You've probably experienced the 2008 recession. Even if your home or job was not lost, it is likely that you knew someone who was. Even though the recession was over, its effects lasted well beyond that point. Many Millennials cite the knock-on effects of that recession as the reason why they have not bought a house or started a family.
Depressions can be just as bad as recessions. The latter are more severe pauses in economic activity and can be described as much rarer. Only one depression has been experienced by the United States in its history. It was the Great Depression. This period lasted from 1929 to 1939, when the U.S. started mobilizing for World War II.
Today we will examine the key characteristics that distinguish a recession from a depression, and provide examples of their order of magnitude.
The Key Takeaways
Federal legislation passed after and during the Great Depression pertaining to policies such as unemployment insurance and deposit insurance means that the U.S. will not fall into depression.
Definition of a recession
The National Bureau of Economic Research is responsible for declaring recessions in the United States. A recession is defined as two consecutive quarters with negative growth in domestic product (GDP).
This is not a rule that the NBER accepts as a firm rule. They don't consider economic activity to be merely real GDP. The NBER can also be affected by the extent of negative GDP growth. They may not declare a recession if GDP falls for more than two quarters consecutively but only marginally.
The NBER uses economic indicators to determine the quarter's occurrences instead of the traditional rule of 'two consecutive quarters. The following are some of the most important data points.
Unemployment: The NBER takes into account employment numbers in recessions and does so with great nuance. These numbers are measured by the Current Population Survey (CPS), which is a monthly survey of approximately 60,000 eligible homes across the country. Sometimes, an increase in unemployment means that more people are looking for work after becoming unable to work.
Non-farm jobs are generally considered a net gain for the economy. The NBER examines non-farm payrolls. It considers the available work, hours worked, and compensation.
Industrial price index (IPI). The IPI measures monthly production across the mining, gas and electric industries. A healthier economy is one that has more output. Since the 18th century, the government has been collecting data for the IPI.
Wholesale-retail sales are a sign of a growing economy. While a rise in retail sales indicates a growing economy and a decrease in retail sales, it is a sign that there has been a contraction. Inflationary pressure and lower retail sales tend to go hand in hand. NBER articles will show that these data must be 'adjusted to price changes' in order to account for seasonal pricing fluctuations.
This is the real personal income less transfers (PILT). It is reported monthly by FRED. This includes wages but does not include any government transfer payments such as Social Security payments or unemployment benefits.
GDP: The gross domestic product is the total market value for all goods and services sold in the United States during a given month. Two-quarters of GDP contraction is usually associated with a recession, though it may not be the case all the time. This metric should not be used in isolation, but as a part of broader economic picture.
The NBER does not usually designate recessions in actual-time. After all data has been received, the NBER will designate the start and end of a recession. You could be living in a recession for months without it being acknowledged. If the NBER has already declared a recession, it may end, but not officially declared over until later.
Receding economies are a normal and inevitable part of the economic cycle. They are more common than depressions. Since the Great Depression, there have been 14 recessions.
The Sahm Rule
Experts frequently cite unemployment among the most important indicators of recession. The Federal Reserve has a rule called the Sahm Rule. It states that if the three-month moving mean of the national unemployment rate increases by 0.50% or greater relative to the 12-month average, then the country is in recession.
Economists consider unemployment to be one of the most important indicators of economic depression. The table below shows that unemployment rates in the Great Depression were over 20% while they peaked at 10% during the 2008 recession.
The NBER takes into account GDI (gross Domestic Income) as well as GDP. Both measures U.S. economic activity in slightly different ways. GDP measures the financial products such as goods and services. GDI measures how much money people or companies 'get' for those goods and services. GDI also includes data such as wages and taxes.
The NBER does not adhere to the rule of 'two quarters with negative GDP growth' because they consider both equally. The statistical discrepancy between GDP and GDI is also known as the statistical dispersion. This is due to differences in survey techniques and accounting for seasonal price fluctuations. The GDP estimates and GDI estimates are often revised after publication. This makes it more important for the NBER that they consider a wider range of data before declaring a recession.
Definition of depression
There is no one definition of depression. They can be described as a type of recession, but they are worse.
The 1930s saw the end of the US's only depression. Its effects swept into the decades that followed and preceded it. The recession included two periods of severe depression: one that lasted for 43 months between 1929 and 1933, the other lasting 13 month from 1937 to 1938.
There is a difference between a recession or a depression
The primary difference between a recession or a depression is the severity. Here is a comparison between key metrics in the 2008 recession and those during the Great Depression.
Great Depression 29% between 1929-1933
10% between 1937-1938
1933: 25% peak
Between 1937 and 1938, 20%
From 1929-1933, 47%
32% between 1937-1938
2008 Recession 4.3% 10% 10% 18 months
The Depression saw a much greater drop in GDP, industrial production, and unemployment than 2008, which was why they were so much more severe. The Great Recession was also the longest period of recession since the 1940s.
Governmental safeguards against depressions
The United States learned and applied some lessons from the Great Depression.
Many banks were forced to close during the Great Depression. This caused financial institutions and people who had money with them to suffer. Post-Depression policies were largely focused on restoring public trust in banks.
Through the Banking Act of 1933, the government established the Federal Deposit Insurance Corporation. This created deposit insurance, which we still call today. The FDIC offered coverage up to $2,500 for every depositor at the time. The FDIC now backs deposits made at reliable banks up to $250,000.
The FDIC was established in 1934 and has maintained that no insured money has been lost to bank failures since its creation.
This program was also a direct response to the Great Depression. This program, which was established with the 1935 Social Security Act, provides partial wages for those who have lost their jobs. This allows them to continue to have enough money to meet their basic necessities and allows money to circulate in the economy and into business.
Before the Great Depression, the banking system was not particularly strong. It was not unusual for banks to fail and bank runs to follow. 1929 was a significant turning point in the history of this country. Bank failures were a major concern. The Federal Reserve was established in 1913 to provide a cash reserve for banks.
The system was still young in 1929. The Reserve was only one-third of all banks that were part of it. There were often problems with the Reserve not having enough cash. Early leaders struggled to agree on the best way forward, which meant that in many cases, the Reserve erred toward inaction.
The Great Depression allowed the situation to spiral out of control and become deflation. Prices dropped on average 7% each year between 1930 and 1933. Low demand and excess supply are the main causes of deflation, which can also lead to unemployment.
The Federal Reserve is much more proactive in managing inflation and deflation today, partly because it is an independent, consolidated entity. The FDIC has taken over some of the Federal Reserve's responsibilities like deposit insurance.
It is possible that we are currently in a recession. The NBER will decide when and if one began, which could be several months later. Analysts are still speculating about whether we are in recession. The NBER has the data. To understand the country's current economic situation, you can do your own research.
It would be easier to identify a depression. It would be obvious because of its severity. Even if it took several months for government agencies to catch up with official diagnoses, the low demand, high unemployment and sinking cost would be obvious.
It doesn't matter if the economy is going up or down, one thing remains constant. The market has historically been a rising market over long time periods.