What Causes Economic Depression?

Technically, an economic depression is an extreme type of recession. There is a good deal of debate over how an economic depression should be defined. A commonly applied standard that is utilized to ascertain if an economic depression exists is an actual decline in the Gross Domestic Product that exceeds 10 percent. In the alternative, a depression is said to exist if a recession lasts for three years or longer. A variety of underlying factors, usually in combination, give rise to an economic depression.

Restriction of Credit

A common cause of economic depression is a significant restriction in credit. A severe credit restriction causes what might best be described as a snowball effect. Businesses are unable to access financing and cut back on production. In turn, these enterprises reduce their workforces. Consumers suffer their own set of personal financial problems as a result.

Numerous Bankruptcies

Another of the underlying causes of economic depression is a rise in bankruptcies. Numerous business and personal bankruptcies contribute to a decay of the economy. If the higher volume of bankruptcies carries forward over time (a couple of years), the foundation for a severe recession or economic depression is laid.

Abnormal Unemployment Rates

Abnormal rates of unemployment contribute to and cause economic depression. Abnormal employment is best defined as a sustained level of unemployment that reaches the level of 10 percent or more for a period that extends beyond a period of six months.

Shrinking Investment

Shrinking investments also contributes to the occurrence of economic depression. While shrinking investments occur for many different reasons, one of the net results is to strain the economy as a whole. In that there is a sustained shrinking of investments--upwards to one year and beyond--the prospect of this situation causing economic depression becomes a realistic possibility.

Volatile Currency Fluctuations

Volatile fluctuations in the value of a national currency is another element that can cause inflation. When currency is unstable in contrast to foreign currencies, imports and exports are significantly affected. This causes waves throughout a national economy, in some instances sufficient enough to set the stage for economic depression.

Hyperinflation or Deflation

Hyperinflation or deflation--the bookends surrounding a sound monetary state--are factors that influence and cause economic depression. There are a variety of milestones utilized to define hyperinflation. If inflation reaches a 20 percent level for any significant period of time, many experts consider that to be hyperinflation. Deflation is a consistent drop in the price of products and services. While consumers initially might find this a welcome relief, in the end, deflation can be harmful to the economy as a whole.

References

• The Return of Depression Economics and the Crisis of 2008; Paul Krugman; 2008

Resources

• National Bureau of Economic Research