What Is the Difference Between a Recession and a Depression?

What Is a Recession?

Financial markets and the overall economy go through periods of ups and downs. But that doesn't mean a down week in the stock market qualifies as a recession—economic analysts focus on business cycles on the scale of months to years. Recessions are widespread and typically impact almost every sector of the economy.

One common explanation of a recession is two or more consecutive quarters of negative gross domestic product growth (GDP), though it's not an official definition. The GDP, which measures the total value of finished goods and services during a specific time frame, is a leading indicator of the economy's health.

Still, other factors besides the GDP come into play. When it comes to determining when the U.S. has entered or emerged from a recession, the National Bureau of Economic Research (NBER) is considered the quasi-official arbiter.

Signs of a Recession

An NBER panel of eight economists reviews various economic factors to determine if the economy is in a recession. A recession begins when these indicators start a long, steady decline and ends when they eventually rise again.

• Industrial production: This is an indicator of GDP growth because it is influenced by consumer demand and interest rates. Less demand results in companies producing fewer goods and services.
• Higher unemployment rates: During a recession, companies lay off workers and enact hiring freezes due decreased demand for their business.
• Lower personal income: Facing reduced hours and job losses, consumers have less personal income to spend on goods and services.
• Declining stock market: Waning consumer confidence, earnings reports and lack of growth in the economy at large lead investors to pull back from the stock market.
• Negative GDP growth: GDP growth is a leading indicator economists review to determine when the economy enters and exits a recession.

What Causes a Recession?

Every recession is unique and can be triggered by various economic events, such as the following:

• Oil prices: Near quadrupling of oil prices and high inflation significantly contributed to a recession from November 1973 to March 1975.
• Inflation and monetary policy: These two often go hand in hand. For example, strict monetary policy to gain control of inflation in the early 1980s was one factor in the recessionary period of 1981 and 1982.
• Stock market crashes: Fortunately, these events are rare, but their impact can be catastrophic. The bursting of the dot-com bubble and the September 11 attacks contributed heavily to a 2001 recession.
• Asset bubble collapses: This was a major factor in kicking off the Great Recession of the late 2000s. Lax lending standards led to a wave of mortgage default and foreclosure, which caused the housing sector to collapse and pull the American economy into a full-on recession.
• Unexpected events: NBER recognized the COVID-19 recession as lasting from February 2020 to April 2020, though its impact was deep. An astounding 20.5 million Americans lost their jobs in April 2020.

What Is a Depression?

An economic depression is similar to a recession, but much more severe and longer lasting. Not only does a depression last longer, but its effects can be far-reaching and linger long after the economy begins to recover.

The NBER has no formal definition for a depression but points out that the last event widely regarded as a depression was the Great Depression of the 1920s and '30s. During this depression, the national unemployment rate climbed to nearly 25% and the GDP declined by nearly 27%. A depression can also greatly reduce international trade and wreak havoc globally.

Causes of Depressions

The Great Depression was the longest and most severe financial crisis of its kind in the U.S. during the industrial era. It started with a recession where the country saw spending decline and subsequent manufacturing decline, but before long had evolved into a depression that rippled out across the world. Even people who kept their jobs saw their incomes plunge by 42.5%.

Similarly, the Panic of 1837 launched a prolonged financial crisis that ultimately led to a depression that lasted through 1842. Leading up to 1837, widespread land speculation in the West and lenient credit requirements led to skyrocketing land prices. The land bubble burst in 1837, and banks declared bankruptcy or closed.

However, the long-lasting effects of the Panic of 1837 turned into a depression that lasted through 1842. During that period, total bank assets were nearly chopped in half, commercial credit was hard to come by and business went cold.

How Does a Recession Differ from Depression?

Author Geoffrey H. Moore states in his book, "Business Cycles, Inflation, and Forecasting," that "a recession is a period of decline in total output, income, employment and trade, usually lasting six months to a year and marked by widespread contractions in many sectors of the economy."

Moore follows with a simple definition for a depression: "A depression is a ‘Big Mac' recession."

Thankfully, we know enough about recessions and depressions to define some of their differences, as illustrated in the following table:

The Bottom Line

Recessions are a normal part of the business cycle, and fortunately, they tend to be brief. But as the NBER points out, the recovery period after a recession to return to peak economic activity can be lengthy. For their part, many economists believe another depression is unlikely, thanks to a wide variety of safety measures enacted since the Great Depression, such as unemployment benefits and Federal Deposit Insurance Corporation (FDIC) insurance on bank deposits.

Regardless of what the coming year holds, now is as good a time as any to take a second look at your finances by building an emergency savings fund, paying off debt, reviewing your budget and increasing your income. Shaping up your credit health is another wise measure you can take. Get your credit report and credit score for free to see where your credit stands, and take steps to improve your credit if necessary.