What is the Definition of an Economic Depression?

The current economic situation is dire. For more than two years the housing market has been declining rapidly, and last year the credit markets froze up in response to that and other economic factors. The latest, and worst economic reaction of all, is the rapid rise in unemployment in the United States. The latest figures from January 2009 put unemployment at 7.6%. In the last three months alone, the American economy has shed about 1.7 million jobs. The latest preliminary Gross Domestic Product figures show a decline of 3.8% in the fourth quarter of 2008. It is certainly clear that the United States is in a recession, but the larger question that many consumers are asking now is "Are we in a depression?" There is definitely no way to answer that question yet, as only time will tell, but first I wanted to take a look at exactly what an economic depression is and how it is defined.

It is often known on Wall Street and in the business world as simply "The D Word." Yes an economic depression is such a severe and awful thing that even investment strategists and those who are most familiar with the economy can hardly fathom saying the word. What exactly is an economic depression? The strange truth is, there is no single definition for an economic recession, as different economists tend to use different metrics to measure what constitutes a depression. Probably the most popular definition of a depression is a Real GDP loss of 10% or greater. Other economists prefer to use the length of a recession as the guide for whether the economic situation classifies as a depression or not. This school of thought is that any economic recession lasting three years or more is termed a depression. The fact that there is no set definition for a depression means that some might characterize a downturn as a recession while others view the same downturn as a depression.

While economists don't necessarily agree on exactly what constitutes a depression, they do agree more on what causes a depression. A depression is typically caused by a huge increase in unemployment and the ripples that sends through the economy. If someone is unemployed they certainly won't be spending in the economy. In addition to unemployment, fiscal and monetary policy mistakes can also be major causes of economic depressions. Many believe that the Great Depression of the early 1930's in the United States was caused due to the lack of fiscal and monetary policies of that time.

No one knows exactly what defines a depression, but everyone understands that we are dangerously close to that point right now. The hope is that some monetary policy moves and some fiscal stimulus will help avoid a repeat of the Great Depression.