What’s the Difference Between a Recession and Depression?

Keeping up with the economic news is a spooky proposition lately … terms like recession and depression keep popping up.

It’s enough to make the bravest of traders question the markets. Especially when companies are so unsure that they aren’t giving guidance anymore.

The coronavirus pandemic has changed everything. Lockdowns around the world are bringing global economies to a screeching halt.

Oil futures went negative. Unemployment claims in the U.S. are at record levels.

According to some analysts, all signs point to a looming recession … Or will it be a depression?

To some, the Great Recession still seems too fresh … even after a bull run of over 10 years. But the idea of a recession or depression is downright scary for most. There were a lot of comparisons between the last recession and the Great Depression…

But how accurate were those claims — and what’s the difference between the Great Recession and the Great Depression?

How do you tell the difference between a recession and depression at all?

Let’s take a look.

Recession and Depression Difference

Most of us are familiar with the ups and downs of the business cycle, better known as peaks and troughs.

During the expansion phase, business growth increases in response to high consumer confidence and spending. Wages rise as companies vie for workers. Investment grows. Supplies of goods increase, as do profits.

Eventually, the economy can’t expand any more — it reaches its peak.

From there, unfortunately, there’s nowhere to go but down. Recession sinks in as demand slows, bringing on layoffs and higher unemployment. The national gross domestic product (GDP) falls.

The economy is now in the contraction phase of the business cycle.

A trough represents an economy in the absolute doldrums. Usually, the growth rate slips into negative territory. But since it’s a cycle, things will improve after a while. The cycle begins again.

And there’s a common question here: Can a recession turn into a depression?

In theory, yes — but it’s not probable. More on that in a bit. First, let’s look at the difference between a recession and depression.

Definition of Economic Depression

A depression is a severe and prolonged downturn in the economy — much deeper and more severe than a recession.

There’s a dramatic decline in economic activity with a sharp fall in growth and production. Economic output plummets by a minimum of 10%, while unemployment shoots up to at least 20%.

If things get bad enough, recovery can take a whole decade. Let’s look at an example.

Example of Economic Depression

The Great Depression is the most famous example of an economic depression. It was the worst economic downturn in the history of the industrialized world … lasting 10 years.

It had drastic social and cultural effects. And it represented the harshest adversity faced by Americans since the Civil War. Bread lines, soup kitchens, and an increased homeless population became common across America.

It was so devastating that even though it originated in the U.S., it created negative effects in almost every country in the world.

The Great Depression started with the stock market crash of 1929. But that wasn’t the sole cause of the depression. Billions of dollars were lost. That sent Wall Street into a panic and wiped out millions of investors.

Then in 1930, many people lost confidence in the banking system and demanded their bank deposits be paid to them in cash. By 1933, 15 million Americans were unemployed and nearly half the country’s banks had failed.

It was a dark time in history that lasted for years.

In 1941, World War II started, pushing the nation’s factories back into full production mode while decreasing unemployment, leading to the end of the Great Depression.

Definition of Recession

Recessions are much milder than depressions. The general definition of a recession is a decrease in real, or inflation-adjusted, GDP for two consecutive quarters.

The National Bureau of Economic Research uses a more detailed yardstick to measure the economy’s health. This panel of economic experts is the official arbiter of whether the economy has fallen into recession (or depression, for that matter).

The NBER measures the peaks and troughs of the economy. In addition to the decline of real GDP for two successive quarters, the committee also considers negative changes in the unemployment rate, wholesale and retail sales, industrial output, and real income.

These conditions must continue for several months for the NBER to declare the economy officially in recession.

Generally, recessions last about 12 months. That’s compared to three years or more for a depression.

Example of Recession

A good example of a recent economic recession is the Great Recession that lasted from December 2007 to June 2009.

The demand for housing slowed dramatically at that time and caused the housing bubble to burst. This, in turn, led to borrowers defaulting on their mortgage payments.

Because many borrowers stopped paying their mortgages, investments and derivatives that were tied to these mortgages became worthless. Many banks and firms holding these investments failed and the stock market crashed in 2008.

The Dow registered one of the largest point drops in history and unemployment reached 10%.

On February 17, 2009, Congress passed a $787 billion economic stimulus plan that helped lead to the end of the recession.

Are Recessions and Depressions Really That Bad?

That’s the difference between a recession and depression in economic terms. Now you might wonder if there are any upsides to cyclical downturns in the economy…

Most of us view recessions with caution. But it’s important to note that they’re a normal part of the business cycle.

As the saying goes, “What goes up must come down.” Expansionary periods can’t go on forever. Eventually, an economic boom will start to lose steam, and the economy will start to contract.

Can a Recession Be Healthy?

Recessions can actually help clear out the detritus of a booming economy and restore balance.

For example, the rising wages due to labor shortages can spur inflation as businesses raise prices to make up for increased costs. Layoffs during recessions inflate the labor pool and reduce wage inflation.

When demand is high in boom times, companies often ramp up production. That can lead to high inventory levels. When businesses pare payrolls, inventories can drop to more normal levels since there’s a slower production of goods.

Similarly, expansions can encourage a raft of new businesses as entrepreneurs try to take advantage of increasing demand. Recessions help weed out the weak companies (remember the dot-com bubble?) that can drain — rather than support — a healthy economy.

Housing prices also tend to fall during recessions. That’s a bummer for homeowners who want to sell. But it helps buyers.

Recessions also check consumer demand and spending. In our consumer-driven economy, a dip in consumer confidence often gets the recessionary ball rolling. Price inflation is usually the trigger that makes consumers cut spending, thus reducing demand.

That pullback can result in layoffs and business closures … and make consumers even more cost-conscious. It all feeds the downward spiral.

But this scenario isn’t necessarily all bad. As consumers tighten down on spending, they often begin to pay down debt. They also save more, which can put them in a better position to spend again once the recession fades. And that can aid economic recovery.

One final thought here: The slump in equities that usually comes with a recession can potentially spell opportunity for bargain hunters. For example, some brave souls who bought into bank stocks that fell into penny-stock territory during the Great Recession made a nice profit in the following years.

The Difference Between the Great Recession and the Great Depression

So how close were we to a depression during the subprime mortgage crisis?

The Great Recession and the Great Depression had several commonalities … but some major differences, too.

For example, both economic events featured a huge stock market crash. In 1929, the S&P 500 lost 86% of its value. Over 56% of the benchmark’s value evaporated in 2008.

In both cases, it took years for stocks to recover — 25 years for the 1929 crash. After the Great Recession, stocks regained pre-crisis values by 2013.

Bank failures, bankruptcies, and defaults were common for both crises. But an estimated 9,000 banks failed during the Great Depression, compared to only 500 between 2008 and 2015.

Without the government’s bailout program, however, many more financial institutions would’ve likely failed.

Unemployment never again reached the 25% mark caused by the Great Depression. It rose to 10% during the recession that followed the financial crisis — that’s the highest it had been since 1982 when it clocked in at 10.8%.

Real GDP took an enormous hit during the early 30s when it slumped to –12.9% in 1931. By comparison, the Great Recession registered a decrease in real GDP of –4% in 2009 but began to recover shortly after.

Was 2008 a Recession or Depression?

Ben Bernanke, the acting head of the Federal Reserve at the time, called the recession in 2008 the worst financial crisis in global history, surpassing even the Great Depression.

So why wasn’t it labeled an economic depression?

Also, the Great Recession of 2008 was scary, but it didn’t reach nearly the same level of economic distress that came with the Great Depression. So why did he say it was the worst?

Here’s the thing … although the financial shocks in 2008 were bigger than those that came with the Great Depression, the Fed learned from past mistakes and reacted much differently.

In 1929, central bankers responded timidly and even tightened monetary policy. They learned the hard way that hiking interest rates in the middle of a financial crisis is the exact opposite of what’s helpful.

In comparison, in 2008, the Fed acted aggressively — slashing rates and pumping a large amount of liquidity into the system.

During the Great Recession, Congress enacted a bank bailout package called the Troubled Asset Relief Program, or TARP, to prevent the collapse of the global financial system.

Had they not acted so aggressively, the Great Recession might have surpassed the Great Depression in negative impact … and the recession of 2008 would have been a depression.

Conclusion: What Is the Difference Between a Depression and a Recession?

Despite similarities, there are key differences between economic recession and depression.

Both of them cause a significant decline in economic activity spread across the economy for an extended period of time.

Although recessions are unpleasant, they’re part of the normal economic cycle. A depression, on the other hand, is an extreme economic failure and something we should do everything to avoid.

One good thing to come out of both is that we’ve learned good lessons. The safeguards put in place by lawmakers can make another economic downturn of those proportions far less likely.

Are we headed for a recession or depression in the wake of the coronavirus pandemic? No one can say for sure. In the U.S., we have stimulus packages to aid individuals and small businesses. Keep an eye on the market as things start to reopen.

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What’s your view of the markets right now? How are you prepping for a possible recession — would you trade through it? Tell me your recession strategies in the comments below!