What is an economic depression?
Simply put, an economic depression is a sustained, severe, and prolonged downturn in the economic activity of a country. It is also described with the following expressions to indicate its severity and the extent of it:
- An extreme recession.
- A deep and extended period of negative economic growth.
- An economy in a state of financial uncertainty and turmoil.
In addition, an economic depression is characterised by a declining real gross domestic product (GDP) lasting for several years. (The ‘Great Depression’ in the United States of America (USA) lasted for 10 years (1929 – 1939 and the GDP of the USA was negative for 6 of the 10 years).
The term ’depression’ is also generally associated with the Great Depression.
Is a depression worst than a recession?
Yes, much worse indeed. Although also described as a significant decline in economic activity, a recession usually lasts for only a few months. A decline in economic activity is officially identified as a recession when a decline in GDP occurs in two consecutive quarters, even if the decline during those quarters is relatively mild.
Harry Truman, the 33rd president of the United States (serving from 1945 – 1953) once observed: ‘It’s a recession when your neighbour loses his job; it’s a depression when you lose yours.’
Economic factors defining an economic depression
There are various economic factors that can be involved in an economic depression. Factors such as:
- A significant decline in consumer confidence
This is the primary reason for the start of a depression. Consumer confidence leads to a decline in the demand for goods and services, causing a domino effect that enhances the possibility of a recession, and eventually a depression.
- Increasing of unemployment rate
A worsening unemployment rate is one of the consequences of the decline in consumer confidence. High levels of unemployment imply that consumers will lose their purchasing power, causing lower demand for luxuries and eventually for basic services and products.
- Rising inflation
Inflation is a term in economics that describes the general rising of prices and goods in an economy. Although too much inflation will reduce spending by entities and people, jeopardising the buying power and causing a decline in the demand for products and services.
- Deflation
One of the major causes of deflation in an economy is the fall in the total demand for goods and services, which causes falling prices.
Deflation, referred to as negative inflation, signals a weakening economy. Manufacturers react to falling prices by cutting back their production, which leads to salary reductions, or worse, the dismissal of workers.
- Continued negative gross domestic product (GDP) growth
A contraction in a country’s economy is reflected in a decline in its gross domestic product (GDP) during a given period of time. During a depression negative growth of a country’s economy can last for several years.
- Significant fall in stock market prices
Shares of public traded companies are traded on stock markets. When investors and traders start to withdraw substantial amounts of money from stock markets, it reflects the state of health of an economy. Put differently, stock markets are overwhelming bear markets during a depression.
When a stock market experiences a considerable outflow of investors’ money, it can be a telltale sign of investors’ declining confidence in the economy.
- Declining property sales
During healthy economic times, property prices, including residential properties, are generally high. However, an impending economic depression forces property prices down, indicating dwindling confidence in the economy.
- Liquidity trap
A liquidity trap refers to an economic situation where people hoard their money instead of spending or investing it.
It is a situation in which the efforts of a central bank of a country to stimulate spending and economic growth through interest rate cuts fail because people are too afraid to spend money.
A liquidity trap is dangerous for an economy because it can start a deflationary spiral: low-interest rates cannot stimulate people to spend enough to keep up employment, the purchasing power of people starts to decline, prices fall, causing people to delay spending, causing prices to decline even more, and so on.
- Increase in bankruptcies
A bankruptcy occurs when an individual or business is unable to repay its outstanding debts, leading to a legal proceeding.
- Available credit shrinks
In the financial world, credit generally refers to money borrowed by people and businesses from financial institutions, such as banks.
A drop in available credit implies less money available for spending by people and businesses.
- Sovereign debt defaults
Sovereign debt, also referred to as government debt, public debt, or national debt, refers to the debt of the government of a country.
Sovereign debt is usually created when a government issues government bonds, which are debt instruments utilised by governments to raise money for projects and other government expenditures. Governments are obliged to pay interest on the bonds and repay the initial amount of the bond at its date of maturity.
Unfavourable economic situations and an unfavourable change in exchange rates can make it difficult for a government to pay interest on time. A government can even default on the full repayment of the initial amounts.
- Reduced trade and international commerce
In economics, trade involves the buying and selling of goods and services between different parties.
International commerce, also called global commerce, is trade between businesses in different countries or trade between countries.
Due to the decline in purchasing power of individuals and businesses, as well as falling currencies, trade and international commerce are reduced, meaning less money in the pockets of individuals and businesses.
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