6. RECESSIONS
The U.S. National Bureau of Economic Research defines a recession as a period with “a significant decline in economic activity spread across the country, lasting more than a few months, normally visible in real GDP growth, real personal income, employment (nonfarm payrolls), industrial production, and wholesale-retail sales.” During that time business profits typically decline as well. As a result, public-sector tax revenue also falls.
What You Should Know
Many call it a recession simply when a country’s GDP declines two calendar quarters in a row, or when the unemployment rate rises 1.5 percent in less than twelve months.
Technical definitions aside, perhaps Harry Truman had the best definition of a recession, and how it differs from a depression: “It’s a recession when your neighbor loses his job; it’s a depression when you lose yours.”
Recessions can be notoriously hard to forecast. For instance, how many really predicted the Great Recession, and especially its severity? When things are going well, we tend to become complacent, even optimistic, about the idea that anything can go wrong. We’ve grown accustomed to federal government intervention to prevent recessions by lowering interest rates and taking other measures to stimulate the economy (see #8 Business Cycle). Even the markets can’t tell us much; as economist Paul Samuelson famously stated: “The stock market has forecasted nine of the last five recessions.”
The National Bureau of Economic Research, the U.S. government organization generally responsible for identifying recessions, has noted ten recessions since World War II. As you can see from the table, recessions are generally short in duration—lasting less than a year—and typically happen about twice a decade.
The most recent of these, the so-called Great Recession, was also the largest since World War II, with a drop in GDP from peak to trough of 5.1 percent. By contrast, from August 1929 through March 1933, during the Great Depression, the GDP dropped 26.7 percent—hence “Depression” instead of “Recession.”
Table 2.1 U.S. Recessions 1945–2012
Occurrence
Duration
November 1948–October 1949
11 months
July 1953–May 1954
10 months
August 1957–April 1958
8 months
April 1960–February 1961
10 months
December 1969–November 1970
11 months
November 1973–March 1975
16 months
January 1980–July 1980
6 months
July 1981–November 1982
16 months
July 1990–March 1991
8 months
March 2001–November 2001
8 months
December 2007–June 2009
18 months
Source: U.S. Bureau of Economic Research
Why You Should Care
Recessions mean less for everybody, and unless you have a pile of money or are in a business largely immune to downturns, you should prepare to make adjustments when recession clouds start to gather. Warning signs include changes in the employment rate, an excess of debt, or “irrational exuberance” in some or all markets (like dot-com stocks in 2000 and real estate in 2006). You should learn to recognize when times are good, and use those times to save some money.
You should also watch to make sure your standard of living is matched to the worst, not to the best, of times. In good times, avoid allowing your lifestyle to consume all of your income, and worse, to put you into debt. If you do, you’ll have the flexibility to get through the bad times.
7. DEPRESSIONS
In economics, a depression is a sharp, protracted, and sustained downturn in economic activity, usually crossing borders as a worldwide event. It is more severe, and usually longer, than a recession, which is seen as a more-or-less normal feature of the business cycle (see #8 Business Cycle).
Depressions are usually associated with large collapses in business, bankruptcies, sharply reduced trade, very large increases in unemployment, failures in the banking and credit system, and a general crisis mentality and panic among the population, big corporations, and policymakers. Depressions can cause severe economic dislocations, including deflation (see #19 Deflation) and the wholesale demise of certain industries.
Of course, the Great Depression is the granddaddy of all depressions, lasting, by most accounts, from the 1929 stock market crash, which triggered subsequent banking failures and spread to the larger economy, all the way to World War II.
What You Should Know
To give an idea of the severity of depressions, the unemployment rate during the Great Depression went from 3 percent in 1929 to 25 percent in 1933 (37 percent for nonfarm workers). In some cities with a large factory base, it rose as high as 80 percent.
The good news is that depressions don’t happen often. As of 2012, there have only been three “depression” events in U.S. history: the Great Depression in the 1930s and two less severe panics in 1837 and 1873.
A long and large economic expansion that turned into a speculative bubble fueled by borrowing and debt preceded all three depressions. Those who borrow too much fail first, as they cannot service their debt, and that causes a rise in bankruptcies and asset prices to fall, leading to a vicious circle of debt-unwinding known as deleveraging (see #9 Deleveraging).
The challenge of the government is to intervene effectively to help out the economy. The Great Depression led to a significant banking panic. As banks failed, the government adopted a “laissez-faire” mentality, letting weaker elements be flushed from the system. This approach is good in theory, but it accelerated the panic. A misguided attempt to protect American business through trade tariffs failed miserably and made the problem worse.
Government may intervene, but history shows it has yet to do so effectively. By the time the U.S. government stepped in, it was too late; markets and businesses starved first for credit and then for customers had shut down. The government started stimulus programs to put people to work, moved away from the gold standard, devalued the dollar to make U.S. goods more competitive internationally, and passed legislation to protect the public from such calamities in the future. It was a very long and rocky ten years.
Why You Should Care
The Great Recession had some of the earmarks of a depression in the making, with severe stress on the banking and credit system and sharp rises in unemployment. But the many safeguards, like deposit insurance, Social Security, unemployment insurance (see these entries in Chapter 5), and various other forms of government intervention made a downturn of 1930s proportions seem unlikely. That said, you, as a person in charge of your finances, must always recognize the possibility—not probability but possibility—that such an event could occur, and keep your finances protected against such a downturn.
8. BUSINESS CYCLE
The term “business cycle” describes a more-or-less normal flow of American and world business activity over time from strength to weakness and back to strength. “Boom” conditions describe strong business growth throughout the economy, while a “bust” occurs when the economy gets tired, or some intervening event occurs that sends the tide the other way. Booms and busts have occurred throughout economic history, and naturally, one follows the other, but their pattern isn’t identical or predictable.