Economic Downturn, Recession & Depression

Recent events that have unfolded about the current global economic situation especially in the USA have made great news fodder for the business sections of various vernacular print media. For the first time in history, three local Malaysian banks have surpassed that of the goliath Citigroup in terms of market capitalisation. Citigroup, the world’s largest bank by market value before the credit bubble burst  has recently seen its share price dip as low as 97 cents on Wall Street on Thursday 5th of March. Its market value was capitalised at USD5.59 billion (RM20.66 billion) at its USD1.02 close that day, lesser than that of Public Bank Berhad (market cap: RM28.26 billion), Maybank (market cap: RM22.16 billion) and BCHB (market cap: RM21.65 billion).

With stock market shares and property prices going on downwards movements, higher inflation and unemployment rate and lower take-home salary and wages, often readers of the various print media will come across such words as economic downturn and recession.

What are the meaning of the word downturn, recession and depression and what do they actually refer to in the economic sense and in the business world?

A downturn is a decline. In economic terms, the word downturn refers to a decline in economic or business activity.

‘Recession’ comes from the word ‘recess’ meaning something that recedes or withdraws from a place or point. In economic terms, recession means temporary decline in economic activity or prosperity. (Note the word ‘temporary’). Some economists define it as a downturn in the business cycle characterized by two successive quarters of negative rates of growth in the real Gross National Product. The downturn is temporary because it is followed by resumption in growth.

The ominous sounding ‘depression’ which comes from the word ‘depress’ meanwhile has the meaning of state of extreme dejection, often with physical symptoms. In economic terms, it is a long period of financial slump. (Note the term ‘long period’). There is no official quantitative definition of a depression as is the case with recession. But the general definition is that it is a severe trough in the business cycle where there is widespread and sustained unemployment.

The following excerpts taken from a recent article written by a business journalist for the Washington Post, posted in the net distinguishes the characteristics of recession from depression, via a series of historical economic events that took place in the US. 

Recession:

Recession is easier to define than depression.

Before the 1930s, any serious economic downturn was called a depression. The term "recession" didn't come into common use until "depression" became burdened by memories of the 1930s, said Robert McElvaine, a history professor at Millsaps College in Jackson, Miss. 
"When the economy collapsed again in 1937, they didn't want to call that a new depression, and that's when recession was first used," he said. "People also use 'downward blip.' Alan Greenspan once called it a 'sideways waffle.'" 

Most postwar U.S. recessions have come after the Fed has increased interest rates to cool down rapid economic growth and inflation. Later, the Fed lowers rates and helps restart the economy, with the housing and auto sectors — both sensitive to interest rates — leading the way. 

This time is different: As Senate Banking Committee Chairman Chris Dodd, D-Conn., said, "Our housing and auto sectors are leading us not out of recession, but into it." 

What's more, the Fed no longer has the ability to kick-start recovery by lowering interest rates. The central bank has already effectively lowered the short-term rates it controls to zero. 

And there are no guarantees the massive economic stimulus package and series of bank bailouts will stave off a nightmare recession, or worse. 

"It is certainly plausible that the kinds of policy measures that have been good enough to tame the business cycle are no longer adequate in a fast-moving, highly leveraged, highly networked economy," said Anirvan Banerji of the Economic Cycle Research Institute. 

No one disputes that the current economic downturn qualifies as a recession. Recessions have two handy definitions, both in effect now — two straight quarters of economic contraction, or when the National Bureau of Economic Research makes the call.

Depression:

Declaring a depression is much trickier.

Food lines, rampant unemployment, a wipeout in the stock market. The economy can sink into a milder depression, the kind spelled with a lowercase "d."

There are no firm rules for what makes a depression. Everyone at least seems to agree there hasn't been one since the epic hardship of the 1930s.

But with each new hard-times headline, most recently an alarming economic contraction of 6.2 percent in the fourth quarter, it seems more likely that the next depression is on its way.

"We're probably in a depression now. But it's not going to be acknowledged until years go by. Because you have to see it behind you," said Peter Morici, a business professor at the University of Maryland.

By one definition, it's a downturn of three years or more with a 10 percent drop in economic output and unemployment above 10 percent. The current downturn doesn't qualify yet: 15 months old and 7.6 percent unemployment. But both unemployment and the 6.2 percent contraction for late last year could easily worsen.

Another definition says a depression is a sustained recession during which the populace has to dispose of tangible assets to pay for everyday living. For some families, that's happening now.

Morici says a depression is a recession that "does not self-correct" because of fundamental structural problems in the economy, such as broken banks or a huge trade deficit.

Or maybe a depression is whatever corporate America says it is. Tony James, president of private equity firm Blackstone, called this downturn a depression during an earnings conference call last week.

The Great Depression retains the heavyweight crown. Unemployment peaked at more than 25 percent. From 1929 to 1933, the economy shrank 27 percent. The stock market lost 90 percent of its value from boom to bust.

And while last year in the stock market was the worst since 1931, the Dow Jones industrials would have to fall about 5,000 more points to approach what happened in the Depression.

Few economists expect this downturn will be the sequel. But nobody knows for sure, and nobody can say when or whether the downturn may deepen from a recession to a depression.

In his prime-time address to Congress last week, President Barack Obama acknowledged "difficult and trying times" but sought to rally the nation with an upbeat vow that "we will rebuild, we will recover."

The next day, Federal Reserve Chairman Ben Bernanke told the House Financial Services Committee that the "recession is serious, financial conditions remain difficult." He held out a best-case hope that it might end later this year, with "full recovery" in two to three years.

Despite the tempered optimism, the economic outlook remains grim. Consumer confidence has fallen off the table, stocks are at 12-year lows, layoffs come by the tens of thousands, and credit remains tight.

The current downturn has many of the 1930s characteristics, including being primed by big stock market and real estate booms that turned to busts, said Allen Sinai, founder of Boston-area consulting firm Decision Economics. 

Policymakers and economists note there are safeguards in place that weren't there in the 1930s: deposit insurance, unemployment insurance and an ability by the government to hurl trillions of dollars at the problem, even if it means printing money. 

Today's economic indicators don't project a depression. But Banerji is cautious. Economic data in 1929 didn't show that the stock market crash was about to lead to years of economic misery, either. 

"It did not look like the kind of plunge that would be a depression until after the recession began," Banerji said. "The Great Depression didn't start out as a depression. It started out as a recession." 

The depression that consumed most of the 1870s and followed something called the Panic of 1873 makes a better comparison to what's happening now, said Scott Nelson, a history professor at the College of William and Mary. Financial markets had become centrally located by the 1870s, notably in London. And nations had not yet enacted the protectionist trade policies that were in place by the 1930s. 

The results were not exactly promising. Gangs of orphans roamed city streets as men moved west to pursue cattle industry jobs. Widows struggled to make money by serving unlicensed liquor. Thousands of workers, many Civil War veterans, became transients. 

The downturn lasted more than five years, according to the economic research bureau — four times as long as what the United States has endured so far in this downturn. 

Today's recession is already longer than all but two of the downturns since World War II. But for now, public officials are being extremely cautious about the D-word. Alfred Kahn, a top economic adviser to President Carter, learned that lesson in 1978 when he warned that rampaging inflation might lead to a recession or even "deep depression." 

When presidential aides asked him to use another term, Kahn promised he'd come up with something completely different.

"We're in danger," he said, "of having the worst banana in 45 years.

Business Cycle

Perhaps the best way to understand economic downturn, recession and depression is by looking at the economic cycle. There are three important business cycles namely the business cycle which drives the occupier market, the credit cycle which influences bank and institutional funding, and

Barras (1994) has identified the key events of the economic cycle which are depicted in the chart (refer to chart).

From the  chart of business cycle, it can be seen that economic downturn occurs at some point from phase (1) to phase (2) which when worsens would lead to phase (3) which is the recession phase. The length or duration of this recession phase will in turn influence or determine the occurrence of depression, whereby if the recession period is long enough and the economic fundamentals cannot be any worse than they already are (worst case scenario), depression sets in. Most economists agree that a normal economic cycle takes between 10 to 13 years time to complete. This means that an economic cycle whereby the recession phase turns into depression will take longer than 15 years to complete.

Written by:
Sr Nik Nazariah bt Nik Jaafar
Associate Director, Nilai Harta Consultant Sdn Bhd

Reference:
The Edge (Monday 9 March 2009 issue)
Cadman & Topping (1995)
The Oxford Dictionary of Current English
Dictionary of Economics (Bannock et al)