The question what makes a recession turn into a depression has been on my mind for some months now. Basically, both seem to be the same, except that a depression is magnitudes worse than a recession: unemployment is even higher, the fall in GDP as well, and investment tanks more and so on. I have been reading a paper by Papadimitriou and Wray (1999) in which the authors explain Minsky’s Analysis of Financial Capitalism. On page 3, the authors write:
Minsky argued that post-war recessions are unusual because government deficits place a floor on employment, personal income, and profit flows; in fact, in some recessions, personal income and profits actually continue to rise — thwarting the normal, cumulative, invisible hand processes that would lead to depression.
I thought it might be interesting to look at real personal income again since we had the dot-com bust and the Great Financial Crisis after the paper was written, and one would expect that personal income would be quite stable in the first and falling in the second if Minsky (or this interpretation of Minsky) is to make any sense. Let’s have a look at the data:
As you can see, the data confirms the prediction. The quite mild recession following the dot-com bust did not lead to a pronounced fall in real personal income and was therefore a typical post-WWII recession (never mind the jobless growth that followed). The Great Financial Crisis, however, led to a visible fall in real personal income. It is obvious that businesses will react to this indicator as demand comes straight from real personal income. Those seeking an explanation for a depression that is not rooted on the demand side would have a hard time, it seems.