Thu, January 22, 2009
Recession? Depression? What’s the Difference?
It's now agreed that our nation is in a recession. With increasing frequency, recent media discussions about the economy have turned to the question of whether it will turn into a depression. What's the difference?
You’ve probably heard the old joke that answers this question: a recession is when your neighbor loses his job; a depression is when you lose your job.
As I noted in an earlier post, the definition of conditions that constitute a recession is sometimes debated; as economist Jeff Frankels (who is a member of the committee that officially proclaims US recessions) admits, it can be hard to get all the data to even lead to the same conclusion as to when a recession has started. It comes as no surprise, then, that practitioners of the dismal science sometimes get into skirmishes over the question of when a recession becomes a depression.
Prior to the period known as the Great Depression (roughly 1929 – 1938), economic downturns were mostly just called depressions. They were preceded by “panics,” events which caused financial markets to seize, precipitating business failures, unemployment, and reduced economic activity (sound familiar?). Prior to the Great Depression, there was a worldwide depression that lasted from 1873 to 1896; at the time, that was called the “Great Depression.”
It’s sometimes said that a depression is a downturn in which real (after-inflation) Gross Domestic Product declines by more than 10%. In the period from 1929 (when the stock market crashed) to 1938, there were actually two severe dips in GDP: a drop of almost 33% lasting from August 1929 to March 1933, and a second decline of 18% between May 1937 and June 1938. Since the second World War, US economic activity has not come close to declining by 10%.
David Merkel has argued that a depression exists when most of a nation’s economy does not have the capacity to absorb more debt, because no lender will extend credit. When banks and other conventional sources of capital are reluctant to lend, as they are now, the economy cannot expand. After many years of a credit-induced high, the world economy needs to sober up. Some economic contraction is unavoidable; the question is, how much contraction do we need before things start to get better?
Presently, economic activity has not contracted to levels needed to constitute a depression by most standards (although the present does fit Merkel’s definition, which focuses on the impairment of the financial markets). In the depressions of 1873 and 1929, joblessness was as high as 25% in many places. We’re nowhere near those levels, but businesses are generally expressing a lack of confidence in the economic future. That tends to depress spending and investment. Nations that have grown dependent on selling goods to the US have seen our demand contracting. Many of these same nations have been financing our national debt through the purchase of treasury securities; foreign holdings of US Treasuries increased by $750 billion between November 2007 and November 2008. If we’re not buying, their economies will also contract unless they can stimulate domestic demand.
Our government’s capacity for deficit spending is ultimately limited by the demand for Treasuries. With a desire for risk-avoidance at an all-time high, demand for Treasury securities is so great that at times in the last year purchasers were even willing to accept a negative yield – to pay Uncle Sam a small amount for the privilege of lending the US money for three months, in return for the perceived safety of US Treasury bills. That’s great for now, but if the perceived safety of US government debt were to erode, the effects would be swift and nasty.
It remains to be seen whether government intervention will be sufficient to prevent more widespread economic declines. Until the “bad” loans held by the banking industry have been addressed, uncertainty will continue to be the order of the day in the financial markets. An upturn in housing markets would help, but a general bottoming-out of housing prices is not yet in view.
National mood strongly influences people’s outlooks and behavior, and hopefulness for the future begets economic activity. Doubtless this is what FDR meant when, in his first inaugural address, he opined that “the only thing we have to fear is fear itself.” At present it’s difficult for me to conclude that we are in a nationwide depression, although there are doubtless localized areas where economic activity and unemployment are at depression-like levels. Everyone will remain nervous until there are clear signs that the debt crisis is being addressed successfully, banks are lending freely, and companies are growing rather than contracting.