Correction vs. recession vs. depression: Understanding the differences

Recession, depression, market correction—these financial terms are often lumped together, but they're not the same thing. What sets them apart, and why does it matter for your money?

We can understand economic downturns in terms of both market performance and overall economic conditions. Here's a breakdown of common terminology.

Financial markets clearly are connected to the health of the broader economy, but the two don't necessarily move together. In general, market changes are easier to measure and identify.

• Market correction. A correction is defined as a decline of 10% or more in the value of a stock market or index after a recent high. A correction can be sudden or gradual, but it generally does not last as long as more severe downturns before rallying.
• Bear market. Markets enter bear territory when they fall by 20% or more. Bear markets usually last longer than market corrections and take more time to recover. They are the opposite of bull markets, which occur when a market increases by 20%.

Stagflation, recession and depression describe economic conditions, rather than measures of economic activity. They also vary in severity and duration.

• Stagflation. Stagflation describes a situation characterized by stagnant economic growth, high unemployment and high inflation. This is a particularly troubling situation since actions taken to spur the economy can make inflation worse, and steps to curb inflation can slow the economy even further.
• Recession. Defined as a drop in GDP that lasts for at least two consecutive quarters, a recession is often accompanied by rising levels of unemployment and reduced incomes. A recession generally lasts six to eighteen months.
• Depression. Depressions refer to prolonged periods, often lasting several years, of severe declines in economic activity accompanied by significant increases in unemployment. Financial markets normally decline meaningfully during recessions.

Economic growth, the employment rate, GDP and inflation are all common ways to measure economic health.

• Economic growth. Refers to overall economic expansion compared to prior periods, usually one year or earlier. It's assessed by looking at a number of factors, including GDP and employment. GDP and the employment rate both tend to increase when the economy is growing.
• Employment rate. This is the percentage of the labor force that is currently employed. It does not describe the percentage of the total population that is employed. Increases in the employment rate are generally positive, while reductions may indicate a slowing economy.
• Gross Domestic Product (GDP). GDP measures the total value of goods and services produced within a country during a specific time period, often a quarter or year. Higher GDP levels indicate a more active economy. Economists often look to changes in GDP to gauge whether the economy is growing or shrinking.
• Inflation. This refers to a sustained rise in the general cost of goods and services over a period of time—meaning money buys less than it used to. The most common measure of inflation is the change in the consumer price index (CPI). The CPI measures the prices of a sample of products commonly purchased by urban households. For example, if the price of that sample selection rises by 3% over some period, we say that inflation was 3%.

Knowing the differences between these terms can help you understand how policymakers may respond. It also can help you determine the appropriate actions to take with your own finances.

The Federal Reserve uses monetary policy tools to stabilize prices and support maximum employment. During periods of economic decline, such as recessions or depressions, the Fed may cut interest rates or buy bonds in the open market to increase the money supply. For example, during the Great Recession of 2007-09 the Fed gradually lowered the discount rate from 5.25% to 0%, making it less costly to borrow money to encourage spending and boost the economy.

Financial market downturns, such as corrections and bear markets, often spark uncertainty and fear, but they can present good investment opportunities as well. Investing new money before the market rebounds can allow you to take advantage of temporary price declines. But significant market moves can cause your portfolio to drift from your target allocations. You may need to rebalance existing investments, as not all prices will fall at the same rate.

Financial markets and the broad economy, though often connected, are not the same thing. Understanding the distinction between terms like recession vs. depression and correction vs. bear market can help you make sense of what's happening.

If you need help understanding the current economic environment, financial markets and how to navigate them, speak with a Thrivent financial advisor who can help you prepare for any economic scenario in the months and years ahead.