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What is Depression in Economics?

  • Soumalya Bhattacharyya
  • Sep 13, 2022
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Economic historians generally confirm that the Great Depression, which started in 1929, was the worst economic downturn in American history and the worst ever experienced by the Western industrialized world, even though there is no agreed-upon definition of what constitutes a depression among economists (and, consequently, no consensus regarding how many depressions the United States has experienced since 1854).


For instance, between 1929 and 1933, industrial production decreased by around 47%, GDP shrank by 30%, and unemployment rose to over 20% in the United States.


A recession is "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales," while depression is "a particularly severe period of economic weakness" that is typically undetectable, according to the National Bureau of Economic Research, which keeps records of the cyclical peaks and troughs in U.S. economic activity dating back to 1854.


The Great Depression is believed to have been caused by several reasons, but a sharp decrease in consumption, or aggregate demand, was its main driver. They included the 1929 U.S. stock market crash, which had a terrible impact on consumer confidence across the nation, and banking panics, which led to the failure of numerous banks and therefore significantly decreased consumer spending and company investment.


What is Depression in Economics?


In terms of economics, a depression is a significant downturn in the business cycle that is marked by rapid and sustained declines in economic activity, high rates of unemployment, poverty, and homelessness, an increase in personal and business bankruptcies, sharp declines in stock markets, and significant drops in international trade and capital movements. 


A recession is often characterized, by a national economy, as a period of at least two consecutive quarters of declining real (inflation-adjusted) GDP, or gross domestic product. Depressions, on the other hand, are a particularly severe and protracted kind of recession.


A significant and persistent decline in economic activity is referred to as depression. A harsh recession that lasts three years or more or that causes the real gross domestic product (GDP) to fall by at least 10% in a particular year is generally referred to as a depression in economics. Depressions tend to be accompanied by high unemployment and low inflation and are often less common than lighter recessions.


Depression is defined as a fast decline in growth, employment, and output that is accompanied by a severe slump in economic activity. Recessions that persist longer than three years or that cause the yearly GDP to fall by at least 10% are frequently classified as depressions. There have been several recessions in the US economy, but very few catastrophic depressions.


Depression vs. Recession:


A recession, a typical feature of the business cycle, often happens when GDP declines for at least two consecutive quarters. On the other hand, depression is a severe decline in economic activity that lasts for years as opposed to only a few quarters. As a result, there have been 33 recessions and just one depression in the United States since 1854.


Furthermore, even if those times of contraction are somewhat moderate, economists define a recession as two consecutive quarters of negative GDP growth. Contrarily, a depression is identified by a decline in GDP of at least 10% over a year.


Example of an Economic Depression:


Approximately ten years long, the Great Depression is largely regarded as the greatest economic slump in the history of the industrialized world. It started soon after the "Black Thursday" U.S. stock market falls on October 24, 1929. The stock market bubble burst after years of careless speculation and investment, and a massive sell-off with a record 12.9 million shares exchanged started.


The Great Depression began on Tuesday, October 29, 1929, when the Dow Jones Industrial Average plunged 12% in a massive sell-off, adding to the country's already existing slump. 


Even though the Great Depression started in the United States, its effects on the global economy lasted for more than a decade. A decline in consumer spending and investment, as well as exorbitant unemployment, poverty, hunger, and political upheaval, were hallmarks of the Great Depression. In the United States, unemployment increased to about 25% in 1933 and stayed there until 1941, when it finally decreased to 9.66%.


The overall U.S. economic production decreased by 30% during the Great Depression, with unemployment reaching 24.9%, salaries falling by 42%, real estate values falling by 25%, and stock prices falling to 10% of prior highs rendering many investors' portfolios utterly worthless.


The Federal Deposit Insurance Corporation (FDIC) was established to safeguard depositors' funds shortly after Franklin D. Roosevelt was elected president in 1932. To oversee the American stock markets, the Securities and Exchange Commission (SEC) was established.


The Great Depression appears to have taught policymakers a valuable lesson. To avoid repetition, new rules and regulations were passed, and central banks were compelled to reconsider the most effective ways to address economic stagnation.


Modern central banks respond to inflation more quickly and are more likely to deploy the expansionary monetary policy to support the economy when times are tough. Utilizing these strategies assisted in preventing the late 2000s severe recession from degenerating into a full-blown depression.


Also Read | What does the 24% shrink in India's GDP mean?


Features of an economic depression


An economic depression would include:


  • Unemployment rates turned out to be extremely high (during the Great Depression, they frequently reached 20% or more).

  • Decrease in real wages.

  • Very little inflation and perhaps deflation.

  • Price declines for assets, including those in the stock market and real estate.

  • Declining consumer and corporate confidence.

  • Interest rates are decreased, but this does little to increase demand, creating a liquidity trap.


Causes of an Economic Depression


A decline in consumer confidence is the main cause of an economic slump since it causes demand to decline, which finally leads to firm closures. Businesses must make budget adjustments, which may entail hiring fewer people when customers cease purchasing goods and paying for services.

Causes of an Economic Depression:   1. Stock market crash 2. Low demand in manufacturing 3. Deflation 4. Jump in oil rates 5. Decline in consumer faith

Let's examine the other causes of economic depression in greater detail, though.


  1. A stock market collapse:


Securities owned by investors in publicly traded corporations make up the stock market. A country's economy can be seen in changes in shareholdings. A sign of investors' waning faith in the economy might be seen when the stock market falls.


  1. Lower manufacturing demand:


The demand for a company's goods and services is what makes it successful. A fall in manufacturing orders, especially one that lasts for a long time, might trigger a recession or, worse, an economic depression.


  1. Control over wages and pricing:


Price restrictions were implemented once as prices were rising under former U.S. President Richard Nixon. Additionally, when wages are set by the government and employers are prohibited from lowering them, firms may need to fire workers to survive.


  1. Deflation:


In essence, deflation is the gradual decline in consumer prices. It may appear to be a positive thing since consumers can now afford to buy more goods, but the prices are falling as a result of a decrease in demand as well.


  1. Jump in oil rates:


It is well known that increases in the price of oil may have an impact on nearly everything in the market. When this occurs, customers' purchasing power is reduced, which may cause demand to drop.


  1. A decline in consumer faith:


When customers lose faith in the economy, they will change their spending patterns, which will ultimately result in a decline in the demand for products and services.


  1. Soaring unemployment:


A rising unemployment rate is typically a precursor to a coming recession. Consumers will gradually lose purchasing power due to high unemployment rates, which will eventually reduce demand.


  1. Increased inflation:


Inflation can be an indication that demand is increasing because of rising wages and a strong labor force. But excessive inflation can reduce demand for goods and services by discouraging consumers from making purchases.


  1. Falling sales of real estate:


Consumer expenditure, including the sale of properties, is often high in an ideal economic environment. The selling of properties, however, declines at times of an oncoming economic slump, a symptom of waning economic confidence.


  1. Rising defaults on credit card debt:


High credit card usage often indicates that consumers are making purchases, which is advantageous for the GDP. However, if debt default rates increase, it can be a warning of a downturn in the economy since people's ability to pay is declining.


Also Read | 5 Factors Influencing Consumer Behavior



Steps to Prevent Economic Depression:


The following actions are recommended by economists to prevent another "Great Depression" from occurring since there is a persistent concern that it will.


  • Reduced interest rates are part of an expansionary monetary policy, which promotes borrowing and investment. Consumers will get more for their money when borrowing rates are lower, which will encourage them to spend more.

  • Increasing government spending, lowering taxes, or doing both at once is known as an expansionary fiscal policy. Consumption is boosted by tax reductions because consumers have more disposable income.

  • Government guarantees of bank deposits are a key component of financial stability since they enhance banks' legitimacy.

  • The Great Depression led to the establishment of several New Deal legislation and government organizations. They were created specifically to stop further instances of that terrible economic suffering. For instance, the Federal Deposit Insurance Corporation provides deposit insurance for banks. As a result, further bank runs are stopped and depositor confidence is restored.

  • Without fiscal policy, monetary policy can only accomplish so much. The $2 trillion Coronavirus Aid, Relief, and Economic Security Act was enacted by Congress in March 2020. By boosting the economy in 2009, the economic stimulus measure contributed to the avoidance of a slump. Monetary and fiscal policies should be combined to avoid another world depression. The recurrence of the Great Depression is quite improbable.


It is vital to seek to provide yourself with as much financial security as you can because an economic slump causes widespread economic instability. For instance, you could wish to make your emergency fund larger or look for less hazardous options. You must be ready for the possibility of several difficult years because depressions persist considerably longer than recessions.

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