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

Martin Feldstein (front), president of the National Bureau of Economic Research, speaks in Washington, D.C., in 2003. See more recession pictures.
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There are people whose entire careers are spent tracking and detecting the presence of recessions and depressions. These people look at a whole array of economic indicators -- from the Bureau of Labor Statistics' employment reports to the National Association of Home Builders' number of new homes being built. While there are lots of organizations dedicated to sniffing out recession, the National Bureau of Economic Research (NBER) is the group whose opinion on the matter is most widely relied upon. In other words, if the NBER says we're in a recession or a depression, we're probably in one.

Recession Image Gallery

Although the word can strike fear in the hearts of white collar and blue collar workers alike, recession in and of itself isn't a bad thing. Still, it can have massive and far-reaching consequences. Unemployment goes up as businesses find their customers less willing to part with money. When there's less money to go around, consumers spend less. As profitability declines, so, too does the value of companies' stocks. Recessions are like ouroboros -- the snakes that eat their own tails, forming a never-ending circle.

But recessions do end. In fact, some economists believe they're a natural part of an economic cycle that is characterized by peaks and troughs. But what about depressions? If recessions are economically painful, then depressions are like having your financial teeth yanked without Novocain. What exactly is the difference between a recession and a depression? That depends on your point of view. Recessions and depressions are definitely related -- to understand one you have to understand the other. Read about recessions on the next page.

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Recession Hurts

To combat decline, the Federal Reserve (led by Chairman Ben S. Bernanke, shown in China in 2006) may adjust interest rates to jumpstart the economy.
To combat decline, the Federal Reserve (led by Chairman Ben S. Bernanke, shown in China in 2006) may adjust interest rates to jumpstart the economy.
Elizabeth Dalziel/AFP/Getty Images

The word "recession" simply refers to a market in decline. The term doesn't necessarily describe all of the negative things that can come out of a falling market, like unemployment. It might help to visualize recession as a line graph. It begins immediately following the peak of what's called a business cycle. Some economists think that markets exist on the law that what goes up must come down. So a complete business cycle goes from its lowest point -- the trough -- to its highest point -- the peak -- and then back down. Here, the cycle begins again. A recession simply describes one side of the business cycle's wavelike structure: The decline from top to bottom.

Unfortunately, there's no graph that economists can follow in real time to see whether or not a business cycle has entered recession. And even once it's clear that the economy has entered decline, it's hard to tell if the recession will be a long or short one. Graphs that depict market decline usually come about after a recession has already made its presence known in the markets.

There are a variety of factors that determine a recession. In a recession, all (or most) of the sectors that make up the economy (like the stock market, employment, retail trade and industrial production) enter decline at the same time. For the decline to be classified as a real recession, these sectors must suffer longer than a month or two [source: FRBSF].

The National Bureau of Economic Research (NBER) looks at a few indicators to determine if a recession is taking place. The organization watches real personal income (what Americans take home in their paychecks after taxes) and employment figures on a monthly basis. Additionally, the NBER looks at industry output. For instance, are carpet manufacturers putting out more rolls of Berber than last month? Manufacturing and wholesale sales are an important consideration too: Are more of those carpet rolls being sold than last month? [source: NBER]. The NBER says it may also look at the gross domestic product (GDP). This is the sum total of the value of all of the goods and services produced in America. If these indicators all decline for several consecutive months, the NBER is likely to conclude that the United States economy has entered a recession.

As a result, money becomes scarce as wages drop and people spend less. To combat the decline, the Federal Reserve may step in and change interest rates to jumpstart markets again by infusing them with cash.

So if the economy gets really bad, does the recession become a depression? While recessions and depressions are related, there's a difference between them. Read about it on the next page.

Recession versus Depression

With unemployment hitting 25 percent in 1933, soup kitchens, like this one run by Al Capone, were popular during the Great Depression.
With unemployment hitting 25 percent in 1933, soup kitchens, like this one run by Al Capone, were popular during the Great Depression.

It's pretty easy to understand depressions once you get the concept of recessions. A depression is simply a prolonged or particularly excruciating recession. Economists don't really have a watermark to indicate a depression. Believe it or not, there's even an economists' joke that describes the ambiguity between recessions and depressions: A recession is when your neighbor loses his job; a depression is when you lose your job [source: FRBSF]. While the presence of a recession is debatable, when a depression hits, the issue is no longer up for debate.

Depressions are generated by the same factors that cause a recession. You can look at depression as an extended recession on the graph of the business cycle wave. Unemployment rises, gross domestic product (GDP) drops off, stock prices fall and the stock market crashes.

In simple terms, depressions are really protracted versions of recessions. In February 2008, the unemployment rate in the U.S. was 4.8 percent [source: Bureau of Labor Statistics]. But it wasn't until March 2008 that economists began to seriously consider that the economy was entering a recession. By contrast, during the Great Depression unemployment grew from 3 percent before the stock market crash of 1929 to 25 percent in 1933 [source: Bernanke]. In that same period, the U. S. gross domestic product fell by nearly half, from $103.8 billion to $55.7 billion [source: National Parks Service].

While no one wants to see the country in a depression, not everyone views a recession as a bad thing. The National Bureau of Economic Research says that expansion -- the opposite of recession, represented by the upward movement of the market wave -- is the normal state of a market [source: NBER]. But some economists take more of a Zen approach, considering recession as neither bad nor good, but part of a natural market cycle. When the Federal Reserve Bank steps in to adjust interest rates, some say this actually tampers with the natural order of the economy. Even worse, some economists believe that changing interest rates to pump up a recessing market can make matters worse by extending the decline. However, few people seem to resist when the Fed adjusts markets during a recession.

For lots more information on economics, visit the next page.

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Sources

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