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Monday, October 18, 2010

The 2007-2009 Recession: Similarities to and Differences from the Past

Marc Labonte
Specialist in Macroeconomic Policy

According to the National Bureau of Economic Research (NBER), the U.S. economy was in a recession for 18 months from December 2007 to June 2009. It was the longest and deepest recession of the post-World War II era. The recession can be separated into two distinct phases. During the first phase, which lasted for the first half of 2008, the recession was not deep as measured by the decline in gross domestic product (GDP) or the rise in unemployment. It then deepened from the third quarter of 2008 to the first quarter of 2009. The economy continued to contract slightly in the second quarter of 2009, before returning to expansion in the third quarter. The recent recession features the largest decline in output, consumption, and investment, and the largest increase in unemployment, of any post-war recession.

Previously, the longest and deepest of the post-war recessions were those beginning in 1973 and 1981. Both of those recessions took place in a context of high inflation that made the Federal Reserve (Fed) hesitant to aggressively reduce interest rates to stimulate economic activity. The Fed has not shown a similar reluctance in the recent recession, bringing short-term rates down to zero. Although inflation exceeded the Fed’s “comfort zone” in 2007 and 2008, it was not nearly as high as it was in the 1970s or 1980s recessions. The economy briefly experienced deflation (falling prices) at the end of 2008, and inflation has generally remained very low since. Deflation may be a bigger threat to the economy in the near term, although some economists are fearful that the Fed’s actions will cause inflationary problems once the economy returns to full employment.

Both the 1973 and 1981 recessions also featured large spikes in oil prices near the beginning of the recession—as did the recent one. Disruptions to oil markets and recessions have gone hand in hand throughout the post-war period.

The previous two recessions (beginning in 1991 and 2001) were unusually mild and brief, but subsequently featured long “jobless recoveries” where growth was sluggish and unemployment continued to rise. The recent recession did not feature a jobless recovery longer than the norm, but employment growth has been weak in 2010.

A decline in residential investment (house building) during a recession is not unusual, and it is not uncommon for residential investment to decline more sharply than business investment and to begin declining before the recession. The recent contraction in residential investment was unusually severe, however, as indicated by the atypical decline in national house prices.

One unique characteristic of the recent recession was the severe disruption to financial markets. Financial conditions began to deteriorate in August 2007, but became more severe in September 2008. While financial downturns commonly accompany economic downturns, financial markets have continued to function smoothly in previous recessions. This difference has led some commentators to instead compare the recent recession to the Great Depression. While the onset of both crises bear some similarities, the effects on the broader economy have little in common. In the first contraction of the Great Depression, lasting from 1929 to 1933, GDP fell by almost 27%, prices fell by more than 25%, and unemployment rose from 3.2% to 25.2%. The changes in GDP, prices, and unemployment in the recent recession were much closer to those experienced in other post-war recessions than the Great Depression. Most economists blame the severity of the Great Depression on policy errors—notably, the decision to allow the money supply to contract and thousands of banks to fail. By contrast, in the recent recession policymakers have aggressively intervened to stimulate the economy and provide direct assistance to the financial sector.

Date of Report: October 6, 2010
Number of Pages: 11
Order Number: R40198
Price: $29.95

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