Depression

What Is a Depression?

A depression is a severe and prolonged downturn in economic activity. In economics, a depression is commonly defined as an extreme recession that lasts three or more years or which leads to a decline in real gross domestic product (GDP) of at least 10%. in a given year. Depressions are relatively less frequent than milder recessions, and tend to be accompanied by high unemployment and low inflation.

Understanding Depressions

In times of depression, consumer confidence and investments decrease, causing the economy to shut down. Economic factors that characterize a depression include:

Economists disagree on the duration of depressions. Some believe a depression encompasses only the period plagued by declining economic activity. Other economists argue that the depression continues up until the point that most economic activity has returned to normal.

Depression vs. Recession

A recession is a normal part of the business cycle that generally occurs when GDP contracts for at least two quarters. A depression, on the other hand, is an extreme fall in economic activity that lasts for years, rather than just several quarters. This makes recessions much more common: since 1854, there have been 33 recessions in the U.S. and just one depression. Moreover, a recession is marked by economists as two consecutive quarters of negative GDP growth, even if those periods of contraction are relatively mild. A depression, on the other hand, is marked by a drop in a year's GDP over 10% or more.

Important

Depressions and recessions differ both in duration and the severity of economic contraction.

Example of a Depression 

The Great Depression lasted roughly a decade and is widely considered to be the worst economic downturn in the history of the industrialized world. It began shortly after the Oct. 24, 1929, U.S. stock market crash known as Black Thursday. After years of reckless investing and speculation the stock market bubble burst and a huge sell-off began, with a record 12.9 million shares traded.

The United States was already in a recession, and the following Tuesday, on Oct. 29, 1929, the Dow Jones Industrial Average fell 12% in another mass sell-off, 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 a drop in consumer spending and investment, and by catastrophic unemployment, poverty, hunger, and political unrest. In the U.S., unemployment climbed to nearly 25% in 1933, remaining in the double-digits until 1941, when it finally receded to 9.66%.

During the Great Depression, unemployment rose to 24.9%, wages slid 42%, real estate prices declined 25%, total U.S. economic output fell by 30%, and many investors' portfolios became completely worthless when stock prices dropped to 10% of their previous highs.

Shortly after Franklin D. Roosevelt was elected president in 1932, the Federal Deposit Insurance Corporation (FDIC) was created to protect depositors' accounts. In addition, the Securities and Exchange Commission (SEC) was formed to regulate the U.S. stock markets. 

Why a Repeat of the Great Depression Is Unlikely

Policymakers appear to have learned their lesson from the Great Depression. New laws and regulations were introduced to prevent a repeat and central banks were forced to rethink how best to go about tackling economic stagnation.

Nowadays, central banks are quicker to react to inflation and are more willing to use expansionary monetary policy to lift the economy during difficult times. Using these tools helped to stop the great recession of the late 2000s from becoming a full-blown depression.

What Triggers a Depression?

A series of factors can cause an economy and production to contract severely. In the case of the Great Depression, questionable monetary policy took the blame.

After the stock market crashed in 1929, the Federal Reserve (Fed) continued to hike interest rates — defending the gold standard took priority over pumping money into the economy to encourage spending. Those actions triggered massive deflation. Prices declined by about 10% each year and consumers, mindful that the prices for goods and services would continue to fall, refrained from making purchases.