In the world of finance the word “depression” is popping up more often than at any time in the past 60 years.

There is an old joke among economists that states:

A recession is when your neighbour loses his job; A depression is when you lose your job!

The popular rule of thumb for a recession is two consecutive quarters of falling GDP. A more scientific definition was put forward by America’s National Bureau of Economic Research which was based on a more rigorous analysis of a range of economic indicators (business activity) such as employment, industrial production, real income and retail sales. They define a recession as the time when business activity has reached its peak and starts to fall until the time when business activity bottoms out.

However there is no widely accepted definition of a depression. Before the 1930’s all economic downturns were commonly referred to as depressions. The term “recession” was coined to avoid stirring up nasty memories and also to distinguish between major downturns and less those less severe.

There are (generally) 2 accepted principal criteria for distinguishing a depression from a recession; a decline in real GDP that exceeds 10% or one that lasts for more than 3 years. Since the Second World War only one developed economy has suffered a drop in GDP of more than 10%: Finland contracted by 11% during the 3 years to 1993.

So, do we have a depression or recession today? America’s GDP has fallen by an annualised 6% in the fourth quarter of 2008 but most economists dismiss the likelihood of a 1930’s-style depression because policymakers are unlikely to repeat the same mistakes of the past. In the 1930’s the Fed let hundreds of banks fail (which shrank the money supply by 1/3), raised taxes and cut spending. There is no indication that this will be the strategy followed this time round as seen by the recent actions and the rhetoric of the President-elect. So, whilst policymakers may not make the same mistakes twice they may make new ones.

However, this reassurance comes from many of the same economists who said that a nationwide fall in American house prices was impossible and that financial innovation had made the financial system more resilient. Hopefully they are right this time but only time will tell.

A final witticism from an economist – Alfred Kahn, who was one of Jimmy Carter’s economic advisers, was scolded by the President for scaring people by using the “D” word. So in his next speech he simply removed the offending word saying “We are in danger of having the worst banana in 45 years.”

Is there a distinct whiff of bananas in America’s economy once again and how far will it spread?

Article by: Kevin Owen owenk@finteg.com