Recession Versus Depression and How to Tell the Difference

What makes a depression so much worse than a recession?

A recession is a widespread economic decline that lasts for several months. A depression is a more severe downturn that lasts for years.

There have been 33 recessions since 1854. Since 1945, recessions have lasted for 11 months on average.

There's been only one depression, the Great Depression. It lasted a decade. According to the National Bureau of Economic Analysis, it was actually a combination of two recessions. The first lasted for 43 months, from August 1929 to March 1933. The next lasted 13 months, from May 1937 to June 1938. Combined, the severe downturn lasted for around 10 years.

If you are wondering if we are in a depression or recession, it's probably a recession.

What Is a Recession?

In a recession, gross domestic product contracts for at least two quarters. In a typical recession, GDP growth will slow for several quarters before it turns negative.

There's also a drop in four other critical economic indicators: income, employment, manufacturing, and retail sales. Since these reports come out monthly, they usually signal a recession long before GDP turns negative.

What Is a Depression?

A depression is longer and more destructive than a recession. It has years, not quarters, of economic contraction. In the Great Depression, GDP was negative for six out of the 10 years. In 1932, it shrank by a record of 12.9%.

Unemployment reached 25%. International trade shrank by more than two-thirds, and prices fell more than 25%.

The devastation of a depression is so great that the effects of the Great Depression lasted for decades after it ended. The stock market didn't recover until 1954.

Where Are We in the Current Business Cycle?

The best way to find out if we are in a recession or a depression is to understand where we are in the business cycle. A recession typically follows the peak of the business cycle. The peak is marked by irrational exuberance and asset bubbles.

In early 2020, the U.S. economy entered the contraction phase of the business cycle. The 2020 recession was caused by the COVID-19 pandemic. The government closed non-essential businesses and urged people to stay at home to stop the spread of the virus. The economy contracted 5.0% in the first quarter of 2020. By April, there were 23.1 million unemployed, sending the unemployment rate to 14.7%.

Cause of the Great Depression

During the Depression, the Federal Reserve raised interest rates when should have lowered them. It was trying to protect the gold standard. Today, the world is no longer on the gold standard. Instead, the U.S. dollar is the global currency.

The Fed did not increase the money supply, as it should have, to combat deflation. As consumers noticed prices were falling, they put off making major purchases. That further lowered demand. The Fed also ignored bank failures.

Follow the Great Depression Timeline to find out what caused the Depression, how bad it was, and what finally ended it.

As a result of the Great Depression, the Fed now lowers interest rates at the first sign of a recession. It makes sure that banks have plenty of capital to lend.

12 Causes of Recession

There are 12 causes of a recession. Almost all of them involve a loss of business or consumer confidence. Without confidence in the future, consumers will stop buying and businesses will lay off workers. These situations create a downward spiral of unemployment, loan defaults, and bankruptcies.

What triggers this panic reaction? Often, it's a shock like a stock market crash, wage-price controls, or the collapse of an asset bubble. It can also be an unanticipated reaction to government action, such as deregulation or an increase in interest rates. Other times, it's business behavior, such as poor management or credit crunches. In 2020, it was a pandemic.

How a Stock Market Crash Causes a Recession

A stock market crash can easily trigger a recession. Since stocks are a piece of ownership in a company, the stock market is a vote of confidence in the future of all these companies. As such, it's also a referendum on the U.S. economy itself.

A crash can scare consumers who then buy less, triggering a recession. The crash restricts financing for new businesses. The sale of stocks provides them the funds they need to grow.

If confidence is not restored, the stock market will continue to fall. If it drops more than 20%, that's the start of a bear market. This extreme loss of confidence is also enough to trigger a recession.

Is the United States Headed Toward the Second Great Depression?

If the United States were to experience an economic downturn on the scale of the Great Depression, your life would change dramatically. One out of four people would lose their jobs. The stock market would drop by 50% and take decades, not months, to recover.

The COVID pandemic, while causing a recession, probably won't cause a depression. Central banks around the world know how to prevent them. They made sure that banks have enough capital. They have lowered interest rates to zero.

Unlike the early years of the depression, Congress has used expansionary fiscal policy to cushion the 202 recession. The CARES Act sent a $1,200 stimulus check to eligible adults earning up to $75,000. It also expanded unemployment benefits.

During a Depression, Is My Money Safer Under the Mattress?

During the Depression, there were many bank failures. This made people take their money out of the bank, known as a run on the bank. Fortunately, you don't have to hide your money under a mattress.

The Federal Deposit Insurance Corporation insures 100% of your savings, checking, and money market deposits. As long as you are within their guidelines, your money is safe in a bank. What’s more, if it is in a bank, you may be able to earn interest and lose less to inflation.