A recession is a significant decline in economic activity that is spread across the economy and lasts more than a few months.
The most severe recession on record, which doesn’t meet the definition of a depression, was the Great Recession between 2007-2008 in the aftermath of the Global Financial Crisis. The shortest recession recorded was between February 2020-April 2020 during the onset of the Covid-19 pandemic. In total, there have been 34 recessions in the United States since 1845.
Recessions are economic contractions that occur relatively frequently and are usually short-lived. During a recession, economic growth slows down. When this happens throughout the economy as a whole and lasts for several months, economists call it a recession.
Economic contraction is measured using declines in real Gross Domestic Product (GDP) as well as other factors such as employment and industrial production.
A depression is a prolonged and severe recession. The most famous example of an economic depression is the Great Depression which lasted for almost a decade. The Great Depression was so severe that it changed economic theory and monetary policy and led to the abandonment of the gold standard in the United States.
In the United States, the National Bureau of Economic Research (NBER) officially announces and records recessions.
According to the NBER, there were 34 recessions in the United States since 1854. NBER. “US Business Cycle Expansions and Contractions“. Accessed June 1, 2022. Since 1980, there were 5 recessions, including the Great Recession and the shortest recession in recent history in response to the Covid-19 pandemic.
The NBER doesn’t define or track depressions separately from recessions. It also rejects the common but incorrect definition of a recession as two consecutive quarters of economic contraction. NBER. “Business Cycle Dating Procedure: Frequently Asked Questions“. Accessed June 1, 2022.
While most recessions meet this criteria, some don’t. The NBER uses a more flexible way of measuring recessions which occasionally includes periods of economic contraction that last less than two consecutive quarters.
Apart from the Great Depression in the 1930s, the recession in 2008 was one of the most severe economic contractions in recent history.
It was so severe that economists dubbed it the “Great Recession”. Chair of the Federal Reserve at the time, Ben Bernanke, feared that the recession in 2008 could spiral into a more severe and prolonged economic depression. Bernanke, S. Ben et al.: Firefighting. The Financial Crisis And It’s Lessons (2019)
There are different theories as to what caused the Great Recession. Some of them attribute it to lack of regulation of financial markets, shadow banking and loose lending requirements for mortgages. Others believe government and central bank intervention into free markets caused it.
In response to the Global Financial Crisis, and to prevent the Great Recession from turning into a prolonged depression, Bernanke engaged in unprecedented monetary policy.
This includes the use of quantitative easing, which together with other interventions were extremely unpopular at the time. Many in the general public viewed it as a de facto bailout of Wall Street.
During the Great Recession, US GDP fell 4.3%. Federal Reserve History. “The Great Recession“. Accessed June 1, 2022. Real estate prices across the country fell as much as 30% in a matter of months and the S&P 500, a leading stock market index, fell 57%. Federal Reserve History. “The Great Recession“. Accessed June 1, 2022.
According to Bernanke, the entire financial system and global economy was at the brink of collapse. Only decisive government and central bank intervention can prevent a Great Depression-like collapse.
The Great Depression, on the other hand, saw stock market declines of up to 90%. Federal Reserve History: “Stock Market Crash of 1929” Accessed Feb. 24, 2022. Real estate and most other assets crashed as well. Many banks went bankrupt in a series of bank runs.
As a result of contagion caused by the Great Depression, most industries only operated at a fraction of their capacity. This led to a significant rise in unemployment.
Most notably, the Great Depression was accompanied by deflation. Along with asset prices, consumer prices dropped sharply. The advent of the Great Depression gave rise to Keynesian economics, named after John Maynard Keynes, who believed the depression and deflation was caused by lack of aggregate demand.
As a result, economists and policy makers called for swift and decisive intervention in the form of fiscal and monetary stimulus in response to the Great Recession in 2008.
The Keynesian theory of counter-cyclical intervention received criticism in the 1970s when economists had to deal with a phenomenon called stagflation for the first time in history. Federal Reserve History. “The Great Inflation“. Accessed June 1, 2022.
Stagflation is when high inflation and slow economic growth, including high unemployment, occur at the same time.
Proponents of Keynesian theory and policy believed that inflation and unemployment have an inverse correlation. When inflation is high, unemployment should be low. However, the advent of stagflation in the 1970s invalidated this theory.
While the NBER defines recessions as significant declines in economic activity that last for more than a few months, this doesn’t explain why recessions exist in the first place.
There are different theories as to the causes and effects of recessions. Most of them acknowledge the existence of the business cycle or trade cycle.
A business cycle can be defined as a period of economic expansion, or a boom, followed by an economic contraction or bust. Many mainstream economists, including proponents of Keynesian counter-cyclical intervention, view recessions as normal.
According to them, recessions and depressions are the result of an imperfect market that fails to self-regulate. In order to soften these naturally occurring business cycles, central banks and governments should intervene with fiscal and monetary stimulus. Keynes, John Maynard: The General Theory of Employment, Interest and Money (2009)
This government intervention can stimulate aggregate demand when consumer and investor sentiment is low and unlikely to recover by itself.
Some other, mostly heterodox economic schools, reject the idea that business cycles are failures of the free market to regulate itself.
Proponents of the Austrian Business Cycle theory argue that government and central bank intervention in the free market causes economy-wide recessions and depressions. Rothbard, N. Murray: America’s Great Depression (1963), pp.3ff.
According to the Austrian school of economics, artificially low interest rates cause booms. As central banks lower interest rates below the rate the free market would choose, entrepreneurs misallocate capital into malinvestments.
These investments appear to be profitable due to the low interest rates and distorted market signals. But under normal market conditions, they wouldn’t be sustainable. When the artificial boom comes to an end, this triggers an economy-wide recession or depression.
Keynesian economists claim that free markets are responsible for recessions and call for government and central bank intervention to regulate and stimulate the economy.
Austrian economists make the opposite claim. They argue that free markets are self-regulating and efficient. To them it’s exactly the intervention in free markets that the Keynesian prescribe that cause artificial booms and busts.
To Austrian economists, recessions and depressions are the remedy to the artificial boom. It’s how the market rids itself of all the malinvestment. While painful in the short-run, it’s necessary so the economy can return to a state of equilibrium.
There are other theories that aim to explain recessions. Marxist economists believe that the rate of profit drops as factories and machines replace human labor.
Unlike the Austrian and Keynesian economists, which are generally in favor of free markets and capitalism, Marxist economists believe the only remedy is to abolish capitalism.
According to them, the recessions and depressions will get increasingly worse, leading to more poverty and misery, until the capitalist economy collapses and is replaced with a socialist or communist economy.
Some other explanations of business cycles includes Schumpeter’s business cycle theory as well as theories that economy-wide recessions and depressions are caused by overproduction, underconsumption or changes in psychological factors.
Economists and policy makers had largely believed that major economic contractions, such as experienced during the Great Depression, were a thing of the past.
The idea held by many mainstream economist was that after the Great Depression, and using expansionary monetary policy, the economy could remain in a state of prolonged economic expansion.
Downturns, if they should occur at all, should be relatively mild and short-lived. After the Great Depression, most recessions for the next 70 years were comparably mild.
For the most part, the economy appeared to be on a trajectory of long-term expansion. When the Great Recession took the economy by storm between 2007-2009, many mainstream economists didn’t see it coming. Even more so, they were surprised by the severity of the recession.
Without decisive intervention, Ben Bernanke believed the global financial system and economy would have collapsed. This could have triggered another depression that matched or exceeded the Great Depression in length and severity.
While a meltdown of the global financial system and economy was prevented last minute, the question remains whether and when the next recession or depression occurs.
In 2022, the Federal Reserve began quantitative tightening to get inflation under control. This triggered fears of another recession or even a period of stagflation.
Stagflation is harder to contain than a recession. When inflation is running high, measures that would usually stimulate the economy like lowering interest rates and quantitative easing, can contribute further to inflation.
|↑1||NBER. “US Business Cycle Expansions and Contractions“. Accessed June 1, 2022.|
|↑2||NBER. “Business Cycle Dating Procedure: Frequently Asked Questions“. Accessed June 1, 2022.|
|↑3||Bernanke, S. Ben et al.: Firefighting. The Financial Crisis And It’s Lessons (2019)|
|↑4, ↑5||Federal Reserve History. “The Great Recession“. Accessed June 1, 2022.|
|↑6||Federal Reserve History: “Stock Market Crash of 1929” Accessed Feb. 24, 2022.|
|↑7||Federal Reserve History. “The Great Inflation“. Accessed June 1, 2022.|
|↑8||Keynes, John Maynard: The General Theory of Employment, Interest and Money (2009)|
|↑9||Rothbard, N. Murray: America’s Great Depression (1963), pp.3ff.|