Thursday, February 5, 2009

Depression Vs Recession

Another addition to the list of semantic debates at these bleak economic times has been about the difference between recession and depression. There is no dispute in that both refer to periods of economic slowdowns. The NBER has a formal definition of recession as generally two consecutive quarters of declining economic output.

The Economist distinguishes between the two by drawing attention to two popular definitions of depression - a decline in real GDP that exceeds 10%, or one that lasts more than three years. By this definition, only one developed country has suffered a Depression since the War (Finland, in the aftermath of the collapse of erstwhile USSR), whereas there hae been thirteen instances of depressions in developing economies in the past thirty years.

Another distinction is made based on the cause of the downturn - recession usually follows a period of tight monetary policy, but a depression is the result of a bursting asset and credit bubble, a contraction in credit, and a decline in the general price level (deflation). Therefore both demand separate policy responses. A recession can be cured by lower interest rates, but fiscal policy tends to be less effective because of the lags involved. By contrast, in a depression conventional monetary policy is much less potent than fiscal policy.

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