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Depressions are extraordinary events. We explain what makes them unusual.
What is a depression?
A depression is a severe economic downturn that lasts for an extended period of time, characterized by a steep contraction in gross domestic product (GDP), employment and other key economic indicators. There is no official measure of the length and depth of an economic contraction that constitutes a depression, and they are considered rare events. A depression can be considered a more severe and longer-lasting version of a recession.
A depression has widespread and far-reaching impacts on an economy and an entire society, and usually affects more than one country. Depressions are characterized by the unavailability of credit, stark declines in income, increased debt loads and defaults, a massive slowdown in retail and wholesale sales, declines in output, and the loss of value of a country’s currency. Massive unemployment is a central hallmark of a depression. A depression typically diminishes regional or even global trade.
Like a recession, a depression is touched off by a financial crisis, stock market crash or the implosion of an asset bubble, combined with big declines in consumer confidence. Unlike recessions, they are not considered a normal part of the business cycle. A recession is generally triggered by the same phenomena as a depression: as the business cycle reaches its peak and prices outstrip underlying asset values, causing a market crash. Investors, business people and consumers pull back, spending and credit dries up, and recession sets in. The difference is that a depression lasts much longer, and recovery is much more difficult.
The National Bureau of Economic Research (NBER) officially declares the starting dates and ending dates of recessions in the United States, but it has no similar official role for depressions. Economists generally agree that a depression is characterized by a period of GDP contraction that lasts longer than two years and an overall decline in GDP greater than 10 percent.
Because the causes of a depression are complex, the solutions are generally very complicated, requiring extensive economic intervention by governments and central banks. Governments launch special programs to stimulate job creation and boost wages, in order to restore consumer confidence. Central banks pursue very easy monetary policy, as well as negative interest rates, and create special initiatives to provide liquidity and stimulate investment.
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The most notable depression in modern history is the Great Depression, which began with stock market crashes in 1929, and by some measures lasted until 1941. There was a steady increase in consumer debt throughout the 1920s, including several asset bubbles in real estate and stocks. A series of stock market crashes in 1929, including the Black Thursday crash on October 24th, 1929, sparked widespread panic and wiped out the investments of both professional investors and regular citizens.
Over half of the banks in the U.S. failed, unemployment climbed to more than 25 percent in the early 1930s, and output fell precipitously. By some measures, GDP contracted around 30 percent between 1929 and 1933. The federal government instituted a wide variety of aid programs under President Franklin Delano Roosevelt, and also created the foundation of the welfare state, including Social Security. Some economists believe that only the entry of the U.S. into World War II and the accompanying industrial expansion ultimately pulled the economy out of depression.
Fluctuations in the economy affect your wallet. Find out the impact these ups and downs have on your bottom line.
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