After the crash of 1987, the running joke between traders on Wall Street was that the difference between a recession and a depression is that when your co-worker gets laid off, it is a recession. When you get laid off, it is a depression.
While there was little to laugh about as the markets rattled back in 1987, it did bring up a question between the definitions of the two events.
The global pandemic and the ensuing downturns in economic activity in countries that have been affected have rekindled the questions of when circumstances are a recession and when they can be appropriately labelled depressions. The definition is heavily weighted on the depth of the economic downturn and its duration.
What is a Depression?
Economists do not really have an academic delineation to define or indicate exactly when an economic downturn morphs into a depression.
Generally, a depression can be best explained as a recession that can be measured in years as opposed to quarters of economic contraction. It is far more severe than a recession and its impact is more broadly felt than a recession. Depressions are generated by the same factors and occurrences that cause a recession.
The one depression the U.S. has had was the Great Depression of 1929, which lasted almost 4 years. In terms of its severity, half of all banks failed, unemployment reached 25%, housing prices plummeted 30%, international trade dropped 65%, and prices fell 10%. In addition, government programs like FDIC insurance, unemployment insurance, and government mortgage programs were not in existence at that time. The devastation of the Great Depression was so great that its effects lasted for decades after it ended.
What is a Recession?
The benchmark measure of our economy’s strength is the gross domestic product (GDP). The “text book” definition of a recession is two consecutive quarters of negative GDP.
How do you know when you are in a recession?
By definition, you do not know when you are in a recession. You only know when you were in a recession. This is because there is no real time data that economists can follow to see whether or not an economy has entered recession and it is equally as hard to tell if the recession will be a short one, long one, or one that might tip into a depression.
Data that depicts market declines usually comes about after a recession has already made its presence known in the markets.
Are there ways of predicting a recession?
The sage philosopher, Yogi Berra, once said, “It's tough to make predictions, especially about the future”. Any attempt to gauge a recession is far from a science, as it is based upon “guesses”, albeit educated guesses, as to what the components that go into measuring GDP might be. Some of the data that is looked at include:
Job market report from the Department of Labor
Here you do not only want to look at the percentage of people unemployed but also the number of hours worked by full and part-time employees as employers will generally cut hours when demand is declining and they are worried about the future.
Leading Economic Index
This is a report from The Conference Board, and is comprised of 10 components:
-Average weekly hours, manufacturing
-Average weekly initial claims for unemployment insurance
-Manufacturers’ new orders, consumer goods and materials
-Institute for Supply Management(ISM) Index of New Orders
-Manufacturers’ new orders, nondefense capital goods excluding aircraft orders
-Building permits, new private housing units
-Stock prices, 500 common stocks
-Leading Credit Index
-Interest rate spread, 10-year Treasury bonds less federal funds
-Average consumer expectations for business conditions
It is intended to forecast future economic activity. The Conference Board, which is a non-governmental organization, determines the value of the index using the ten key variables above. These variables have historically turned downward before a recession and upward before an expansion.
This report tells you when businesses order new big-ticket items like machinery, automobiles, computers, furniture, commercial jets, and industrial equipment.
This is important because historically, when the economy weakens, companies may postpone the purchase of expensive new equipment to save money. When they regain confidence about the future economy, they buy new equipment. As such, business orders generally decline as the economy begins to decline and will pick up when the economic downturn ends.
While the indicators above are all mathematically based, the Confidence Level is based on how people are feeling. There are a number of organizations who measure the level of “emotion” including The Conference Board, the University of Michigan, and the National Federation of Independent Businesses.
The importance of these numbers lies in the implication that when consumers feel uneasy about their economic future, they are apt to pull back their spending, which causes sales to fall. This can be a recessionary factor.
Recessions by the numbers
There have been 33 recessions since 1854 and 11 recessions since World War II. The average length of a recession after World War II was 11.1 months, and periods of expansion lasted 58.4 months.
In an economic downturn, we are more likely to sink into a recession than a depression. While there are similarities, the key differences between economic recession and depression lie in time, severity, and scope of the downturn.
The key to keep in mind are safeguards that were put in place by lawmakers can make another economic downturn morphing into an event like the Great Depression of 1929 far less likely.
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