DEPRESSION & REGRESSION
What’s a recession? How do we know if we’re in one?
There’s an old joke among economists that states:
A recession is when your neighbor loses his job.
A depression is when you lose your job.
The difference between the two terms is not very well understood for one simple reason: There isn’t a universally agreed upon definition. If you ask 100 different economists to define the terms recession and depression, you’d get at least 100 different answers. I’ll try to summarize both terms and explain the differences between them in a way that almost all economists could agree with.
The standard newspaper definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters.
This definition is unpopular with most economists for two main reasons.
First, this definition does not take into consideration changes in other variables. For example this definition ignores any changes in the unemployment rate or consumer confidence. Second, by using quarterly data this definition makes it difficult to pinpoint when a recession begins or ends. This means that a recession that lasts ten months or less may go undetected.
Recession: The BCDC Definition
The Business Cycle Dating Committee provides a better way to find out if there is a recession is taking place. This committee determines the amount of business activity in the economy by looking at things like employment, industrial production, real income and wholesale-retail sales. They define a recession as the time when business activity has reached its peak and starts to fall until the time when business activity bottoms out. When the business activity starts to rise again it’s called an expansionary period. By this definition, the average recession lasts about a year.
Recession? Depression? What’s the difference?
Before the Great Depression of the 1930s any downturn in economic activity was referred to as a depression. The term recession was developed in this period to differentiate periods like the 1930s from smaller economic declines that occurred in 1910 and 1913. This leads to the simple definition of a depression as a recession that lasts longer and has a larger decline in business activity.
So how can we tell the difference between a recession and a depression? A good rule of thumb for determining the difference between a recession and a depression is to look at the changes in GNP. A depression is any economic downturn where real GDP declines by more than 10 percent. A recession is an economic downturn that is less severe.
If we use this method then the Great Depression of the 1930s can be seen as two separate events: an incredibly severe depression lasting from August 1929 to March 1933 where real GDP declined by almost 33 percent, a period of recovery, then another less severe depression of 1937-38.
Now you should be able to determine the difference between a recession and a depression without resorting to the poor humor of the dismal scientists.