What is the difference between a recession and a depression?

We explain the key differences between a recession and a depression.

Recession definition: what is a recession?

A recession is declared when a country reports negative gross domestic product (GDP) growth for two consecutive quarters and represents the period in which an economy is shrinking rather than growing. A recession lasts for at least six months but there is no agreed limit on how long one can last.

Although recessions are the toughest period for any economy, it is a necessary part of the business cycle. Economies tend to grow before reaching their peak, which signals the beginning of a downturn that sees the economy contract, eventually enough to enter a recession. An economy will then recover from the recession and begin expanding again to repeat the entire cycle over again.

GDP is the key measure used to define when a country has entered a recession, but many believe this view is too simplistic. For example, the International Monetary Fund (IMF) says defining recessions by GDP movements is a ‘useful rule of thumb’, but admits it has its downfalls.

‘A focus on GDP alone is narrow, and it is often better to consider a wider set of measures of economic activity to determine whether a country is indeed suffering a recession. Using other indicators can also provide a timelier gauge of the state of the economy,’ the IMF says.

This has prompted some organisations to take a more holistic view of their economy and define any downturns using more than just GDP. This could include other key measures such as employment, industrial production, retail spending, or the stock market, and can provide a more detailed glimpse into the state of the economy than when focusing on GDP alone. Plus, this type of data is released more regularly than GDP, which means it can be used to flag a potential downturn or recession sooner.

There can be numerous triggers of a recession, like a banking crisis, a stock market crash, asset bubbles, or the collapse of the housing market, to name a few. This quickly escalates because of how interconnected a nation’s or even the world’s economy is. Some of the worst downturns have been triggered by a crash in the stock market but caused by major industries collapsing, such as banking or housing.

Recessions typically lead to higher unemployment, reduced investment and lower output while consumers also tighten their belts and lose confidence in their economic prospects. Inflation tends to also fall during a recession, but some countries suffer what is known as ‘stagflation’, when inflation remains high despite lacklustre economic growth and low employment.

Read more: Everything you need to know about recessions

The Great Recession

The recession caused by the 2008 financial crisis was the worst one on record since the end of the Second World War, and is sometimes referred to as the Great Recession.

Banking and financial markets in advanced economies, particularly in the US, went through a period of deregulation in the years leading up to the crisis, encouraging banks to expand their mortgage lending and to introduce more high-risk - but misunderstood - financial products to the market.

Problems started to surface in 2007 and spawned from US banks providing mortgages to people who couldn’t afford them. After the US housing market was hit by a downturn, many people suddenly couldn’t afford to repay their debts and banks were plunged into trouble. The fact that house prices crashed meant many people now owed more money than what their house was worth, which put more pressure on the banks. Banks and hedge funds started to go bankrupt, with the collapse of Lehman Brothers in September 2008 being one of the most notable, and the stock market went into panic mode.

The high degree of interconnectedness between the US and the rest of the world meant it didn’t take long for these problems to spread globally, and particularly hit other advanced economies. It triggered another banking crisis in Europe and contributed to the subsequent crisis in the eurozone in 2011-2013.

Many countries were plunged into a recession at roughly the same time, which meant the global impact was much more severe than previous recessions. In fact, 2009 was the only year that real global GDP declined since 1950. The US was hardest hit followed by the likes of Europe, but emerging and developing countries did not suffer as much and also managed to recover at a quicker rate.

Depression definition: what is a depression?

There is no agreed definition for a depression, but it is widely considered as a more prolonged and severe form of a recession. However, the IMF says some consider a decline in GDP of over 10% as a depression. Ultimately, it is an extended and sharper economic downturn that has greater consequences on the long-term prospects for its recovery.

A depression will always be borne out of a recession, but there is a debate over when one ends. Some believe a depression ends as soon as an economy starts to grow again, while others think it only ends once growth and output start to return to pre-crisis levels.

The Great Depression

The worst downturn ever recorded started in 1929 and lasted for at least ten years, leaving a deep scar on the global economy. Notably, the depression was actually comprised of two separate downturns, one between 1929 and 1933 and another between 1937 to 1939. The reason they are not separated is because the initial downturn was so severe that there was a weak recovery from 1933 that was quickly erased once the US hit trouble again in 1937. The US only started to return to its usual level of growth in 1942.

The Great Depression originated in the US and, much like the more recent Great Recession, was sparked by the stock market crashing in an event known as the Great Crash. Banks once again had been encouraged to lend more, but found themselves in trouble when people started to default on their debts as low wage growth and decline of major sectors like agriculture started to bite. This left banks with large amounts of loans they could no longer collect, sparking a financial crisis that hit the stock markets.

One defining aspect of the Great Depression was the gold standard, which fixed the value of many major currencies to that of gold. This meant many major currencies traded at fixed exchange rates because they were all pegged to gold and this was the main reason why the downturn in the US spread so quickly to other parts of the world – the dollar crashed and brought other currencies down with it, plunging other nations into trouble.

The Great Depression is the only widely recognised depression on record, but there have been more recent ones if you define depressions by a 10% decline in GDP. For example, Finland reported a 14% drop in GDP during the 1990s in the wake of the Soviet Union breaking up, which disrupted trade with one of the country’s main partners.

What are the key differences between a recession and a depression?

A depression is a more severe and prolonged form of a recession. For example, the US economy shrank 33% peak-to-tough during the Great Depression and unemployment peaked at 25%, whereas the Great Recession only saw a 5% decline in GDP and an unemployment rate of 10%.

Depressions are also much more destructive than recessions. Businesses will curtail investment and cut jobs during a downturn and that affects the economy’s ability to recover. Many businesses will close, investment is lost, and unemployed people lose their skills – and this makes it harder for an economy to bounce back. This also means it tends to take much longer to recover from a depression compared to a recession.

The world is highly integrated thanks to globalisation and the severity of a depression means there is a higher chance that one will have a global impact. On the other hand, recessions can be more localised and may only be felt in individual countries or regions. The IMF says there has been over 120 recessions in 21 different advanced economies since 1960, while the World Bank says there has been just four global recessions: in 1975, 1982, 1991 and 2009.

This also shows that depressions are much rarer than recessions, which are quite common because they are part of the business cycle. Some believe its volatility has been reduced as central banks and governments get better at spotting potential downturns and reacting to them with fiscal and monetary policy. However, that appears to have done little to counter the actual damage of each recession considering the recent one was the most acutely felt and prompted the slowest recovery of any recession to date.

How to trade the global recession of 2020

The world is preparing for the next global recession, but one unlike any other. This global recession is being driven by the coronavirus pandemic, whereas previous recessions have been rooted in problems within financial markets. The World Bank expects it will plunge virtually every country around the globe into a recession, but many are hoping it will be a temporary blip that can be overcome by finding a vaccine or treatment.

You can read more about how to trade and invest during the 2020 global recession here, or view our analysis of how the coronavirus is impacting the global economy here.

Publication date : 2020-09-14T09:17:22+0100

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