The topic now under discussion among economists is ‘what shape will the economic recession and recovery take once the COVID-19 crisis is over?’ There is no definitive answer yet, but we can look forward by discussing these shapes in this blog.
Firstly, you should know that ‘shape’, as mentioned above, refers to the letters V, W, U and L. In economic science, each of these letters represents the shape of a chart of economic measures economists create when judging recessions and recoveries. We’ll discuss all the relevant shapes here and start with the letter V.
V: the best-case scenario
During a V-shaped recession, the economy suffers a sudden and sharp economic decline, but quickly and strongly recovers. Such recoveries are generally encouraged by a significant shift in economic activity caused by increased consumer demand and spending. If this is the shape of things to come after the COVID-19 crisis, we can expect a sharp rise in GDP growth in 2021. However, this recovery depends on the following conditions:
- The lockdowns manage to restrain the virus and are therefore limited to Q1 and Q2 of 2020;
- There are no lockdowns required in 2021;
- The financial system and supply side of the economy survive the crisis mostly ‘unhurt’.
The V-shaped recession of 1953
The 1953 US recession is a clear V-shaped example. In the early 1950s, the economy was booming, but the Federal Reserve anticipated inflation and thus raised interest rates. Growth began to slow in the Q3 of 1953, resulting in recession, but by the fourth quarter of 1954, it was back at a pace above the trend.
W: a double-dip recession
A W-shaped recession takes off in the same way as a V-shaped recession and then turns back down again after showing false hints of recovery. In other words: the economy drops twice before it reaches the road to full recovery. This is why W-shaped recessions are also called ‘double-dip recessions’.
Twice the pain
One of the biggest pitfalls of a double-dip recession is that investors tend to jump back into the markets after they believe the economy has reached the bottom, which isn’t the case. They end up getting burned twice: first on the way down and secondly after the false recovery.
The bathtUb recession
A U-shaped recession looks like its V-shaped counterpart but lasts longer. In this case, GDP is likely to shrink for several quarters in a row, and only gradually returns to the growth level seen before the downturn. The US had a U-shaped recession in 1973. At the start of this year, the national economy began to contract distinctly and slowly and leanly grew for almost two years. It only returned to its previous growth expansion rate in 1975.
You go in, you stay in. The sides are slippery. Maybe there’s some bumpy stuff at the bottom, but you don’t come out of the bathtub for a long time.Simon Johnson, a former chief economist for the IMF.
L: worst-case scenario
Of all shapes, the L represents the worst-case scenario because of a drastic drop in economic growth and the lack of recovery for a significant period of time. This is why an L-shaped recession is called a depression.
Back to full employment
One of the most critical features that define an L-shaped scenario is a failure of the economy to progress back to full employment after a recession. In this situation, large numbers of employees remain unemployed for a long time or even leave the workforce entirely. As a result, factories and equipment stand idle or underutilised for extended time-frames as well, worsening the depression.
The bubble that burst
Japan suffered an L-shaped recession in the 1990s. The country had seen substantial economic growth in the years after World War Two until the end of the 80s. That led to what turned out to be a massive over-pricing of assets or a so-called ‘bubble’. This bubble burst in the early 1990s and as a result, Japan is still not growing as fast as in the period from 1950 to 1990.
What’s the shape of things to come?
Which of these recessions we will actually see in the wake of the coronavirus pandemic is, unsurprisingly, the subject of debate among economists. We will, of course, keep you informed on this topic. If you have any questions about it, feel free to contact us. We’ll put you in touch with one of our expert business advisors.
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