions.[1] Generally, periods labeled depressions are marked by a substantial and sustained shortfall of the ability to purchase goods relative to the amount that could be produced using current resources and technology (potential output).[2] Another proposed definition of depression includes two general rules:[3][4]

  1. a decline in real GDP exceeding 10%, or
  2. a recession lasting 2 or more years.

There are also differences in the duration of depression across definitions. Some economists refer only to the period when economic activity is declining. The more common use, however, also encompasses the time until economic activity has returned close to normal levels.[1]

A recession is briefly defined as a period of declining economic activity spread across the economy (according to NBER). Under the first definition, each depression will always coincide with a recession, since the difference between a depression and a recession is the severity of the fall in economic activity. In other words, each depression is always a recession, sharing the same starting and ending dates and having the same duration.

Under the second definition, depressions and recessions will always be distinct events however, having the same starting dates. This definition of depression implies that a recession and a depression will have different ending dates and thus distinct durations. Under this definition, the length of a depression will always be longer than that of the recession starting the same date.

A useful example is the difference in the chronology of the Great Depression in the U.S. under the view of alternative definitions. Using the second definition of depression, most economists refer to the Great Depression, as the period between 1929 and 1941. On the other hand, using the first definition, the depression that started in August 1929 lasted until March 1933. Note that NBER, which publishes the recession (instead of depression) dates for the U.S. economy, has identified two recessions during that period. The first between August 1929 and March 1933 and the second starting in May 1937 and ending in June 1938.[5]

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