Monday, December 8, 2008

Depression vs. recession

I have not yet run across any really good definitions for an economic depression. In fact, ten years ago when I was reading about The Great Depression, I saw references to the fact that "depression" was once the standard term for what today we call a "recession." The question is whether there is a qualitative difference, or whether the distinction is simply quantitative and whether a depression is simply a recession that is much worse and much longer than a "typical" recession. A recession is usually considered "temporary", which a depression tends to be "prolonged."

I will start working on my own definition.

One important quality is that the economy usually bounces back to a new high level of activity fairly quickly (a few months to a year or two), while a depression "destroys" enough economic capacity so that it may take more than a few years to restore the level of output, employment, and income to its previous peak, and that recovery is only after a prolonged decline to the "bottom", maybe two years or more.

A typical recession results in temporary job loss, such as factories firing workers due to excess inventory and then rehiring those same workers once inventory levels have declined to a level requiring significant replenishment. A depression would tend to involve widespread permanent destruction of jobs such that people are forced to seek employment at new positions that did not exist before the decline, and obviously that process will not tend to be rapid, especially if reduced credit and capital result in slower formation of new firms and new positions.

Note that Obama is talking about creating new "green" jobs, rather than bringing back more jobs to Detroit or residential housing construction.

In short, a typical recession tends to be "cyclical" (inventory fluctuations) while a depression tends to be disruptive and "structural."

Another question is whether a depression could be relatively brief, such that it could actually be shorter than a "bad" recession. For example, could the destruction of many "old economy" jobs in favor of gradual creation of "new economy" and "green" jobs qualify the current episode as a depression, even if massive fiscal stimulus permits the economy to bounce back within a year.

That begs the question of whether the economy would be headed for a depression if massive fiscal stimulus (coupled with massive Federal Reserve support) was not in the offing. So, even if we do not see the kind of declines in output, employment, and income usaully associated with a depression, would the level of stimulus indicate that an "imminent depression" was in fact a plausible possibility.

-- Jack Krupansky


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