Economy: Are We in a Recession or Depression?

During his 1980 Labor Day speech at New Jersey's Liberty State Park, Republican presidential nominee Ronald Reagan listed the economic failures of his opponent, President Jimmy Carter. With the Statue of Liberty as a backdrop, Reagan used the moment to respond to Carter, who had accused Reagan of misusing the term "depression" to describe a recession that began in January of that year. "Let it show on the record that when the American people cried out for economic help, Jimmy Carter took refuge behind a dictionary. Well, if it's a definition he wants, I'll give him one. A recession is when your neighbor loses his job. A depression is when you lose yours. And recovery is when Jimmy Carter loses his."

However imprecise Reagan's macroeconomic definitions may have been, he'd made his point. Semantics don't mean much to Americans who have lost or are about to lose their jobs, their savings and their homes. But for those charged with charting the fastest course to an economic recovery, knowing the exact severity of the situation is critical. So what does constitute a recession, or a depression? Answering that question is harder—and takes longer—than you might expect.

Some economists define a recession as two consecutive quarters of economic contraction, or a decline in real gross domestic product (GDP). By that measure, the U.S. wasn't off to a bad start this year. According to the Bureau of Economic Analysis, real U.S. GDP rose 0.9 percent in the first quarter of 2008 and 2.8 percent in the second quarter. The problem with such a simple definition, according to James Poterba, president of the National Bureau of Economic Research (NBER), the official arbiter of when recessions begin and end, is that it "omits the possibility that you see two very tiny declines in two quarters, and [it also] doesn't look at other information for the rest of the economy, which may suggest that what is happening is not a broad decline."

According to NBER's definition, a recession occurs when a "significant decline in economic activity is spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales." The beginning of a recession is commonly referred to as a business-cycle "peak," and the end of it is called a business-cycle "trough."

Robert Gordon, a member of the NBER committee responsible for determining the beginning and end dates of recessions, says making a determination is often complicated by the fact that figures like GDP can be revised substantially even years later. Roy Smith, a professor at NYU's Stern School of Business, adds, "It's very frustrating for commentators and other folks who feel like they know in their gut that we are in a recession, but that is not a very scientific [approach,] so people can get it wrong. The choice is that someone calls it based on their gut, or we wait for the data."

Waiting for the data tends to take some time. As a result, most recessions have not been declared by NBER until at least five months after they've ended. The one marker that seems to be a constant in most recessions is unemployment. "There has never, in the postwar U.S., been a 1 percentage point increase in unemployment without a recession having been declared, and much of that increase in unemployment occurs after the recession started," says Gordon. "Right now, we've had a 1.7 percent increase in unemployment. On historical precedence, absolutely this is a recession. All we have to do is figure out when it began."

Still, to NBER, the means by which to measure a recession make as much sense today as they did 50 years ago. Harvey Pitt, former chairman of the Securities and Exchange Commission and CEO of the global consulting firm Kalorama Partners, says there is another reason why the process by which a recession is defined will likely go unchanged. "It's fairly elastic, because it has enormous economic as well as political consequences," he says. "Whoever is running the government at any particular time wants to avoid people drawing the conclusion that economic stagnation is a recession."

When it comes to depressions, Pitt believes the term is fairly well understood, even if there is no official definition. A common unofficial definition for a depression refers to a deeper and prolonged recession during which the GDP declines by more than 10 percentage points. That was certainly the case in the 1930s, when the GDP dropped by more than 30 percent from 1929-33, with unemployment rates peaking at 25 percent in 1933. "These numbers were monstrously larger than anything we'd experienced otherwise," says Smith. "We have no other modern experience of it and will likely not have any, because we've installed safeguards that didn't exist then to prevent such a catastrophe."

Smith doubts there's a need for an official definition, because he believes it is unlikely that the country will find itself in such a drastic situation again. The NBER's Gordon says that coming up with one would likely be difficult, because "really, all we agree on is that a depression is much more severe than a recession, and everyone agrees we haven't had one since the 1930s."

When it comes to searching for definitive explanations, Reagan may have gotten it right back in 1980. In that same speech, he said, "Human tragedy, human misery, the crushing of the human spirit … They do not need defining—they need action."

Economy: Are We in a Recession or Depression? | Business