We use historical events to illustrate many concepts developed on the Muddy Water Macro site. Yet one event, the “Great Recession,” which began in late 2007, merits its own separate section on this site. While not the most severe economic downturn that the U.S. economy has ever experienced (the Great Depression of the 1930s was much worse), the Great Recession and the stagnant recovery that followed have certainly been the most significant disruptions to the modern U.S. economy. As a result, more economists and policymakers have been forced to re-think their basic understanding of macroeconomics in the last five years than in any other period since World War II. The Great Recession has also reinforced the relevance of the basic Keynesian macroeconomic theory that is at the foundation of the ideas presented on Muddy Water Macro.
If you have not done so already, please review our Keynesian Basics pages for a quick primer on the theory that underlies this discussion of the Great Recession.
It is obvious that the Great Recession that started in 2007 and the stagnant recovery that followed is markedly different from the other economic fluctuations that the United States has experienced over the past half-century. Its unique standing in this respect can be attributed to its unusual severity, length, and also the degree to which economic weakness of this magnitude in a major economy was unexpected from the perspective of mainstream economic thinking prior to the event.
Although recessions are usually defined primarily in terms of output (real GDP), the number of people working in an economy is a more accessible measure of the severity of economic downturns, and a measure that probably more significantly affects the general public’s perception of the economy. The graph below compares the Great Recession jobs profile to that of each U.S. recession since 1974. The lines on the graph start at 100 in the month that each recession begins. The lines then trace the evolution of employment during the recession relative to that starting point. For example, jobs dropped quickly to a level of 97.3 in the first few months of the 1974-75 recession indicating that employment fell by 2.7%. The lines then trace the recovery of employment until it first exceeds the level it had attained prior to each recession.
Defining a Recession
Economic commentary on television or in the newspaper may refer to the Great Recession in the past tense, but for most Americans the pain of unemployment and lackluster growth still persists four years after the official end of the recession in the summer of 2009. This disconnect springs from the disparity between the technical definition of a recession and the informal use of the term in day-to-day conversation. A more detailed exposition of the difference can be found here.
In the four U.S. recessions prior to the Great Recession, employment usually dropped between 1% and 2% and never by more than 3%. During the Great Recession (shown by the dark purple line in the above graph) employment dropped more than 6%. In addition to being so severe, the recovery from the Great Recession has also been unusually long. In the four other recessions of the past forty years, employment has always returned to its pre-recession level in fewer than four years (and, in one case, in as little as sixteen months). After more than five years since the start of the Great Recession, however, employment was still about 2% below its 2007 level.
It is important to note here that although the Great Recession was widely unexpected, the signs of economic fragility and rising stress in the American economic structure were evident long before 2007. The following sections (still under construction) explain how a variety of factors came together over a few decades to sow the seeds of the greatest American economic collapse since the Great Depression.
Although mainstream economists mostly did not foresee the dramatic events of the Great Recession, some economists, particularly those associated with the perspective developed in Muddy Water Macro, did predict both the severity of the crisis and the way in which it would unfold. We will add references to some of these predictions soon.
What is a Recession?
Most economists defer to the National Bureau of Economic Research (NBER) to officially determine the beginning and end of U.S. recessions. The NBER defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” According to this definition, the economy is in recession when economic activity is declining. The recession ends when the decline ends—that is, when the economy begins to grow.
But after a decline in economic activity, resources are typically under-utilized, and unemployment is high. The economy may not be deteriorating, yet its performance remains disappointing. Most people would perceive the economy as weak and may think of it as still “in recession,” even though it’s technically no longer declining. To use an analogy from health: when the recession ends, the economy may not be getting any sicker, but it is still sick.
The Great Recession and its aftermath provide an important example of the difference between the technical definition of recession and the more common way that journalists and the general public use the term recession. The period of declining economic activity officially spanned eighteen months according to the NBER: from December 2007 to June 2009, after which the economy began to grow slowly. The technical “recession” ended by the summer of 2009. However, with disappointing growth, unemployment remained extraordinarily high. Additionally, the recovery has been so anemic that even four years after the technical recession ended, the economy still seems stagnant.
Therefore, people often think of the economy as “in recession” when economic activity, particularly the labor market, is weak—even if the economy is no longer declining.
Key Points
- The Great Recession and its stagnant aftermath is the most severe economic crisis faced by the U.S. economy since the 1930s.
- Most mainstream economists did not think such a severe event was possible prior to 2007, which makes the Great Recession an important laboratory for testing and understanding the perspective on macroeconomics presented in Muddy Water Macro.
Why did this historic disruption occur? We provide some answers in the next page, “Causes of the Great Recession.”