Economic turbulence is always painful for any economy, especially the developing ones. People in the workforce are afraid of losing their jobs. Businesses fear a lack of demand for their products and services, and governments fear negative growth prospects. Recession and depression both are situations that a central bank and central government of any country want to avoid.
You must have read or heard both these terms in newspapers and primetime news. But, do you know the actual meaning of these terms, and more importantly, the main differences between depression & recession. People use both these terms interchangeably on many occasions. However, there are key differences between them, which are highlighted in this article. Here it goes:
What does it mean when a country faces a Recession?
A country is technically said to be in recession when it witnesses two consecutive quarters (six months) of negative GDP growth. This is the theoretical definition of recession given in 1974 by Julius Shiskin, an economist from the US. This duration is the key point of difference in the recession and depression classification.
The world has witnessed 34 instances of recession starting from 1854, and since 1945, the average duration of them is 11 months. The recent and one of the biggest recessions was termed as the Global Financial Crisis of 2008 that started in the US and spread across continents like a forest fire.
Causes of Recession
There are many reasons behind recession, but the aftermath of all of them involves loss of consumer and business confidence. Here are the causes behind any recession:
High–Interest Rates: This situation leads to lesser borrowing by people and businesses, which hamper investment and consumption, leading to lower GDP growth. Central banks raise interest rates to curb the supply of money in the economy, but it has a negative outcome as well in terms of declining growth.
Diminishing Confidence:This is more of a psychological reason wherein consumers and businesses are uncertain about the economic future of the country. This point is common in both depression & recession.
Slowdown in Manufacturing Activity: One of the first signs of recession is the sluggish growth of manufacturing. This was observed during the Global Financial Crisis of 2008 when there was a slowdown in the manufacturing of durable goods from 2006 itself.
Stock Market Crash: Investors are no more frenzied about prospects of the economy, and thus, panic selling starts. This leads to a stock market crash that takes away the foreign capital as well.
What is Depression?
Now that you understand one side of the story in this depression & recession topic, let’s now get to know the other side of the story, which is depression. There is no one-size-fits-all definition of depression, but a severe and prolonged form of recession is known as depression. The International Monetary Fund (IMF) says a contraction in GDP growth rate by over 10% is a depression.
The worst and notable depression was observed in 1929 that lasted for a decade and hit many economies. It was termed The Great Economic Depression, the global GDP shrank by 15% (that is a major red flag in both recession and depression), and there was a negative GDP growth rate for 6 out of 10 years. Unemployment breached all records by touching 25%, global trade fell by 66%, and prices nosedived by 25%. The stock markets recovered 14 years after this depression ended in 1939-40.
What causes Depression, and what are its signs?
There is more than one factor at play that leads up to the situation of depression, these factors are explained below:
Deflation: Deflation is a utopian situation from a layman’s perspective as prices of goods and services fall during deflation. However, from the macroeconomic standpoint, deflation is due to lower demand in the economy that leads to a collapse of that nation’s growth.
Price and Wage Control:This situation is created by the government to put a ceiling on the upper price limit. Companies have no control over prices now and thus begins the layoff leading to massive unemployment in the economy. Rising unemployment is a menace, irrespective of the difference between recession and depression.
Increasing Credit Card Default: This is a good indicator of depression as people are defaulting on credit card payments. They have lost their ability to repay the debt, signalling loss of their pay or job loss.
Blunders during the Depression of 1929
In this depression & recession analysis, we should also learn about what happened during the first-ever known economic depression. The US Federal Reserve did not favour expansionary monetary policy during the Great Depression of 1929. On the contrary, they raised the interest rates to protect the value of gold to maintain the stability of their currency. Also, despite being in deflation, the Fed failed on another front by opting for contractionary monetary policy as they did not increase the money supply. Owing to deflation, prices started falling, and consumers postponed their purchases leading to a decrease in demand. These were the key highlights of the Fed’s reaction to this global crisis.
Key Differences between Recession and Depression
To put it simply, when seen from a time perspective, a recession is ephemeral compared to depression that lasts for a long time. The recession could be for several months, while depression goes on for years. Other key points for the difference between depression & recession are as follows:
|Definition||A contraction in economic growth that lasts for a couple of quarters to a year||A severe form of an economic downturn that lasts for many years|
|After effects||People and businesses reduce spending, investments are down||The after-effects are much deeper, wherein investors’ confidence is at an all-time low|
|Influence||Recession can hurt a specific country or some countries in a region||Depression is felt on a global scale that impacts trade and investments|
|GDP||Negative GDP growth for two consecutive quarters||A drop in GDP growth by more than 10% in a financial year|
This is all we had for you in this edition of the difference between depression & recession. We hope you get a fair idea of what these two terms mean, how they are caused and what are some of their indicators. Above everything, you must be well-versed with the difference between recession and depression.