Recession vs. Depression
As interest rates continue to climb, so does the cost of living. In the housing market, everyone’s eyes are watching the mortgage rate as it reaches double and triple its pandemic lows. It’s normal for prices to fluctuate throughout the year, but understanding the interplay of the housing market with the rest of the economy is critical for investors.
Elsewhere in the market, price increases are hitting even closer to home than bank rates. Food and gas prices are rising, causing living costs to skyrocket. Meanwhile, countless corporations have announced massive layoffs, with more to come in the new year. For the uninitiated, these things could leave you worrying about a recession — or even a depression. What’s the difference, and, more importantly, what lies ahead? Here’s what you need to know.
What is a Recession?
A recession is defined as a significant and prolonged downturn in economic activity. Generally, economists say that two consecutive quarters of gross domestic product (GDP) that measure negative indicate a recession. However, many data points are considered to determine a recession, including retail sales, industrial production, and nonfarm payrolls.
When most people think about a recession, they think about The Great Recession, which occurred between 2007 and 2009. However, recessions do not have to occur globally or necessarily last for years. Here’s what you should know about a recession:
- A recession is a significant and prolonged decline in economic activity.
- The economy could take weeks to years to reach its former peak.
- A recession often feels longer than it is, as unemployment often persists well into the recovery period.
It’s challenging to identify a recession right as it’s starting. It often takes a few months of data to look back and pinpoint when a recession began and when it eventually ended. During a recession, investors may find success investing in off-market and bank-owned properties, but it requires patience and a long-term plan.
What is a Depression?
While depression is also defined as a significant and prolonged downturn in economic activity, it is far more severe than a recession. A recession turns into a depression when it lasts for three or more years or when the gross domestic product (GDP) drops by 10% or more in a year.
Depressions are far less common than recessions, marked by low inflation and high unemployment. Recessions are considered a normal part of the business cycle, whereas depression is an extreme event that the United States has only experienced a few times in history. Since 1854, we’ve experienced 33 recessions and only one depression.
Here’s what you should know about depression:
- A depression starts when a recession lasts three years or more, or GDP drops 10% or more in a given year.
- A depression is more severe and longer lasting than a recession and is marked by high unemployment, bankruptcies, and low to no inflation.
- A depression causes consumer confidence to tank and decreases savings, trading, and global commerce.
Economists disagree on when a depression starts and ends. Some argue a depression ends when the period of economic turmoil ends, while others claim the depression continues until economic activity returns to its pre-depression normal. Most investors would be weary of purchasing property before a depression is over.
How Does a Recession Differ from Depression?
Depressions and recessions sound similar on paper, but comparing the last depression we experienced (The Great Depression of 1929 to 1939) to the last recession we experienced (The Great Recession of 2007 to 2009), shows significant differences.
- Peak unemployment during the last recession was 10%, compared to 25% in the previous depression.
- Peak GDP decline during the last recession was 4.3%, compared to 29% during the last depression.
- Home prices fell by 30% during the last recession, compared to 67% in the previous depression.
Looking at these numbers side-by-side, it’s easier to recognize just how much more severe a depression is next to a recession. Moreover, it makes it easier to put the current economy into perspective to answer questions like where the housing market recession will lead to another depression.
Is There Going To Be A Depression?
Since the Great Depression happened, governments around the world implemented new monetary and fiscal policies to help prevent future depressions from occurring. These policies help drive the business cycle, one reason we’re entering a recession now. While inflation has dampened short-term mortgage affordability, it’s serving its purpose of driving down housing prices, which will be beneficial in the long term.
So, while it’s easy to wonder why the Federal Reserve keeps raising interest rates, it makes more sense once we look back at historical events like the Great Depression. One of the primary reasons the Great Depression happened was that the Federal Reserve didn’t correctly control the money supply and prices, leading to deflation. Many economic crises have been avoided in the decades since, thanks to better policies and foresight.
In addition to the Fed managing supply and prices, the government has also established other protections to help prevent another depression, including:
- Unemployment programs exist to help people who lose their jobs continue to afford food and bare essentials.
- Fiscal stimulus, also known as stimulus checks, can be issued (like during the pandemic) to help cushion tight budgets.
- The Federal Deposit Insurance Corporation (FDIC) now insures deposits up to $250,000.
- The Dodd-Frank Act, instituted in 2010, strengthened the financial system by improving the accountability and transparency of banking and investment activities.
None of these protections existed during the time of the Great Depression, and many of them were developed due to experience gained during the Great Depression. In other words, the chances of a recession turning into a depression anytime soon are highly unlikely. Our economy is more stable than ever and more equipped to handle natural downturns like the current recession without a severe, lasting impact.
While it’s unlikely we will enter a depression, a recession is an authentic event that will impact investors and change how they approach their goals. All investors must keep their eyes on the market, significantly as housing prices drop. If you’re interested in learning more about how the housing market will likely perform this year, ProspectNow has the resources and tools you need to succeed as an investor.
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