What is depression?
A depression is a serious and prolonged slowdown in economic activity. In economics, a depression is commonly defined as an extreme recession that lasts at least three years or causes a drop in real gross domestic product (GDP) of at least 10%.
In times of depression, consumer confidence and investment decline, shutting down the economy. The economic factors that characterize depression include:
- Substantial increase in unemployment
- Decrease in available credit
- Decreasing output
Defects in sovereign debt
- Reduced trade and commerce
- Sustained volatility of monetary values
Key points to remember
- A depression is a serious and prolonged slowdown in economic activity characterized by a sharp drop in employment and production.
- Depressions are much more severe and prolonged than recessions. In general, they are identified as having a duration of more than three years or causing a drop in real gross domestic product (GDP) by at least 10%.
- The U.S. economy has experienced many recessions, but only one major economic depression: the Great Depression of the 1930s.
Depression vs recession
A recession is a normal part of the business cycle that usually occurs when GDP has been contracting for at least two quarters. A depression, on the other hand, is an extreme drop in economic activity that lasts for years, rather than several quarters. This makes recessions much more common: since 1854, there have been 33 recessions and one depression.
Depressions and recessions differ both in duration and in the severity of the economic contraction.
Economists disagree on the duration of the depressions. Some believe that a depression covers only the period marked by the decline in economic activity. Other economists argue that the depression continues until most economic activity has returned to normal.
Example of depression
The Great Depression lasted for about a decade and is widely regarded as the worst economic downturn in the history of the industrialized world. It started shortly after the October 24, 1929 American stock market crash, known as Black Thursday. After years of reckless investment and speculation, the stock market bubble burst and a massive sale began, with a record 12.9 million shares traded.
The United States was already in recession, and the following Tuesday, October 29, 1929, the Dow Jones Industrial Average fell 12% in another massive sale, triggering the start of the Great Depression.
Although the Great Depression began in the United States, the economic impact was felt worldwide for more than a decade. The Great Depression was characterized by lower consumer spending and investment, and by catastrophic unemployment, poverty, hunger and political unrest. Unemployment in the United States rose to almost 25% in 1933, remaining double-digit until 1941, when it finally fell to 9.66%.
During the Great Depression, unemployment hit 24.9%, wages fell 42%, house prices fell 25%, total US economic output almost halved to 55 billions of dollars and many investor portfolios have become worthless.
Shortly after Franklin D. Roosevelt was elected president in 1932, the Federal Deposit Insurance Corporation (FDIC) was created to protect the accounts of depositors. In addition, the Securities and Exchange Commission (SEC) was created to regulate the US stock markets.
What triggers depression?
A series of factors can lead to a severe contraction in the economy and in production. In the case of the Great Depression, questionable monetary policy was the cause.
After the stock market collapse in 1929, the Federal Reserve (Fed) continued to raise interest rates, defending the gold standard took precedence over pumping money into the economy to encourage spending. These actions sparked massive deflation. Prices have fallen by 10% each year and consumers, aware that prices for goods and services will continue to fall, have refrained from making purchases.
Why a repeat of the Great Depression is unlikely
Policymakers seem to have learned the lessons of the Great Depression. New laws and regulations were introduced to avoid repetition and central banks were forced to rethink the best way to deal with economic stagnation.
Nowadays, central banks react more quickly to inflation and are more willing to use expansionary monetary policy to boost the economy during difficult times. The use of these tools helped prevent the great recession of the late 2000s from becoming a real depression.