What is an Economic Depression?

What is a Depression?

An economic depression represents a serious decline in economic activity. The size of the economy will shrink as the gross domestic product (GDP) drops. Many people will likely lose their jobs, and the rate of inflation will slow as consumer demand for goods and services declines. This can be a stressful time for many professionals across a wide range of industries. Learn more about economic depressions and how they can affect your finances.

What Makes an Economic Depression?

An economic depression is defined as a serious downturn in economic activity that lasts three years or more and results in at least a 10% decline in GDP, which measures the total retail value of all the goods and services produced inside the country within a given year.

Economies are expected to grow steadily over time, and a decline in economic activity often means that the country has either spent tax revenue irresponsibly, an asset bubble has burst, or that technology has outpaced consumer demand for products and services, resulting in mass unemployment, an abundance of goods, and declining retail prices.

A depression is much more severe than a recession, which is considered a normal part of the business cycle. A recession may only last a few months or a year, while a depression lasts much longer. A depression can have a dramatic and lasting effect on the average person’s standard of living. It may also take years for the economy to recover and return to earlier GDP levels.

Not all economists agree on the exact definition of an economic depression. Some say it only lasts as long as GDP growth is negative, but others say it lasts until the country’s economy returns to a normal level.

What Happens During a Depression?

An economic depression can result in a downward spiral of declining economic activity. Investors and consumers generally lose faith in the economy before and during a depression. Companies may also lose faith in the central bank’s ability to maintain economic growth using monetary policy.

In some cases, the government may spend taxpayer dollars on things that don’t contribute to economic growth. Corrupt officials may instead pocket the money, leaving residents without access to good-paying jobs and essential goods and services. This makes it difficult for companies to hire workers, which can lead to bankruptcy. Many consumers won’t have enough money to make ends meet, which only increases their reliance on government services.

In other cases, an asset bubble may burst. This is when investors inflate the cost of a particular asset, only to see the value decline sharply over a short period of time. Many investors will lose money, which can start to affect other aspects of the economy.

If consumers and investors feel the bubble is about to burst or that the economy is headed for a depression, it could trigger a major sell-off in the markets, leading to further economic decline.

Depressions typically lead to periods of deflation. Consumers won’t have as much money to spend on goods and services, which reduces demand. Companies will often lower their prices to make ends meet, which often results in more job cuts and lower wages. The Federal Reserve will likely lower interest rates during this time to increase consumer demand and increase the flow of capital. Companies and consumers won’t have to spend as much money to borrow funds that they can use to create jobs and buy products and services.

How Long Do Depressions Last?

Depressions can last three years or more. The depression may end when the country’s GDP starts to rise, and the economy starts to grow after years of declining activity, or when the country’s GDP returns to where it was before the depression.

The worst depression in U.S. history occurred in 1929. The Great Depression lasted more than ten years, with the highest unemployment rates on record, reaching a peak of 25% in 1933. It was largely caused by poor financial policy. The stock market crashed suddenly after a major sell-off.

President Franklin D. Roosevelt’s New Deal, which helped millions of Americans earn a living and rejoin the economy, eventually ended the depression in the early 1940s as the country entered WWII. Unemployment dropped substantially to 9.66% in 1941.

Economists agree that another Great Depression is unlikely to happen in the U.S. Financial regulators and banks can respond to changes in consumer spending much more quickly. The government has also created several agencies to help regulate the stock markets and greater interconnected financial system, including the Federal Deposit Insurance Corporation (FDIC), which protects depositors’ accounts, and the Securities and Exchange Commission (SEC), which is designed to prevent risky investments and illegal trading practices.

How to Invest During a Depression

If you are living in a country experiencing an economic depression, you may lose your job, or your assets may lose value during a market sell-off. You may be tempted to sell off your assets and stocks as they lose value, but there is a chance they will return to their normal levels once the depression ends. You will likely lose money if you sell your assets during the depression, so consider waiting until they have regained some of their value.

Many investors will spend their money on assets that will continue to have value during times of economic uncertainty, including gold, silver, and precious natural resources like fuel and water. You will want to keep your assets or savings in a secure location, such as bank safe deposit boxes, real estate, domestic and foreign stocks and bonds, or a private vault.

RELATED CATEGORIES: Macro