Defining the Shapes of Recessions and RecoveriesMarch 24th 2021
By: Montana Timpson
Following the steep economic decline sustained by U.S. markets at the onset of the COVID-19 pandemic, the National Bureau of Economic Research officially declared a recession, noting that the U.S. economy had fallen into contraction as of February 2020. The official declaration, the first since the “Great Recession” in 2008, prompted debates of plausible recovery trends and brought into question the many shapes of recessions and recoveries.
Recession and Recovery Charts
Recession and recovery charts are developed by economists by examining the relevant measures of economic health, such as employment rates, gross domestic product (GDP), and industrial production indexes. While economic performance always varies across different parts of the economy, economists generally understand economic cycles of recession and recovery to be broadly correlated across all or most sectors of the economy.
Defining V-Shaped Recovery
V-shaped recovery is a type of economic recession and recovery that resembles a “V” shape in charting, where metrics involve a sharp rise back to a previous peak after a sharp decline.
V-shaped recoveries are often an indicator of a strong, rapid and sustained recovery in economic performance — frequently regarded as a best-case scenario following a recession.
V-shaped recovery is just one of the countless shapes a recession and recovery chart can take, in a litany that includes W-shaped, U-shaped, L-shaped and J-shaped recoveries, as well.
A W-shaped recovery refers to an economic cycle of recession and recovery that resembles a “W” shape in charting. A W-shaped recovery involves a sharp decline in metrics followed by a sharp rise, followed again by a sharp decline and ending with another sharp rise.
W-shaped recoveries often represent bearish market rallies (after the first decline) getting stifled by an additional economic crisis, prompting the chart’s second trend downward. For unknowing traders, W-shaped recessions can be particularly painful because the brief recovery that occurs can tempt investors into getting back in too early.
In contrast to the sharp trends charted in V-shaped and W-shaped recoveries, U-shaped recovery occurs when the economy experiences a strong decline and maintains a period of stagnation, followed by a relatively healthy rise back to its previous peak. In this way, there are no immediate rebounds in a U-shaped recovery, only extended periods of recession that recover over time.
L-shaped recovery refers to a recovery characterized by stagnant economic growth following a decline in the economy. L-shaped recovery follows a similar trend to U-shaped recovery, but without an eventual correspondingly steep recovery.
Many charted trends assume a correlation between measures of economic health, though one recovery in particular accounts for divergences. A K-shaped recovery occurs when, following a recession, different parts of the economy recover at different rates, times or magnitudes, resembling a “K” shape in charting while some parts of the economy see strong growth and others continue to decline.
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