What are the causes of economic depression?

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An economic depression is defined as a sustained or prolonged period of recession, or a significant downturn in one or more economies. Because a depression is a prolonged recession, it's best to look at the circumstances that cause recessions.

Identification

Although economists differ greatly on what constitutes recessions and depressions, the rule of thumb is that a recession is two or more quarters of reduced dross domestic product (GDP). This means production stops growing at an increasing rate and begins to shrink, which means fewer jobs and less money, buying and investing.

Easy Credit Cause

Nearly every significant recession and depression was preceded by a period of lax credit standards for lending. This happened in the Great Depression, when people bought too much stock on credit.

Swindlers and Mania Cause

Another telltale sign that precedes recessions is when swindlers create a mania over a certain financial instrument. Most recently, this instrument was a bundle of sub-prime mortgages.

A Bubble Is Created

As people buy into the investment, the price of it increases, which serves the swindlers because their investment goes up in value. The swindlers know to sell early on, while others keep buying with no idea that a bubble is being created that will inevitably burst. Financial bubbles are created when a stock or commodity is overvalued.

The Crash Cause

Easy credit lays the groundwork for a mania, which creates a bubble, which bursts. What follows is a panic, then a crash. Once the crash happens, and two quarters of negative GDP occur because of it, the recession is under way. After the recession has continued for a prolonged period, it is called a depression.

Source:

"Manias, Panics, and Crashes;" Charles P. Kindleberger, Robert Aliber; 2005

Nber.org: The NBER's Business Cycle Dating Procedure: Frequently Asked Questions

More Information:

Economicshelp.org: Causes of Great Depression

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What are the causes of economic depression?

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