To ‘V’ or Not to ‘V’? A Question About Recovery

Are we likely to see a ‘V-shaped’ recovery from the coronavirus-induced recession? And what’s a ‘V-shaped’ recovery anyway?

Economists and economic reporters have coalesced around a veritable alphabet soup for characterizing types of recessions and recoveries, picking letters that somewhat resemble the path of aggregate economic activity, or real gross domestic product (GDP).

The ‘V-shaped’ recovery refers to a steep downward contraction followed immediately by a rapid recovery: Business cycle peak to trough and right back to peak. Recent data releases on initial unemployment insurance claims, the Weekly Economic IndexGDP, and personal consumption all but guarantee the steep downward contraction part. So a V-shaped full recovery is the best-case scenario at present. But both the depth of contraction and our subsequent trajectory for recovery remain very much TBD.

Recent U.S. macro forecasts from Goldman Sachs, JP Morgan Chase, and the Congressional Budget Office (CBO) all show a steep contraction in the first half of the year, on the order of 12-15% cumulatively, followed by rapid growth rates in the second half of the year. These forecasts partially resemble a ‘V’, but are missing the return back to peak: Consensus forecasts show the economy contracting 5-7% on net for the year, a substantially larger decline than cumulatively experienced during the Great Recession, as depicted in the figure below. Call it a ‘V-shaped’ partial recovery:

Fig_GDP_GR copy

Rapid growth rates in the second half of the year would certainly be welcomed news, but even if such forecasts prove accurate, it would be premature to declare “mission accomplished.” Even with such rapid growth rates starting mid-year, CBO is forecasting unemployment rates averaging in the low double-digits throughout 2020 and 2021.

Big caveat: Current macro forecasts involve far more ad hoc guesswork than usual, and are effectively assuming that we get a handle on the coronavirus and economic activity can sustainably resume in the second half of the year.

What could go awry? The biggest downside risk is that a relatively quick end to the public health crisis does not materialize. Perhaps because states prematurely end stay-at-home orders, only to be followed by new waves of cases and renewed regional lockdowns, or because the virus mutates, or there are setbacks in developing a vaccine…

Enter, from bad-to-worse, letters ‘U’, ‘W’, and ‘L’.

The ‘U-shaped’ recession is similar to the ‘V’, but with more of a prolonged struggle to jumpstart the rebound phase. Business cycle peak to rather prolonged trough and then eventually a sustained recovery. The long U.S. recession of 1973-75 is one such example. At present a more prolonged public health crisis and long-lasting social distancing norms could easily delay the recovery phase, morphing a ‘V’ into a ‘U’.

Then there’s the ‘W-shaped’ “double-dip” recession, where an economy contracts, starts to rebound, and then contracts again. The U.S. experienced a severe double-dip recession during 1937-38, upending our recovery from the Great Depression. The second dip—widely blamed on policy blunders of premature monetary and fiscal tightening—caused the unemployment rate to jump from 11% in July 1937 to 20% in June 1938. Here’s a visualization based on industrial production (indexed to 100 in July 1929), via FRED:


More recently Italy experienced a severe double-dip recession during the Great Recession, and then a “triple-dip” recession; these recessionary setbacks have totally stymied recovery, and Italian real GDP is roughly 5% smaller today than at the onset of the Great Recession.

Premature withdrawal of fiscal and monetary policy support could easily induce a “W-shaped’ double-dip. (I’m far more concerned about Congress and misplaced concerns about rising public debt than the Fed on this front.) The virus coming back with a vengeance and forcing renewed lockdowns midway through a recovery in the second half of the year, or early next year, could also push us into a double-dip.

The worst-case scenario is the ‘L-shaped’ recession: Economic activity falling off of a cliff, and then flat lining. The most recent example of an L-shaped non-recovery is Greece’s ongoing depression following the 2007-09 crisis and their subsequent sovereign debt crisis. Greece is a tragic case study in what can happen when a country loses both independent monetary policy and fiscal policy, and the pain of austerity programs without monetary accommodation or the ability to devalue. The Greek economy is roughly 25% smaller today, adjusted for inflation, than it was in 2007. The ‘L’, via FRED:

Greek L

I’m growing more pessimistic about even a ‘V-shaped’ partial recovery by the week. More to follow on the major downside risks against a rapid recovery…

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