Economic Depression

What is an Economic Depression?

An economic depression is a more prolonged downturn in economic activity. It brings a significant decline in real GDP by more than 10% and a more severe recession that could last two or more years.

It is noteworthy to say that depressions are a different category from recessions.

Both terms signify a decline in economic activity, but depression is a more severe and prolonged downturn than a recession.

While some economists consider the entire period of decline and recovery as a depression, others only consider it a depression during the period of decline.

For example, a group of economists may consider a period of sustained decline for two years followed by a slow recovery as a three-year depression.

Meanwhile, other fellow peers may only consider the two years of decline as the actual depression, and the third year of recovery would consider the period of rebuilding the economy. Thus, the interpretation can vary amongst economists.

Understanding Economic Depression

In an economic depression, the availability of credit decreases. The amount of capital you or a business can borrow decreases, thus, leading to a decline in investment and lower consumer and business confidence.

Depressions can last several years, though their economic effects can be felt longer. An example is the great depression in the US, lasting from 1929 until 1939; although, the depression's last effects were erased when the US entered the ongoing World War ll in 1941.

Around the world, governments and central banks implemented economic policies to boost the economy. Still, it was not until World War ll that these economies fully recovered, as countries were arduously boosting their economy to be prepared for war.

Different factors cause an economic depression, such as:

• Financial crises
• Banking failures
• Consumer and business confidence changes
• International events

The effects of depression are widespread and can profoundly impact consumers, businesses, and entire countries and regions.

Governments and central banks can implement various policies, but these policies can take several years to be effective.

Many big financial institutions, such as Morgan Stanley, release forecasts. These forecasts predict how severe they anticipate market fluctuations will be and what specific markets these fluctuations will affect. 

Taking aside the difference in their meaning, both recessions and depressions significantly impact individuals, businesses, and entire countries.

Local governments and central banks around the globe need to take clear and concise solutions to tackle the effects of economic downturns, thus, leading their economies to an economic recovery.

Economics Depressions across the time

Yes, depression can happen again. Although the world has made progress in setting up economic policies and regulations, the possibility of a depression happening is still feasible.

Several factors can be potential catalysts for the chances of depression. For example, a war that has broken out can impact global trade.

However, many countries now have better economic systems and safety nets, which could help prevent depression or lessen its impact.

Economic downturns are normal; economic growth cannot go indefinitely in a straight line; the economic machine needs to cool down from time to time to get ready for the next leg up.

It also tests the overall financial strength of businesses and their resilience, testing their foundations against shocks in the market. Finally, it creates an opportunity for new companies to prove themselves in the market. 

To prepare for and mitigate their impact, governments can take measures such as spending more money or lowering interest rates, and individuals can diversify their investments.

During the global pandemic of 2020, the US government introduced stimulus packages alongside a drop in interest rates. Other countries followed suit.

Overall the markets and the economy showed a V-shaped recovery, accelerating a path toward digital transition and technology.

Let's look at past depressions and their characteristics:

The Panic of 1819

The Panic of 1819 marked the first significant financial crisis in the US, resulting in a slowdown of growth in the cotton industry.

It signaled the country's transition from heavily relying on trade connections with Europe to developing its economy.

Several factors triggered the crisis:

• Global market adjustments due to the end of the Napoleonic Wars.
• Overinvestment in public lands is fueled by banks and businesses releasing excessive paper money.
• Ineffective regulation of state bank credit by the Second Bank of the United States (SBUS).
• The SBUS cut loans from its western branches.
• Unavailability of gold from SBUS reserves when banknotes were presented for redemption.
• State-chartered banks were taking possession of heavily mortgaged farms and businesses.
• Abrupt improvement in European agriculture production in 1817.

The recession led to increased political engagement and defense of local economic interests, widespread criticism of banking and business enterprise, and the belief that federal government economic policy was flawed

The New Republicans and their American System, including tariff protection, internal improvements, and the Second Bank of the United States, were also criticized and faced a strong defense.

Panic of 1837

One example of a historical economic depression is the Panic of 1837, which occurred in the United States.

The panic was a result of several factors, including:

• Speculative lending practices
• A drop in cotton prices
• A bursting of the land market bubble
• International monetary fluctuations
• Tight lending policies in Britain
• The absence of a central bank to regulate fiscal matters

This led to a bank run, causing banks to suspend specie payments and businesses to close. As a result, deflation in wages and prices was widespread, leading to nearly half of all banks failing and mass unemployment.

A key factor was that President Andrew Jackson had not extended the Second Bank of the US charter, leading to a lack of central bank figures to regulate fiscal subjects.

Despite this, the economy experienced a brief recovery in 1838 before going through a prolonged period of recession for seven years. 

The situation improved after 1850 when the economy boomed again due to increased specie flows from the Gold Rush in California.

Long Depression of 1873

The Long Depression was a worldwide economic recession that lasted from 1873 to either March 1879 or 1896, the dates varying depending on the measurement used.

The effects were felt greatly in Europe and the United States. Specifically, the United Kingdom and the United States were enjoying strong economic growth in this era following the American Civil War. 

This economic downturn was known as the "Great Depression" and held that title until the Great Depression of the 1930s.

Causes of the Long Depression of 1873:

• Economic depression in the UK agricultural sector
• The bankruptcy of 18,000 businesses, including 89 railroads, in the US
• Failure of several US banks and states
• Peak unemployment in the US in 1878
• Loss of industrial lead by the United Kingdom over the economies of continental Europe

The UK was considered to have been in a continuous depression from 1873 to 1896, with financial and manufacturing losses reinforced by a long recession in the agricultural sector.

For the US, the Long Depression is referred to as the Depression of 1873 -1879, which lasted 65 months.

The US National Bureau of Economic Research said it was the longest contraction. It was longer than the Great Depression, which lasted 43 months.

Great Depression of 1929

The Great Depression of 1929 lasted until 1939. It was a worldwide economic crisis that deeply impacted most countries.

It was highlighted by a crash in the stock market, particularly in the United States, leading to the longest, most severe, and most extensive economic downturn of the 20th century.

The onset of the depression was seen in September and culminated in the Wall Street stock market crash of October 24, known as Black Thursday.

The depression had devastating effects, including decreased personal income, prices, tax revenues, and profits, and increased unemployment rates that reached as high as 33% in some countries. 

The cities that relied heavily on heavy industry were severely impacted, as was the construction industry, which reached a standstill in many countries. 

Farming communities and rural areas also suffered as crop prices fell by about 60%. 

Areas dependent on primary sector industries were hit the hardest as demand plummeted and job opportunities were scarce.

Here are some of the key causes of depression:

• The sudden collapse of stock market prices in the US.
• Falling sales of consumer goods caused gradual price declines.
• Overproduction results from new production techniques.
• Decreased exports.
• Income inequality
• Rising nervousness among investors.

Despite some countries starting to recover by the mid-1930s, the negative effects of the Great Depression persisted in many countries until the start of World War II. 

Economic Depression Characteristics

Let's first clarify what a recession is. A recession forms part of the economic cycle (expansion, peak, contraction, trough). As the economic machine slows down during a contraction phase, it can eventually lead to a recession.

It is led by a decline in economic activity and other indicators, such as employment and consumer spending, not as extreme as depression.

Recessions are measured as a decline in GDP for two consecutive quarters; depressions are marked by a sustained period of economic decline that can last several years and is a much more severe and prolonged form of decline.

Here are the characteristics of depression:

• High unemployment rates
• Deflation
• Bankruptcies and business closures
• Bear market 
• A reduction in credit lending from banks
• Devaluation of currency
• A significant decline in economic activity, including a decline in GDP, consumer spending, and investment.
• The local government intervenes, including setting up fiscal policies, such as stimulus spending, and monetary policies, such as lowering interest rates.

In a depression, unemployment rates are very high, and businesses struggle to uphold their ground, leading, in many cases, to long-term unemployment. 

Deflation can occur, prompting the cost of living to decrease and making it harder for businesses to repay debt. Many businesses fail during a depression, leading to bankruptcies and closures, which can cause a ripple effect throughout the economy. 

Government intervention is often necessary during a depression to stimulate growth and prevent further decline. This includes measures such as fiscal policy and monetary policy.

For example, the government stimulation for World War II during the 1940s led the economy to erase the last effects of the depression of 1929.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Gross Domestic Product (GDP)
• Recession
• The Great Depression
• Trade Wars
• Unemployment