Recession or Depression?

Frequently you hear the definition of a recession as "two consecutive quarters of negative growth in GDP". While this definition approximates the effects of a recession, it is too simplistic. The National Bureau of Economic Research, or NBER, is the arbiter of the business cycle. When they announce the start or end dates of a recession, those dates are considered the official start/end points of the economic contraction.

NBER's definition is more comprehensive:

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough. Between trough and peak, the economy is in an expansion.

Because of conflicting definitions and the fact that data takes time to reflect trends ("lasting more than a few months"), vigorous debates always ensure whether we are or aren't currently in a recession. Debate no more, yesterday NBER officially announced the peak of economic activity (and thus the beginning of the current recession) as being December 2007.

It is also important to note that the recession lasts from the peak of economic activity to the trough. From the trough upward is recovery or "expansion" as NBER calls it. Put another way, the recession is the period of falling economic activity, not the level. Recovery is technically "expansion" because the economy is growing, i.e. it is a directional definition. The recovery or early expansion usually still has high unemployment because the overall level of activity is still below the previous peak.

So what is a "depression"? Surprisingly, there is no official definition of "depression" in economics. (Psychologists have their own definition, which may apply to nearly everyone if the recession becomes an economic depression though). In general, the term depression refers to a particularly severe period of economic weakness. What is implied by "particularly severe"? Consider that all economic contractions (recessions) since WWII have resulting in a decline in GDP of less than 3%. The 1929-33 period called "The Great Depression" experienced a 27% contraction in economic activity- roughly 10x the magnitude. How is that for severe?

When commentators mention a possible depression, I immediately think of 25% unemployment and a 27% decline in GDP over 4 years. Might a 10% decline be a depression, just not "The Great" one? A matter of semantics for sure and painful for everyone either way.

Several economists are calling for a 5% contraction in GDP this quarter (4Q08). How deep and long will it be? Time will tell, but I'm deeply troubled at the prospects.