When central banks and governments start to announce new economic policies and people are faced with unemployment, the struggles of everyday life start to become more real than ever. Recession and depression are terms that are used interchangeably in such situations.
Let’s talk about what happens when our economy faces significant declines and compare them to past financial crises. After learning about past economic depressions and recessions, you’ll be able to define a recession and understand its effects if it spreads across the economy.
In this guide:
What is a recession?
A recession is generally when the economy stops growing.
Most financial organizations define a recession as an economic downturn that causes a decline in economic activity. Usually, recessions are measured in months. Generally, governments define a recession as an economic downturn after a period of two consecutive quarters with a negative gross domestic product (GDP).
A recession can be limited to one geographical region or country. To be able to identify a recession, one must look at the country’s economy. A U.S.-based NGO, the National Bureau of Economic Research (NBER), defines a recession as a “significant decline in economic activity that is spread across the economy and that lasts more than a few months.” While different criteria, such as depth, duration, and diffusion, are needed to reach certain levels to reach a recession, only one of these may partially offset a recession.
The economy is subject to cycles, and recessions are often predictable. A recession could mean stagnant wages, higher costs, and lower consumer spending. For those looking to achieve financial freedom, it’s worth considering the inevitable recessions that you will live through.
Some refer to a recession as “the lesser of the two evils.” That’s because a recession is often associated with depression.
What causes a recession?
There are many factors that can cause a recession, including inflation and deflation cycles. Other reasons for a recession are the burst of an asset bubble such as real estate and stocks, a slowdown in manufacturing, and loss of consumer confidence. A stock market crash or high-interest rates can trigger any of these situations.
In recent years, the worldwide COVID-19 pandemic forced many businesses to close down their doors, which triggered an instant increase in unemployment. This leads to consumers with no income that cannot afford to pay their monthly bills, leading to greater debt, which only cripples the economy even more. The economic situation is expected to worsen until people can return to work and live a normal life. However, with today’s tools and many online job offers, some might find it easier to survive a recession, as there are many high-paying freelance jobs available online.
Characteristics of recession
During an inflationary recession, the stock markets are up, and unemployment is down, despite the pandemic. The NBER has released a report indicating that the U.S. could be in a recession by the end of 2021.
Recessions can be characterized by these economic developments:
- High unemployment: Companies lay off workers in recessions to meet declining demand.
- Falling prices and sales for real estate and houses
- The stock market falls: Investors lose faith in the economy. They also see businesses failing to make a profit.
- Wages decline: Consumers may have a hard time paying their bills when their income is stagnant or, even worse, declining.
- Negative GDP: This means that consumers are less likely to spend, resulting in lower demand for goods.
It’s important to point out that recessions do happen during an economic cycle. A total of 13 recessions have happened since the end of World War II. One of the most important is the Great Recession of 2008. This recent recession started in December 2007 and ended almost two years later, in June 2009.
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The main cause of the Great Recession was the subprime mortgage crisis. This led to a total collapse of the housing market and ignited a global financial banking crisis.
Some statistics from the 2008 Great Recession:
- Half of all families lost 25% of their wealth
- One-quarter of U.S.-based families lost 75% of their wealth
- More than 8.7 million jobs were lost between December 2007 and 2010.
While the Great Recession had a terrible effect on all segments of the economy, it must not be confused with depression. Let’s take a look at the differences between the two and compare recession with depression.
Recession vs. depression: the major differences
As detailed above, recession refers to a downtrend, which is part of the economic cycle, and it’s characterized by unemployment and a decrease in production. The income of a household decreases, and investments are being put off.
Depression refers to a severe economic downturn. It is marked by a sharp decrease in industrial production, widespread unemployment, and a significant reduction in international trade and capital movements. Companies reduce their production and shut down their manufacturing factories, resulting in fewer exports.
Note that a recession is not the same as a depression. Moreover, recessions can be restricted geographically (limited to one country), while depressions may affect many countries (such as the Great Depression in the 1930s).
The Great Depression lasted from 1929 to 1939 and had devastating consequences in terms of both its severity and impact. The Great Depression was the worst economic downturn in history. It began in America in 1929 with a recession before spreading to other parts of the world, especially Europe.
The Great Depression of the 1930s
The United States faced the following during the Great Depression:
- Skyrocketing unemployment: At its worst times, nearly 25% of the workforce was unemployed.
- Falling wages: Even people who managed not to lose their job started to earn less than what they did before the depression. During the Great Depression between 1929 and 1933, wages fell by 42.5%.
- Large declines in GDP.
During the Great Depression, many banks went bankrupt between 1930 and 1933.
| Great Recession of 2008 | Great Depression of 1930 | |
|---|---|---|
| Duration | Lasted for two years | Lasted a decade (1929–1939) |
| Unemployment | Up to 10.6% | Peaked at 24.9% |
| Location | Confined to an individual country’s economy | The Great Depression was felt across the world |
| GDP | Dropped by 4.3% | Dropped by 30% |
As you see, in a recession vs. depression comparison, the latter is much worse, and luckily, we haven’t had as many.
Like any long-term economic crisis, there was more than one event that caused the Great Depression. It was a combination of several events, including the 1929 stock market crash and severe drought in the 1930s.
Before the crash, the economy was already declining. Unemployment rose, and manufacturing declined, making stocks highly overvalued. On Oct. 24, 1929, a day also known as “Black Thursday,” investors sold almost 13 million shares of stock to signal to consumers that they were right about their lackluster confidence. That marked the beginning of a period of increased debt, foreclosures, and bank failures.
Recession vs. inflation
Inflation represents an increase in the cost of goods and services in an economy over time. Consequently, the currency decreases in value, which means you can buy fewer services and products with the same amount. As a result, the currency is said to be weakened. While economists believe moderate inflation can be beneficial to an economy as it may help economic growth, high inflation is bad news for consumers and their savings.
Inflation is caused by the increase in demand for services and products. When the demand increases and exceeds the supply, the prices rise. Inflation can be expressed as a percentage. It is a decline in the buying power of a currency.
Types of inflation
- Demand-pull inflation: This is represented by a gap between the demand and supply of goods and services. This is inflation that occurs when there is a greater demand than the economy can produce.
- Cost-push inflation: This refers to inflation that is caused by an increase in the cost of production, resulting in a rise in the price of the final product.
- Built-in inflation: This is caused by past events that persist today. Workers may be able to demand an increase in their wages, which can lead to a rise in prices for products and services.
| Recession | Inflation | |
|---|---|---|
| Definition | The overall drop in economic activity as a result of a drop in GDP drop for two consecutive quarters | Represents an increase in the price of goods and services over a period of time |
| How is it measured? | GDP | Wholesale Price Index (WPI) and the Consumer Price Index (CPI) |
| Period | Only in certain economic periods | Always exists |
As the assets increase in value, inflation favors asset owners. It does not favor those who hold cash, as the currency’s value declines. Usually, inflation should be controlled through monetary policies, where the central bank determines how much money is available and at what rate.
As more people are planning for retirement, you should be aware that inflation is a necessary evil within any country’s economy and that you have to calculate it in your retirement fund.
What is an inflationary recession?
An inflationary recession, also called stagflation, is a period in which inflation is high while there is a decline in economic activity. During all this, unemployment remains high. Economists find inflationary recessions hard to manage, since any policies that would help one situation would make others worse. Since the oil crisis in the 1970s, there have been repeated stagflation periods in our economy.
Although it was once thought impossible, economists now have several explanations for these periods of stagflation.
One of the most popular theories explaining what causes stagflation is the price of oil. When the price of oil suddenly rises, it reduces an economy’s production capacity. One such example is the 1973 embargo on Western countries imposed by the Organization of Petroleum Exporting Countries (OPEC). During this time, the transport costs increased, making products more expensive to produce, and transporting them to shelves was more costly. Prices rose even though people were being laid off. However, others believe that a sudden increase in the price of oil did not cause simultaneous periods of inflation or recession.
Other reasons attributed to former stagnation periods were poor economic policies and the loss of the gold standard.
Recession vs. depression vs. stagflation
Recessions are an inevitable part of daily life. During these periods, we see a decline in economic activity. However, they can be difficult to manage. If unemployment rises more, things get really bad, and an extremely dangerous depression might set in. These are extended periods of time when we see an economic downturn, which can affect the international economy. The government does everything it can to prevent recessions from turning into a depression. Both can be affected by inflation.
Stagflation is more than just the combination of low economic growth and too much inflation. During stagflation, consumers will adjust their economic behavior as a reaction to the monetary policies. This could result in prices rising without being correlated to a decrease in unemployment. But the unemployment rate may drop or rise according to the real economic shocks perceived by the economy. The conclusion is that during a stagflation period, the government may try to stimulate the economy through expansionary monetary policies, causing prices to rise without promoting real economic growth.
Recessions and depressions are both impactful
By being aware of the economic factors that drive these crises; you may be able to start preparing for an economic downturn. It’s normal for individuals to start losing confidence in the economy, but in order to survive, one must first be aware of the situation. Furthermore, being aware of economic events should be part of your journey to achieving financial freedom.
Remember that recessions do happen regularly in all economies, and they usually last for a limited period of time, ranging from a few months to a couple of years. But when it lasts longer, its effects might start to amplify, and it may eventually lead to depression. The last depression the world experienced was the Great Depression of the 1930s, but most experts agree that we must not worry. However, inflation rates are starting to reach alarming points, and consumers should take extra precautions to ensure their economic survival.
Frequently asked questions
How is recession different from depression?
Was 2008 a recession or depression?
Who benefits in a recession?
Is a depression worse than a recession?
Does a recession follow a depression?
What comes first, recession or depression?
What was worse, the Great Depression or a recession?
Is a recession like the Great Depression?
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