Recession or depression? Too early to tell

John W. Schoen Senior producer • Profile • E-mail

By every measure — lost jobs, plunging stock prices, scarce credit and a profound loss of confidence in the banking system — the economy is in awful shape.

The nation's 11th recession of the postwar era began in December 2007 and easily could become the longest since the Great Depression, although most forecasters expect a weak recovery to begin in the second half of this year.

But what are the odds that we’re in the early stages of what will eventually become a depression rather than just a recession?

The answer starts with definitions. While the term "depression" is reserved for the most extreme economic collapses, there is no technical definition, say economists.

“The difference between a recession and depression is primarily a matter of degree,” said Victor Zarnowitz, a University of Chicago economist and a member of the business cycle dating committee at the National Bureau of Economic Research. “A depression is much more severe and usually longer than a recession.”

With no set milestones, the term doesn’t really apply until after it’s clear a downturn is one of the worst in history.

As bad as things are today, conditions are nowhere near as bad as they were during the Great Depression. At least not yet.

The differences are stark. From 1929 and 1933, inflation-adjusted gross domestic product  plunged 27 percent, some 10 times worse than any recession since. Today, even the worst forecasts don’t expect GDP to shrink by more than a few percent this year before recovering in 2010.

Unemployment in the 1930s peaked at 25 percent in 1933; most forecasters don't expect unemployment this time around to rise much above 10 percent, compared with the current 7.2 percent.

Other comparisons don’t measure up either. Since the current crisis began unfolding, the number of banks that have failed or been forced to find merger partners can be measured in the dozens; in the 1930s, roughly a third of all banks failed. Even last year's sickening 38 percent drop in stock prices was fairly tame compared to the 90 percent drop during the Great Depression.

“There is no comparison — an order of magnitude difference in what we're seeing — in the slowdown and the financial stress we're seeing in this economy and what happened in the 1930s,” Federal Reserve Chairman Ben Bernanke, a scholar of the Great Depression, said last month in a speech in Austin, Texas. “So let's put that out of our minds.”

That’s easier said than done. For one thing, until the data begin to show signs of improvement, there’s no way to know how long it will take for this economy to hit bottom. During the Great Depression, the steepest drop in output and employment occurred in the fourth year of the downturn.

“They didn’t know it was the Great Depression in the first year,” said Neil Soss, chief economist at Credit Suisse. “It’s sort of like sort of reading 2008 day-by-day in the newspapers. Why didn’t we know this was about to happen? The reason is you’re living in the fog of unfolding events.”

Those unfolding events are certainly cause for concern, especially given the similarities between today’s headlines and the 1930s. The Great Depression followed a major expansion of consumer credit and home buying; the unwinding of that boom sent consumer spending plummeting. After a period of rapidly rising stock prices, the crash of 1929 destroyed billions of dollars of wealth; stock prices didn’t recover for decades.

Deflation — a persistent drop in prices that prompts consumers and businesses to delay spending and investing — took hold in the 1930s; today, a collapse in housing and energy prices could spark another deflationary cycle.

The current downturn, like the depression of the 1930s, follows a period of rising income inequality as wealth became concentrated in the hands of relatively few people. Much of that wealth was created by an explosion in credit.

During the 1920s boom that preceded the Great Depression, investors relied heavily on borrowed money to buy stocks; today, the financial markets are unwinding losses from a huge buildup of investments based on mortgages that turned out to be worthless. The downturn early in the 1930s accelerated as the banking system collapsed; despite massive government investments, today's banking system is still badly damaged. And much the way global trade flows are slowing today, the 1930s downturn was intensified by a sharp pullback in trade.

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