The different shapes of recovery: Understanding how quickly and strongly an economy can bounce back after a recession
- Recovery shapes are used by economists to characterize different types of recessions and their ensuing recovery.
- The shapes are described as a letters like V, U, W, L and K, named after how each recovery looks when charted on a graph that gauges the overall health of the
- Recovery shapes are a simple way for individuals to discuss and forecast the complexities of an economic downturn, and how long it may take to recover.
Though rarely pleasant, recessions are a normal part of the business cycle, the regular course of rise and fall that all free-market economies run. All recessions begin the same way, with a significant period of economic decline. But how they end can happen in a whole host of different ways.Economists dub the aftermath of a
Understanding recovery shapes
V, U, W, L, and K are the most common letters used to characterize all these various recovery paths. The letters resemble the shape the economy takes on a graph that shows GDP plotted against time.From these shapes, you can glean the duration of the recession and the nature of the economy's comeback. For example, a V-shape shows the economy declining quickly, spending almost no time at the recession's low point, and then bouncing back just as quickly. These aren't necessarily official terms, as there's no formal system for classifying recessions or their aftermath. Rather, the letter-naming first took off during a turn-of-the-21st-century recession as a short-hand to describe predictions of how the economy might recover.
They became increasingly popular after the Great Recession, and are now even more ubiquitous in the wake of the COVID-19 recession.
As letters become an increasingly popular way to describe different recoveries, their ranks have grown from the original (and most common) V-shape and U-shape to include a W-shape, L-shape, and K-shape.
V-shaped recoveryIn a V-shaped recovery, the economy experiences a sharp decline but then bounces back almost immediately to its pre-recession level. If you picture a V-shaped graph, the period in which the economy remains at a low point (the bottom of the V) is extremely brief.
This can occur when the economic interruption that caused a recession doesn't last long. It could be a seasonal slowdown when consumers are temporarily out of work but employers are holding those jobs for them. Or could be that swift and appropriate monetary and fiscal policies successfully mitigate the impact of the recession,
A V-shaped recovery followed the recession of 1953, in which the economy achieved a full comeback by the first quarter of 1954, less than a year after it first declined. It helped that the downturn was fairly mild, but most economists also credit the actions of the Federal Reserve - which spotted the slowdown early on and moderately increased government spending to stimulate the economy - for the swift recovery.
U-shaped recoveryLess ideal than a V-shaped recovery but still far from a worst-case scenario, the U-shaped recovery is one in which the economy declines and then spends a significant period of time at the trough before improving. This doesn't necessarily mean that the recession is more severe in terms of the loss in GDP, but it does mean that it lasts longer.
Some economists also consider the recession of 2001 to exemplify a U-shaped recovery. While this recession was fairly brief and mild by economic indicators such as GDP, a plot of unemployment levels tells a different story. The number of people in full-time jobs stubbornly remained at a trough for several years, until 2005.
W-shaped recoveryA W-shaped recovery, also known as a double-dip recession, is one in which there's a brief economic comeback - sometimes tricking people into thinking they'll get a V-shaped recovery - but then the economy falls a second time. It's essentially two recessions in one, which prolongs the impact of the first and can shatter consumer confidence.
Sometimes the nature of world events forces the economy back into a second recession, and other times fiscal and monetary policies aimed at easing the first decline can send the economy spiraling down into another.That's largely the reason for the only W-shaped recovery the US has ever experienced, which occurred during the early 1980s. In January of 1980 the economy dipped but righted itself just six months later. Then, after the Federal Reserve raised interest rates to counter inflation, the economy fell into a second dip in July of 1981 that lasted 16 months.
L-shaped recoveryResembling an L tilted backward slightly, the L-shaped recovery has the lengthiest recession period of all - so long, in fact, it's sometimes dubbed a depression. After a sharp decline, GDP begins to increase, but recovery is very gradual and lengthy. It can take years for the economy to get back to where it was pre-downturn, and in some cases, this slow revival drags on indefinitely.
Some economists characterize the Great Recession as an L-shaped recovery. Although it technically lasted only from 2007-09, as measured by GDP, many other key economic indicators didn't reach their pre-recession levels for four to six years. And a decade later, the overall economy still lagged behind pre-recession projections.
Some of the reasons former Federal Reserve Chair Ben Bernanke gave for the slow recovery include:
- The failure of the housing sector to rebound after so many foreclosures
- The lack of credit available for both consumer loans and business investments as banks repaid the large amounts of debt they'd amassed
- The lack of ongoing fiscal support provided by the government after the initial collapse of the stock market and the economy due to the subprime mortgage crisis
K-shaped recoveryThe K-shaped recovery is a bit different from the others. It's a relatively new term created to describe what economists see happening with the COVID-19 pandemic.
In this situation, one segment of the economy trends upward - experiencing more of a V-shaped or U-shaped recovery - while another segment either sinks further or recovers much more slowly, like with the L-shaped recovery. This divergence between two different economic groups is depicted by the two diagonal lines in the letter K.
The affected groups are both industries and individuals. Some industries have been able to continue operating or have even thrived during the pandemic (i.e., high-tech and e-commerce) while others have suffered a major slowdown or been virtually unable to function (i.e., travel and hospitality, arts and entertainment).Similarly, individuals have been affected along class, generational, and racial lines. Low-income or paycheck-to-paycheck families, young adults, and Black and Hispanic Americans are largely still struggling to recover. In contrast, many white and upper-class families have bounced right back, especially if their wealth is concentrated in the stock market (which is also on the rebound).
How do the recoveries compare?
The V-shaped and U-shaped recoveries are the most common, although the other shapes are far from unheard of. A V-shaped recovery is the best-case scenario thanks to the short period of time spent in the recession's trough, while an L-shape is the worst-case scenario because it has the most prolonged recovery.However, these letters only tell part of the story. While they describe the duration and nature of
The financial takeaway
When you're still in the middle of a recession, it's impossible to know for certain what shape economic recovery will take. However, once key economic indicators such as GDP, employment, and inflation (price increases, due to growing demand) begin to respond, economists can offer up educated predictions on what the future might hold for investors and consumers alike.Despite it not being an exact science, it is worth paying attention to these conjectures, especially when you've felt the impact of a recession on your wallet. Having an idea of whether the economy might jump back up soon or dip down a second time can offer some guidance on financial decisions. You wouldn't want to pull your investments right before the economy rises again, in the second line of the V-shaped recovery. On the other hand, an impending decline, like the second phase of the W-shape, might signal that you should stash some extra away in your savings account.
If a recovery seems to be sluggish, à la the U or L-shaped, it might be a signal to convert some growth-oriented investments into income-producing ones, in case you're in need of cash.
Just remember to take these predictions with a grain of salt, knowing that certainty in economics only occurs in retrospect. Even if we can't see into the future, though, understanding the nature of each recession helps us better prepare for the next.
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