What Is an Economic Contraction with Examples

Definition: An economic contraction is a decline in national output as measured by gross domestic product. That includes drop in real personal income, industrial production and retail sales. It will usually increase unemployment rates. Companies stop hiring to save money in the face of lower demand. Towards the middle of a contraction, they start laying off workers, sending unemployment rates higher. It's one of the four phases of the business cycle, also known as the boom and bust cycle.

The National Bureau of Economic Research uses economic indicators to determine when a contraction has occurred. Since 1854, there have been 33 contractions. They typically last 17.5 months each. For more, see NBER Cycles.

A contraction is caused by a loss in confidence that slows demand. It's usually triggered by an event, like a stock market correction or crash. But the true cause precedes the well-publicized event. It's typically an increase in interest rates that decreases the capital

Investors sell stocks, sending prices downward and reducing financing for large corporations. Businesses cut spending, then lay off workers. That dries up consumer spending, which creates further business losses and layoffs. For more, see Causes of Recession and What Causes the Boom and Bust Cycle?

A contraction ends when prices fall enough to attract renewed demand. Central bank monetary policy and government fiscal policy can end a contraction more quickly. They will lower interest rates and taxes, and increase the money supply and spending.  For more, see Best Unemployment Solutions.

1920s Contractions

When did the Great Depression start
President Herbert Hoover and his wife, Lou Henry Hoover, in Chicago at the final game of the 1929 World Series between the Chicago Cubs and the Philadelphia Athletics, October 1929. The Great Depression had already begun. Photo by Chicago History Museum/Getty Images

There were plenty of economic contractions during the "Roaring Twenties." The first contraction began in January 1920. One reason was the high maximum income tax rate of 73 percent on incomes more than $1 million. Nearly 70 percent of federal revenue came from income taxes. In 1921, Warren Harding became President. Fortunately, the recession ended in July without any intervention.

Congress increased the corporate tax rate from 10 percent to 12.5 percent. It also passed the Emergency Immigration Act to restricted the number of immigrants to 3 percent of the 1910 population. In 1922, Harding lowered the top tax rate to 58 percent. In 1923, Calvin Coolidge (R) became President. His motto: He lowered the top tax rate again, to 43.5 percent. Supreme Court revokes minimum wage for women in Washington, DC.

Recession began in May 1922, but ended in July 1924.  Despite the contraction the stock market began a six-year bull market. It was fueled by speculation and leverage. Coolidge raised the top tax rate to 46 percent, then lowered it the following year to 25 percent. 

Another contraction began in October 1926. It ended in November 1927 after the Federal Reserve lowered interest rates. Congress raised the corporate tax rate to 13.5 percent. (Source: "Monetary Policy and the Great Crash of 1929," Federal Reserve Bank of San Francisco, March 26, 1999.)

1930s: The Great Depression

soup line
A line of men wait outside a soup kitchen opened durin the depression by mobster Al Capone, Chicago, Illinois, February 1931. The storefront sign reads 'Free Soup, Coffee and Doughnuts for the unemployed.'. Photo by PhotoQuest/Getty Images

The Great Depression was the biggest economic contraction in U.S. history. It began in 1929, the year Herbert Hoover became President. He lowered the top income tax rate to 24 percent, and the top corporate tax rate to 12 percent. But it was too late. The economy contracted in August, signaling the beginning of the Great Depression.  In September, the stock market peaked, crashing on October 24th. (Source: "Historical Highest Marginal Income Tax Rates," Tax Policy Center, February 19, 2015. "Federal Income Tax Policy in the 1920s," Journal of Economic History, June 1995, PP. 285-303.) More

1940s

Harry Truman
7th September 1945: President Harry S Truman (1884 - 1972), holding up the official Japanese document of surrender with Emperor Hirohito's signature at a White House meeting. Photo by Fox Photos/Getty Images

In February 1945, the economy contracted until October 1945.  GDP plummeted 10.6 percent in 1946. In November 1948, the economy contracted until October 1949. GDP fell .5 percent for the year. The WWII demobilization meant that the government cut back production of military weapons. It took months before business production replaced it.  (Source: NBER, Business Cycle Expansions and Contractions.) 

1950s Contractions

President Eisenhower
General Dwight D Eisenhower (1890 - 1969), Supreme Commander of the Allied Forces, watches the Allied landing operations from the deck of a warship in the English Channel during World War II, June 1944. Eisenhower was later elected the 34th President of the United States. Photo by Keystone/Getty Images

In July 1953 the economy contracted for ten months. It was due to the end of the Korean War. Unemployment peaked at 6.1% in September 1954.  GDP contracted 2.2 percent in Q3, 5.9 percent in Q4, and 1.8 percent in Q1 1954. 

In August 1957, the economy contracted until April 1958. GDP fell 4.0 percent in Q4 1957, then fell 10.0 percent in Q1 1958. Unemployment peaked at 7.1 percent in September 1958.

1960s

jfk
circa 1962: American president John F Kennedy (1917 - 1963), wearing dark sunglasses, sits next to US Air Force Chief of Staff Curtis LeMay. Photo by Hulton Archive/Getty Images

In April 1960,  the economy contracted for ten months. GDP was -1.5 percent in Q2 and -4.8 percent  in Q4. Unemployment reached a peak of 7.1 percent in May 1961. President Kennedy ended the recession with stimulus spending.

1970s

nixon-brezhnev.jpg
Caption:23763 09: Soviet leader Leonid Brezhnev signs an agreement with President Richard Nixon June 20, 1973 at Camp David, MD. Brezhnev met with members of the U.S. Senate Foreign Relations Committee to sign an agreement to prevent nuclear war with the US. Photo by Dirck Halstead/Liaison/Getty Images

In November 1973 the economy contracted until March 1975 . Several factors contributed. First, President Nixon authorized wage-price controls. It kept prices and salaries too high. Consumers cut back on demand, and businesses laid off workers. Second, Nixon removed the United States dollar from the gold standard. That created inflation, as the price of gold skyrocketed to $120 an ounce and the dollar's value plummeted. His destructive policies created stagflation and three consecutive quarters of contraction.

  • 1974 Q3 -3.8 percent, Q4 -1.6 percent
  • 1975 Q1 -4.7 percent. 

1980 Contraction

President Ronald Reagan
President Ronald Reagan giving a speech in the Oval Office. Photo: Hulton Archive/Stringer/Getty Images

The 1980 recession was the third worst economic contraction in U.S. history. It was tough to beat because there was also double-digit inflation. A contraction with inflation is called stagflation. That was due to President Nixon's economic policies. The Fed raised interest rates to 20 percent to combat inflation. That hammered business spending and created the contraction.

It began in January 1980. It seemed like it was over in six months. In 1981, President Reagan took office. The Fed began lowering interest rates, since inflation was at normal levels. But the contraction returned in July 1981 and lasted until November 1982. The economy contracted for six of the 12 quarters. That included a 7.9 percent drop in the second quarter 1980 and a 6.5 percent decline in the first quarter 1982. Unemployment increased to a record 10.8 percent in November 1982. It stayed above 10 percent for ten months.  

Reagan lowered the top income tax rate from 70 percent to 28 percent. He also reduced the corporate tax rate from 48 percent to 34 percent. Although he promised to reduce government spending, he doubled spending instead. His expansionary fiscal policies ended the recession.

1990s

President Bush Sr.
U.S. President George H.W. Bush speaks in the Roosevelt Room 1992 in Washington, DC. Photo by David Hume Kennerly/Getty Images

 In July July 1990 the economy contracted until March 1991. It was caused by the Savings and Loan Crisis in 1989. GDP was -3.4 percent in Q4 1990 and -1.9 percent in Q1 1991. For more, see History of Recessions.

2000s

George W. Bush
Photo: Getty Images

In 2001, the economy contracted until November 2001. The Y2K scare, caused it by driving demand for computer equipment. That created a boom and subsequent bust. It was aggravated by the 9/11 attack. The economy contracted in two quarters: Q1 -1.1 percent  and Q3 -1.3 percent. 

In 2008, the Great Recession was the worst U.S. contraction since the Depression. The economy contracted 0.7 percent in the first quarter. It improved in the second quarter, but then contracted in  third quarter, That slump lasted for four consecutive quarters.

  • -2.7 percent in Q1
  • -1.9 percent in Q3
  • -8.3 percent in Q4
  • -5.4 percent in Q1 2009
  • -0.5 percent in Q2

For details, see 2008 GDP and 2009 GDP.