World Depression

Are We in a Recession or a Depression?

The second half of 2008 has seen the worst global economic downfall in decades – every day there are new reports which further dishearten the strength of the world economy. Are we in a world depression? Or merely a recession? What is the difference between the two, and how does the 2008 global economic situation compare to the Great Depression of the 1930s?

• Financial Services

Recession vs. Depression
These terms are often used interchangeably in international and New Zealand finance, and each definition differs depending on which newspaper is writing about it, or which economist is commenting on it. As a general rule, a recession is defined as:

"a mark of when the GDP (Gross Domestic Product) decreases continually over more than one quarter of a year...generally the GDP decrease is measured as less than a 10% decrease".

Economic recessions are measured in quarter year periods, rather than in full year periods, as opposed to a depression, which is defined as:

"a decrease in the GDP of more than 10% in an entire year".

The recession vs. depression debate is one most accurately labelled after the bleak economic period has finished, upon a full evaluation of the events that occurred within that period. While economists have clear mathematical definition of the terms (as above), politicians often use the word which fits their cause most, i.e. an incumbent Government referring to an economical downfall as a 'recession' rather than a 'depression' to deter from a more negative spin on their policies, which the Opposition might attempt to negatively objectify with the use of 'depression'.

Then vs. Now
With international exchange rates chopping and changing daily, and interest rates becoming more of a focus for the average Kiwi, how can we compare the 2008 economic situation to the Great Depression of the 1930s?

The key similarity between both periods are an extended time of ever-increasing prosperity during the years or decades leading up to the downfall. The 1920s saw significant economic advancements, and many believed the market could sustain high price levels. The 1990s and 2000s have seen similar growth and an increased feeling of security of the global economic state, even through periods like the dot com burst.

Many believe overconfidence spurs economic growth too far - and then an economic crash takes place to compensate. Economist Irving Fisher famously proclaimed in 1929:

"stock prices have reached what look like a permanently high plateau"

just days before the Stock Market Crash. Similarly, economists of the 21^st century have believed the same over the last decade.

The Stock Market Crash of 1929 saw a sharp increase in stocks in September '29, increasing them fivefold on the Dow Jones Industrial Average. The market then fell sharply for a month, and on Friday October 24, 12.9 million stocks were traded. Over the weekend this was reported worldwide causing many to loose confidence in their stocks, and on October 28, "Black Tuesday" saw 16 million stocks traded in a complete loss of confidence which sparked the global glut of the 1930s.

The financial crisis of 2008 became visible in September '08 with the worst sell off since 1987 where two major banks filed for bankruptcy - which collapsed because of the enormous exposure to the US subprime mortgage market. A rapid decline of US and European stock indexes saw the significant decrease in value of the market value of equities worldwide - a trend continuing to spiral down because of the loss of confidence by investors trying to get out of their stock investments with as much as they can.

Is the World Economy heading for the Next Great World Depression?

It's the question on everybody's mind - will we see a repeat of the 1930s with another Great Depression due to the financial crisis of 2008? While it is undoubtedly the worst economic situation in decades, it seems that the overwhelming bulk of world economists do not believe we are heading down the same trail as we did some 80 years ago.

The chief economist for the Organisation for Economic Co-operation and Development (OECD) Klaus Schmidt-Hebbel believes a repeat of the depression is unlikely because of the massive economic rescue plans that the world's leaders have in place. While this current crisis is the largest in decades it is comparatively smaller than the Great Depression, and will not have the same effects on output and employment. Government bail-outs and big player mergers have stabilising effects on investor confidence, as does deposit insurance, which did not exist in the 1930s.

While on the whole, the global economy isn't expected to dip like it did in the 1930s - don't expect rationing  and souplines down city streets - rebuilding trust in financial markets will mean a drawn out period of restrictive financial conditional affecting loans and access to funding.

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Business images from Flickr: Markets, New Zealand Flag and Wellington Buildings.