Ronald Reagan is quoted as saying, "A recession is when your neighbor loses his job. A depression is when you lose yours." In truth, the definitions of these two terms are more complex, but the primary differences between the two have to do with time and severity.
What's the Difference?
To the average onlooker the conditions may look very similar, but recession and depression are specific terms used by economists to identify certain market conditions.
In the article, What's a Recession, Anyway?, The National Bureau of Economic Research (NBER) defines a recession as a significant economic contraction of the nation's Gross Domestic Product (GDP) for two or more consecutive quarters.
The formula for calculating the GDP is: Consumption + Gross Investment + Government Spending + (Exports − Imports).
Recessions typically last six to 18 months, and mild ones are often referred to as market corrections. Their greatest threat is that they may turn into depressions if not properly managed. This concern is a large part of the reason the U.S. Government agreed to a "bailout" of the major banks during the most recent economic recession. Even though the cost of the action was substantial, the damage that could have resulted from doing nothing was deemed to carry even greater consequences.
Signs of an economic recession include decreases in:
- Real income
It's also common to see decreases in interest rates, as the government intervenes to stabilize the economy.
Economist aren't quite as clear in their definition of a depression. In Recession or Depression?, economist and author Geoffrey H. Moore refers to a depression as the "Big Mac" of recessions. The Economist offers a more precise definition, stating that to be a depression, the GNP must decline by more than 10 percent and stay at that level for at least 36 months. Investopedia's definition is more lenient, defining an economic depression as a severe recession that lasts 24 months or more. Fortunately depressions are rare events.
Signs of an economic depression include all the hallmarks of a recession, but with increased severity. The signs also extend to:
- A sharp tightening of credit markets
- Instability in currency values
- Governments defaulting on debt or going bankrupt
- Stocks and other assets losing substantial value
- Plummeting consumer confidence
Was the Great Recession Really a Depression?
This was a confusing time for many, because so many of the signs of an economic depression were evident. Yet the general consensus among economists is that the Great Recession did not cross the line into a depression. They point out:
- The Great Recession lasted for approximately 20 months, not the 24 or 36 required to categorize it as a depression. In contrast, the Great Depression lasted a grueling 43 months.
- CNN Money writer Chris Isidore, explains that the National Association for Business Economics records an average drop of only a 3.4 percent in GDP, nowhere near the 10 percent required to declare a depression over the life of the recession. During the Great Depression the Gross National Product (GNP) dropped by 33 percent and employment rates dropped by 32 percent.
- Still other experts believed that the fear of a depression could turn into a self-fulfilling prophecy.
It's important to note that not all experts agree about what happened in the late 2000's.
In his Forbes article How Does The Current Economic Recession Compare To The Great Depression?, David M. Edwards offers a dissenting voice. While he doesn't go so far as to call the Great Recession a depression, he does believe the two are cut very much from the same cloth. Edwards believes that the key differences in the two events are public perception and the power of the government to intervene. His rationale includes:
- In both instances assets were highly inflated and then sharply deflated, which wreaked havoc with equity and debt markets.
- The Federal Reserve had little power during the Great Depression and was limited to reducing reserve requirement. By contrast, the Feds pumped $2.1 trillion into the economy during the Great Recession, shortening its duration.
- While many claim that the unemployment rate was 25 percent during the Great Depression, and only 10 percent during the Great Recession, Edwards claims this is not an apples to apples comparison. The definition of unemployment was broader in the 1930's, causing more people to fall into that category than today. He also cites recent under-employment rates of 20 percent.
- The 1930's saw a number of bank runs and failures, but the Great Recession was/is impacted by global economic collapses that may take years to stabilize. These conditions also lessen the ability of the U.S. to export goods to other countries.
- People lacked food during the Great Depression and were relegated to bread lines. Today one in six citizens rely on some form of public assistance to meet basic daily needs.
Protecting Your Financial Future
Regardless of whether the country experienced a recession or depression, there are a number of simple steps you can take to help safeguard your own financial future. For example:
- Don't spend more than you earn, and avoid using credit cards to live beyond your means.
- Speak to your financial advisor about limiting your stock losses by setting an automatic sell threshold of 15 percent, or whatever number you are comfortable with. Selling when values have dropped dramatically only locks in your losses.
- Work on becoming more self-sufficient by mastering basic cooking, sewing, plumbing, carpentry, and auto repair skills.
- Take a close look at your household budget to see what expenses could be reduced or eliminated.
- Be frugal when celebrating birthdays, holidays, and other special occasions. Avoid overindulging your children and try making handmade gifts whenever possible.
- Consider starting a part-time work-at-home business or taking on freelance assignments to generate an extra source of income if you're worried about the security of your day job.
Take It in Stride
The key thing to remember is that the markets are amazingly fluid and resilient. Downturns, while not fun to live through, are in many ways a natural part of the financial cycle. In fact, many economists believe that one of the benefits of economic recession is that it plays an important role in increasing productivity and efficiency within businesses.