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But the really important question is when a recession ends.

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The media regard it as ending when GDP stops falling; the economists when it starts rising. Both definitions are misleading, as the statistics of the current situation show.

For simplicity, assume that GDP in was In it was less than four-tenths of one percent greater: hence In the first quarter of , it fell at an annual rate of 6. In the second quarter, just ended, it declined at an annual rate of 1 percent, which means that it fell. Hence, by the end of July, GDP was Suppose it is flat in the third quarter of this year and rises at an annual rate of 1 percent in the fourth quarter i.

What's the difference between a recession and a depression? | HowStuffWorks

I am not forecasting; these are hypothetical numbers. Then GDP for as a whole would be That looks like a small decrease since GDP grows at an inflation-adjusted rate all my numbers are inflation-adjusted of about 3 percent a year on average. One quick way to illustrate the difference between the severities of the economic contractions associated with recessions over the period from to is to examine the annual growth rates of real GDP in chained year dollars.

Chart 1 shows the annual growth or contraction in the economy. The gray bars represent recessions identified by the NBER. The two most severe contractions in output excluding the post-World War II adjustment from to occurred during the Great Depression of the s. The differences are telling:.

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During the major contraction phase of the Depression, between and , real output in the United States fell nearly 30 percent. During the same period, according to retrospective studies, the unemployment rate rose from about 3 percent to nearly 25 percent, and many of those lucky enough to have a job were able to work only part-time. For comparison, between and , in what was perhaps the most severe U. Other features of the decline included a sharp deflation—prices fell at a rate of nearly 10 percent per year during the early s—as well as a plummeting stock market, widespread bank failures, and a rash of defaults and bankruptcies by businesses and households.

The economy improved after Franklin D.

Content: Recession Vs Depression

Roosevelt's inauguration in March , but unemployment remained in the double digits for the rest of the decade, full recovery arriving only with the advent of World War II. Moreover, as I will discuss later, the Depression was international in scope, affecting most countries around the world not only the United States. While you can see from the above discussion that recessions and depressions are serious business, some economists have been known to suggest that there is another more casual way to explain the difference between a recession and a depression recall that I began this answer with a promise of a joke :.

First the negative effects:. Rising unemployment is a classic sign of both recessions and depressions.

As consumers cut their spending, businesses cut payroll in order to cope with falling earnings. Recessions and depressions create high amounts of fear. Many lose their jobs or businesses, but even those who hold onto them are often in a precarious position and anxious about the future. Fear in turn causes consumers to cut back on spending and businesses to scale back investment, slowing the economy even further. Asset values sink in recessions and depressions because earnings slow along with the economy.

What Makes a Depression So Much Worse than a Recession?

For example, stock prices fall as slowing earnings and negative outlooks from companies repel investors, while home values sink as demand retreats in the face of economic uncertainty. Economic decline allows the economy to clean out the excess. Inventories drop to more reasonable levels. Moribund firms that had limped along during a period of expansion go out of business, allowing capital and labor dedicated to them to be used in more productive ways.

This process of creative destruction is most closely associated with the 20th-century Austrian economist Joseph Schumpeter , who saw capitalism as a continuous process of destruction and renewal in which entrepreneurs play a key role in overhauling the system.

Recession, Correction, Depression, Oh My!

Recessions and depressions help keep economic growth balanced. Unchecked growth over many years would likely lead to overcapacity or high inflation though Australia has gotten along fine since without suffering a recession. By sparking layoffs, recessions and depressions prevent competition over labor from pushing wages up to the point that prices rise in response, increasing companies' earnings, leading them to hire more, and so on in an inflationary wage-price spiral.

Tough economic times can create huge buying opportunities. As the downturn gives way to recovery, markets often achieve higher highs than before the recession or depression.

Contractions therefore present a money-making opportunity to investors with the time to wait out a recovery. Economic hardship can create a change in the mindset of consumers. As consumers stop trying to live above their means, they are forced to live within the income they have. This generally causes the national savings rate to rise and allows investments in the economy to increase once again.


Some of the positive effects include taking the excesses out of the economy, balancing economic growth, creating buying opportunities in different asset classes and causing changes in consumer attitudes. The negative effects include rising unemployment, pervasive fear and steep declines in asset values. Business Essentials. Investopedia uses cookies to provide you with a great user experience. By using Investopedia, you accept our.