A depression is the severest form of recessions.
Economic activity fluctuates over time. Usually, a country’s economy grows, and output measured in its gross domestic product increases. However, it is normal for economies to experience periods where economic output decreases. These periods of economic contraction are called recessions. Recessions are marked by declining sales, resulting in businesses reducing production, lower profits, laid-off workers, and increased business failures. Unfortunately, the economic output may continue to decline because unemployed workers have less to spend, prompting businesses to cut back further. Companies lower prices to try to attract more business. Eventually, the economy begins to pick up, but if the recession lasts several years with great hardship, it may be considered a depression. (There is no defining moment when a recession becomes a depression.)
The United States has only experienced one depression since 1900, the Great Depression in the 1930s. It began in August 1929. Real gross domestic product, the most common measure of output, fell 27 percent by 1933. Nearly 25 percent of American workers lost their jobs. The lowest point in a business cycle, or trough, was reached in 1933. Economies worldwide suffered as well. After 1933 production slowly began to increase, but it was not until 1936 that production reached the pre-Depression level. Companies were reluctant to hire, so unemployment remained very high. Employment rates fully rebounded during WWII.
Image from iStockGovernments use fiscal and monetary policies to stimulate the economy by increasing government spending, reducing taxes, and manipulating the money supply to reduce interest rates. John Maynard Keynes developed Keynesian economics during the Great Depression to explain the Depression and identify a policy to eliminate it. Keynesians advocate increasing aggregate demand with government spending during recessionary periods to pull an economy out of the doldrums sooner. President Franklin Roosevelt endorsed Keynesian policies, establishing the New Deal, which most economists believe helped pull the US out of the Great Depression. Of course, the spending to finance the weaponry and troops in WWII also increased the aggregate demand. Keynes’ views still influence policymakers today.
The Federal Budget and Managing The National Debt
Fiscal Policy – Managing an Economy by Taxing and Spending
Gross Domestic Product – Measuring an Economy's Performance
Monetary Policy – The Power of an Interest Rate