Sunday, January 16, 2011

Definition of Economic Depression

An economic depression involves a very significant fall in national output and corresponding period of prolonged mass unemployment.

A recession is just a period of negative economic growth. see: Definition of Recession

How To Define a Depression?

There is no single clear way to define an economic depression. It is basically a very severe form of recession. Two common ways would involve:

* A fall in GDP of 10% or more.
* A fall in GDP for over 3 years.

Other features of depression

  • Very high unemployment – over 20%
  • Deflation
  • Asset / credit contraction
Some economists say the cause is important. - Depressions are caused by unwinding credit bubbles rather than exchange rate devaluations which cause a fall in GDP and inflation

Examples of Depressions.

In the Great Depression, US GDP fell 30% between 1929 and 1933. It also fell 13% between 1937-38. With unemployment over 20% and a long period of deflation. It would meet any criteria of a depression and is inevitably used as a yardstick for measuring other depressions.

The Great Depression was also a global phenomenon. In fact many countries experienced a more severe downturn. E.g. countries like Australia and Canada which rely on raw material exports.

The biggest fall in GDP recorded was for the Soviet Union between 1990 and 1998 when recorded GDP fell 45%. However, this was due to the transition from a Command economy to a Free market economy. Part of it can also be explained by 'creative accounting' in the Communist era. Nevertheless it led to widespread economic hardship for the majority of people.

Finland experienced a drop in GDP of 11% in 1993 as it suffered from the collapse of its main trading partner the Soviet Union.

Emerging Economies have also experienced depression like periods of falls in GDP e.g. Argentina GDP fell by 19% between 1998 and 2002.

Causes of Depression

The cause of Depressions are primarily due to unwinding credit / asset bubbles and a consequent fall in money supply causing a sharp fall in demand and prices. This is different to the usual swings in the business cycle.

Are we Facing A Depression?

It is hoped we will avoid a depression because unlike the 1930s, the government is seeking to prevent a collapse in the banking system and a fall in the money supply. Also rather than trying to balance the budget, governments are pursuing expansionary fiscal policy.

However this recession is different to previous recessions which were caused by a mere tightening of monetary policy. This recession is caused by an unwinding credit / asset bubble which has the capacity to cause paralysis through deflation. For example, it is worrying that US house prices are now in their 3rd year of decline. Also rather worryingly is the fact that so far the economy appears to be not responding to standard policy measures such as tax cuts and interest rates.

However, before we hit the panic button. It is to be expected these policies will have significant time lags. It may be a severe recession but it's still a long way off being a depression (at the moment anyway)

More on definition of depression

Before the Great Depression, every downturn was called a depression. The word recession was used to avoid reviving memories of the Great Depression.

In 1978, one of Jimmy Carter’s economic advisers Alfred Khan was referring to the US facing a depression. Jimmy Carter said he didn’t like the term depression, because it created negative connotations. So Alfred Khan noted:

“We’re in danger of having the worst banana in 45 years.”

from: Economist

There is also an old saying - 'A recession is when your neighbour loses his job. A depression is when you lose your job.'

  1. Causes of Great Depression
  2. essays on the great depression

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