Recession vs. Depression: Definitions and Differences
October 24, 1929 was a Thursday.
The decade leading up to that day was one of carefree affluence. Thanks to a combination of more jobs, higher wages, and expanded access to credit, the middle class had more buying power than ever before.
As luck would have it, there was an abundance of things to buy. Henry Ford’s assembly line meant companies could now mass produce goods quickly and cheaply. Consumerism took its spot at the forefront of the American economy. Between 1920 and 1929, the U.S. economy had more than doubled.
This was great news for the stock market. It trended upward for a decade. Buying stock on the speculation it would continue rising (seemingly forever) became a common occurrence.
In the mid-2000s, moneylenders found ways of helping unqualified borrowers get approved for mortgages. They then figured out how to sell that debt to other entities, who could repackage it into a new kind of investment: private-label mortgage-backed security. As housing prices continued to rise, everyone made money—a lot of money.
But, eventually, the housing market began to crash (something people worry might happen again in the near future).
When people could no longer afford their mortgages, the money began to disappear. Banks, other money lenders, and investors started losing money. And, because their success (or failure) influenced the economy, things turn a turn for the worse.
In December 2007, the United States’ economic downturn officially became a recession. It would subsequently be dubbed “The Great Recession.” It took years to recover.
On October 24, 1929, the stock market crashed. It initiated an economic downturn we now call “The Great Depression.” It lasted a decade.
So, what’s the difference between a recession and a depression? While it’s unfortunate that these two events happened, they give us a reference point we can use to illustrate the differences between these two types of economic contractions.
But why is learning the difference important?
Why should I know the difference?
Believe it or not, recessions happen frequently. The exact number may vary depending on who you ask, but some estimate that America has faced around 34 major recessions since the founding of the country. Around a third of these happened after 1948.
While experts have a hard time creating a definition of a “depression” that everyone can agree on, most agree on one thing: America has really only faced one major depression.
So, why should you know the difference between recessions and depressions? Here are what I think are the two primary reasons:
- To help you prepare for the more common recessions.
- To help alleviate your worries about extraordinarily rare depressions.
Recessions are going to happen. We’ve averaged one every six years or so in the last 7 decades. In fact, many worry we might be experiencing a recession at this very moment. As investors, we can use that knowledge to recognize the signs of a looming recession, create a plan of action to sustain us throughout the downturn (like learning how to invest during a bear market), and give us the patience to wait it out—we know it won’t last forever.
On the other hand, depressions almost never happen. Yes, a depression has the potential to spell disaster for many of us. If you’re concerned about one, I say draft up your plan and put it in a drawer for safekeeping. The odds are you’ll never need it. But on the off chance that you do, you’ll have it. Either way, you don’t have to worry.
Now, onto some basics.
Defining economic downturns
Before we discuss their differences, it might be helpful to put on paper exactly what these two terms mean. So, let’s talk definitions.
What is a recession?
A recession is a significant decline in economic activity that lasts at least a few months. The National Bureau of Economic Research (NBER) defines a recession as occurring when there have been two consecutive quarters of economic decline.
Several events and situations can trigger a recession. Whatever the trigger, the result is usually a widespread reduction in spending that affects businesses, the stock market, and other economic factors.
What is a depression?
Again, there’s no definition of an economic depression that all economists agree upon. This is likely due to their rarity—with few things to compare it to, it’s hard to determine the common characteristics.
What most can agree on is that a depression is a much, much bigger version of a recession. This is usually characterized by a sharp, extended economic downturn that lasts several years. Depressions feature severe declines with harsh effects spread across the economy.
What is the difference between a recession and a depression?
If a depression is just “a recession—but bigger!”, does that mean the only differences are based on size?
The short answer: yes.
The more complicated answer: yes, but the differences are of such an enormous size that they’re worth discussion.
That said, here are the key differences between a recession and a depression:
Though recessions can last up to a few years, they often peter out much more quickly. On average, they last about ten months before things even out and begin trending back up. Because of their frequency and compressed timeline, they’re considered part of the business cycle—a cycle of alternating economic expansion and recession.
Business cycles can fluctuate in length, but they average about 4 years. Recessions are simply a natural part of the ebb and flow within that time.
Because they’re more rare, depressions are harder to nail down. According to most economists, a depression lasts for at least three years—that is, longer than a recession, at minimum. Experts have a hard time deciding when the Great Depression ended, as well. Most consider the end to be 1939, though some think it didn’t end until 1941 when WWII helped boost manufacturing in the U.S.
Let’s look at the durations of our examples:
- The Great Recession: December 2007 to June 2009 (19 months)
- The Great Depression: October 1929 to ~1939 (~10 years)
Effects on Unemployment
Because a hallmark of a recession is a large decline in spending, businesses can have a hard time keeping their revenues up. This usually means cutting labor. As a result, unemployment rates go up. When the economy is doing well, unemployment in the US usually hovers at or below 5%. During a recession, unemployment can climb to 8% or higher.
It’s no surprise that, during a depression, unemployment is much worse than during a recession. While this is a big problem today, it was even bigger during the Great Depression—federal social safety nets didn’t exist until FDR introduced legislation for Social Security and Unemployment Insurance as part of his New Deal.
- Great Recession unemployment: 10%
- Great Depression unemployment: 25% (!)
When markets and businesses aren’t doing well, they scramble to cover their losses. You might think this would affect wages during a recession—and, in a way, it can.
Wages don’t typically go up or down during a recession. Instead, wages usually stagnate. This is because companies would prefer to let employees go rather than lower wages, hence the rising unemployment. Ironically, the Great Recession came at a time when citizens had been calling for wage increases—which actually occurred during the recession!
Because there was no minimum wage during the Great Depression, it’s harder to determine how wages changed. But from what we can tell, wages went down during the Great Depression—for some, at least. This is likely because jobs were so hard to come by, and workers eventually decided lower pay was better than no pay at all. If you’re interested in more specifics, I recommend this study by economist Curtis J. Simon.
- Wage change during the Great Recession: $5.15—$7.25 (+$2.15)
- Wage change during the Great Depression: ?
Effects on GDP and the stock market
The Gross Domestic Product (GDP) is the total market value of all final products (finished products ready for immediate use) produced and sold within a given time period. Because of their effects on business and production, economic downturns usually also have an effect on the GDP and the stock market.
During a recession, the GDP might fall around 2%. During a rather rough recession, it could fall as much as 5%. The stock markets also fall. As an example, we can look at the S&P 500. During most of the recessions we’ve experienced since the end of WWII, the S&P has fallen an average of 29%, with a median of about 24%.
For depressions, it gets much worse. Again, we look to the Great Depression. At its worst point in 1933, the GDP fell about 30%.
As for the stock market, 1932 saw the Dow Jones fall a whopping 89% below its highest point. Having lived through the Great Recession, it’s hard to imagine how much worse it must have been during the Depression.
The Great Recession:
- GDP: – >1%
- S&P 500: -55%
The Great Depression:
- GDP: -30%
- Dow Jones: -89%
Scope of legacy
I know I keep stating how much worse a depression is, but please understand that recessions are also quite bad. It’s just that they don’t affect as many people, have as severe consequences or have as many lasting effects. Things got hard during the recession. During the Depression, it’s not hyperbole to say that most people barely had enough money to survive—and many didn’t have that much.
And then, things changed.
By no means is everything perfect these days, but we do owe a debt to the policymakers who saw what happened leading up to and during the Great Depression and made moves to ensure that things wouldn’t get that bad again.
I like to think of it this way: the legacy of a recession is that it changes people’s minds. The legacy of the Depression is that it changes everybody’s life. While recessions can often lead to some policy changes and a changing of personal plans, the Great Depression caused a complete paradigm shift.
With every paycheck, we still pay into Social Security. We still maintain a minimum wage which, though fallible, is still an effort to ensure people can afford to sustain themselves. The Securities Exchange Commission and the International Monetary Fund both exist as a result of the Great Depression.
The United States has experienced 34 recessions and 1 major depression. We talk about a small fraction of those recessions. But we still talk about 100% of the depressions.
Because we must.
FOMO & Investing
Understanding FOMO: Investing’s Poison Pill In the social media age, we’ve become increasingly connected to those around us. Because mostRead more