Depression vs. Recession: Here Are The Differences
BL
Summary:
Although recessions and depressions represent periods of decline in the stock market and the economy, there are some important differences between them. Recessions happen more frequently and are marked by a drop in the stock market, a rise in employment, and stagnating wages. Depressions encompass these effects to a greater degree. You will see much steeper declines in the stock market and very high employment, which can lead to runs on banks and a deflationary spiral.
The “Great Depression,” sparked by the stock market crash in 1929, was defined by massive unemployment, bank runs, a stock market in extreme decline, and an economic malaise never seen before in the post-industrial age. Central banks all over the world spring into action regularly to prevent cataclysmic events such as this. But what about recessions? Recessions share many of the same characteristics as depressions but are not nearly as severe, and they last for a much shorter time. In fact, many economists argue that recessions need to happen and are a normal part of the economy as it progresses through the business cycle.
Get Competing Personal Loan Offers In Minutes
Compare rates from multiple vetted lenders. Discover your lowest eligible rate.
It's quick, free and won’t hurt your credit score
Depression vs. recession
In modern times, recessions are commonplace around the world and have some baseline similarities. Recessions happen with a contraction in GDP growth and are accompanied by a rise in unemployment, a falling stock market, stagnant or decreasing wages, and a stagnant or declining housing market. Depressions have these same characteristics but to a greater degree with worse consequences. They are the most severe economic downturns. With a depression, there is widespread and very high employment, plummeting wages, and huge declines in GDP, among other effects.
Depressions can lead to banks failing, people losing their savings, and businesses going under. This contributes to even more unemployment, more bank failures, and a deflationary spiral in which goods and services drop in price rather than rising. Many central banks try to walk the fine line between recession and depression, and thus it’s important to understand the differences between the two.
Recession 101
The National Bureau of Economic Research (NBER) defines a recession as a “significant decline in activity that is spread across the economy and that lasts for a few months.” This can sound quite vague, so many economists look for two consecutive quarters of negative GDP growth that accompany a recession. Here are some of the characteristics of a recession.
Negative GDP growth
Negative GDP growth for two quarters or more is the most important indicator that an economy is in a recession. This is where the name comes from — GDP does not “progress;” rather, it “recesses,” hence the name.
Rising unemployment
A recession usually has high and rising unemployment. As consumer demand falls, jobs are lost all over the economy. This rise and fall of unemployment during the business cycle is called cyclical unemployment.
Stagnant or decreasing wages
In a recession, wages, on an aggregate scale (not industry specific), will either stagnate or decline. This can lead to less consumer demand, which then leads to the higher employment metric as defined above, as less consumption means less staff needed for businesses.
Stagnating or declining housing market
A drop or stagnation of the housing market typically accompanies a recession. People’s ability to take risks or spend money declines during a recession and the subsequent effects on the housing market are negative. In previous recessions, housing markets fell 5% each year of the downturn.
Time frame
A typical time frame is 10-18 months. Even two quarters of negative growth can be defined as a recession by textbook definition. Although different recessions, such as the COVID recession of 2020, have different time frames, every recession in the United States has lasted 17.5 months on average.
Depression 101
A depression will start off with the same characteristics as a recession, but to a much greater degree and with much worse consequences. Here are some of the characteristics that define a depression.
Significant GDP decline
GDP will decline significantly in a depression along with industrial production. You might see GDP decline a couple of percentage points in a recession. But in a depression such as the Great Depression, GDP can decline by as much as a third. Due to the Great Depression, GDP never really picked up significantly until the eve of World War II.
Surging and extremely high unemployment
A recession usually has high and rising unemployment, and a depression takes that to another level. During the depths of the Great Depression, almost a quarter of the American workforce was unemployed. The decline in economic activity spread throughout the workforce on a massive scale until the start of the war.
Wages spiraling down
During the Great Depression, wages fell a whopping 42.5% between 1929-1939. Wages will decline along with deflationary pressure on goods and services, consistent with an economic crisis.
The virtual destruction of the housing market
A depression can lead to a much greater decline in the housing market. During the Great Recession of the mid-2000s, housing prices fell 30%. During the Great Depression, however, house prices fell an astronomical 67%.
You can see by the characteristics listed above that depressions seem like more intense recessions. In some ways, you are correct, but here are some characteristics of depressions that are unique.
Runs on banks/bank failures
During the Great Depression, more than 7,000 banks failed in the United States. As one bank fails, it creates a domino effect in which everyone goes to withdraw their money (otherwise known as a bank run) and puts huge pressure on bank reserves. This is why the Federal Deposit Insurance Corporation (FDIC) exists today, to protect people’s money from bank runs and falling banks.
Deflationary spiral
Perhaps the most telltale sign of depression is a deflationary cycle in goods in services. Contrary to inflation, in which prices go up over time and is considered normal to some degree, deflation should be avoided at all costs.
Looking for an advisor to help you navigate the economic ups and downs? Here are some that can help.
Great Recession vs. Great Depression
To sum up how much more severe the conditions of a depression are versus a recession, here is a table showing some metrics discussed above.
| Great Depression | Great Recession | |
|---|---|---|
| Duration | 10 years | 18 months |
| Peak unemployment | 25% | 10% |
| Peak GDP decline | -29% | -4.3% |
| Home prices | -67% | -30% |
Why must deflation be avoided at all costs?
For economists, the biggest fear for any economy on a macro level is a deflationary spiral. Inflation, in which the prices of goods and services increase, is considered a normal part of modem economics. You might hear governments speaking about “controlling inflation,” which effectively means they want to get inflation down to a low amount but not have it disappear altogether.
Deflation, however, is a whole different kettle of fish. In a deflationary environment, prices for goods and services continue to drop alongside economic weakness. Consumers feel that as prices drop, they might as well wait longer to buy in case prices drop more. This has catastrophic consequences for the economy as it puts a halt to consumer activity while everyone holds off spending, hoping they can get a better price.
Pro Tip
After the asset bubble burst in Japan in the 1990s, a subsequent recession ensued. However, Japanese politicians have been battling deflationary pressures ever since to avoid a depression. Japan has injected an unprecedented amount of money into the economy as stimulus over the decades to prevent this from happening. Thus, it has the most public debt anywhere in the world.
CPI during the Great Depression
An example of skyrocketing unemployment and falling prices that are characteristic of depression can be found below. You can see here that as unemployment climbed upward in the early 1930s, the consumer price index began to fall. This is the most important baseline characteristic of a depression — rising unemployment/falling wages, combined with falling prices.
Recessions are normal
Recessions are a normal part of an economy under the capitalist system. During the business cycle, in which supply and demand ebb and flow, it’s normal to have a period of contraction. You can see by the graph below the frequency of recessions in the United States since 1968. We provided extra context by adding the quarterly return of the S&P 500 — an index that includes the 500 largest companies in the United States and is often used to reflect the overall health of the stock market — for those years.
During these recessions, there were no runs on banks or deflationary spirals. In fact, some economists such as Ray Dalio, CEO of Bridgewater Capital, claim that everything works in cycles, based on debt accumulated during boom times, including debt bubbles that will cause a recession. The only difference between now and the Great Depression is that governments have the right tools to counteract movements that might cause a normal recession to become a depression.
Walking that fine line
As recessions are a normal part of the business cycle but depressions are horrific, many central banks are ready with tools to make sure recessions don’t spiral into a depression. Much of this revolves around Keynesian economic philosophy, which includes lowering interest rates and fiscal stimulus.
Lower interest rates
By lowering interest rates, you encourage people or companies to borrow cheaply and spend or invest the funds. This injects money back into the economy and increases demand.
Fiscal stimulus
Governments will inject money into an economy to stimulate it in the name of growth and to counteract downward cyclical trends. When a government invests money in, say, infrastructure, this will automatically create jobs. This keeps more people employed and thus puts more money in their pockets. In turn, the money in their pockets contributes to more demand for goods.
FAQ
Was 2008 a recession or depression?
The 2008 financial crisis resulted in a recession; hence its terminology, the “Great Recession.”
Do recessions lead to depression?
Yes, if not curtailed by central banks, a recession could spiral into a depression. This is why central banks and governments walk a fine line dealing with a normal and sometimes welcomed recession while doing everything in their power to prevent a depression.
What comes first, depression or recession?
A recession will come first, and if it is not mitigated by a central bank or if it falls victim to further black swan events, it could become a depression.
Which is worse, inflation or recession?
Inflation and recessions are a normal part of an economy. Some governments will induce a recession to counteract inflation if need be, but they don’t want inflation to disappear just to coax it into controllable levels. What they want to avoid at all costs is deflation. A recession coupled with significant deflation can lead to an economic depression.
Who is hurt most by a recession?
The poor or economically disadvantaged are always affected most by a decline in economic activity, such as a recession. People with no emergency fund or safety net will have a much harder time weathering an economic downturn.
Key takeaways
- Although recessions and depressions both represent periods of decline in the stock market and the economy, there are some important differences between them.
- Recessions occur more frequently and are marked by a drop in the stock market, a rise and employment, and stagnating wages. Recessions are a normal part of the business cycle.
- Depressions encompass these effects but to a greater degree, including much steeper declines in the stock market and very high employment. This can lead to runs on banks and a deflationary spiral. Depressions are outliers and are extremely rare.
- A deflationary spiral is the single most important thing to avoid to escape a depression. Thus, central banks use a variety of stimuli to prevent a recession from turning into a depression.
Share this post: