Genuinely, true depressions are uncommon in economic history. The Great Depression of the 1930s was the only economic downturn in the United States that was classified as a depression over the last century. However, rising inflation, a contracting gross domestic product (GDP), and stagnant wages have made some wonder if the United States is headed for another recession. Therefore, today, we will let you know more about the economic depression, which is very important thing to know.
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The Definition of a Depression
Normally, depression has no formal definition. Nonetheless, economists generally agree that it is a severe and prolonged period of economic decline that affects multiple countries at the same time. An example of depression is the Great Depression, which lasted more than ten years, from the stock market crash on October 24, 1929, to 1941, when the United States entered World War II. At that time, millions of jobs were created to meet wartime needs.
In addition, during a depression, the unemployment rate reaches double digits, and consumer demand drops. In reaction, businesses typically reduce production or close factories, and investment activity dries up. Consequently, the GDP and other measures of economic activity undergo severe contractions. Significantly, depression recovery can take years or even decades.
Indications of a Depression
Although it has been nearly a century since the United States experienced a depression, the effects of the Great Depression continue to be remembered by policymakers and consumers alike.
Although a recession may be immediate, another Great Depression-scale depression is improbable. Examples of depression characteristics that distinguish it from a normal recession include the following:
Increased Rates of Default
When the economy is booming, the loan and credit card default rates are relatively low. The reason is that people have stable incomes and can pay their bills. As the economy worsens, people frequently have difficulty making their monthly payments, leading to a rise in credit card and loan defaults.
Falling Housing Sales
In all industries, consumer spending decreases significantly during a depression. As consumers reduce spending, fewer people purchase real estate, and more choose to rent or remain in their current residence. A cooling housing market also indicates a decline in economic confidence.
Increasing Inflation Levels
When employment is strong, a rise in inflation can indicate a rise in demand. When unemployment is high, and inflation is rising, it may be difficult for consumers to afford the necessities of daily life. As a result, it reduces the demand for consumer goods and services.
High Unemployment Rates
Skyrocketing unemployment rates are a key characteristic of depression. During the worst of the Great Depression, unemployment reached 24.9%, while wages plummeted. Consider the national unemployment rate in July 2022, which was 3.5%, to put this number into perspective. When people lose their jobs, they lose the ability to purchase goods, and product demand tends to decline.
Poor Stock Market Performance
A prolonged decline in the stock market, as measured by broad market indices such as the S&P 500, can indicate a weakening economy and a lack of investor confidence.
Recession vs. Depression
Recession and depression are both terms used to describe economic downturns. However, their characteristics and long-term effects are distinct. Although recession definitions vary, the National Bureau of Economic Research (NBER) defines a recession as a widespread decline in economic activity. Depression resembles a recession in some ways but is more severe and pervasive. For instance, between 1929 and 1933, or during the height of the Great Depression, real output in the United States fell by 30%, and unemployment approached 25%.
In contrast, the recession that lasted from 1973 to 1975, regarded as the most severe recession since World War II, was characterized by less severe levels of decline. Real output decreased by 3.4%, while unemployment increased from 4% to 9%. True depressions are extremely uncommon, whereas recessions are more common. Since World War II, thirteen wars have occurred.
Five Financial Tips to Protect Money in Economic Recessions
Here are five financial tips to help you forecast the recession.
1. Consider alternative sources of income
A recession is an ideal time to reevaluate your budget and seek out additional sources of revenue. If your salary is decreased or you lose your job, another source of income can help you make ends meet.
2. Change your portfolio’s asset allocation
While the economy was thriving, you may have primarily invested in stocks. A stock-heavy portfolio has the potential for high growth, but it is risky during a recession. If you anticipate needing the funds in your investment accounts within the next few years, you may wish to adopt a more conservative portfolio allocation. Consider meeting with a financial advisor to determine the optimal allocation for your current financial situation and long-term objectives.
3. Diversify your investments
If you invest in a small number of stocks, industry or company downturns can devastate your portfolio. Diversify your portfolio by investing in stocks, bonds, and short-term securities to reduce your level of risk. Thus, you should consider investing in a range of industries and both domestic and foreign stocks.
4. Establish an emergency fund
A reserve fund can help you weather a financial storm. Save enough money to cover your expenses for at least six months. This will assist you in making ends meet if your employer announces layoffs or if you experience other financial difficulties.
5. Reduce your debt
Paying down high-interest debt, such as credit card debt, is one of the best things you can do for your finances. You will save money on interest payments and be in a better position if you lose your job or have a decreased income.
In short, depression is a worrisome term, but remember that depression as severe as the Great Depression is improbable. A recession as part of the normal ebbs and flows of the market is more common. Therefore, you must protect yourself from any potential economic downturn by reducing your debt, saving money, and diversifying your investments.
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Read more: Economies
Source: Forbes