What Is an Economic Recovery?

Economic recovery is the business cycle stage following a recession that is characterized by a sustained period of improving business activity. Normally, during an economic recovery, gross domestic product (GDP) grows, incomes rise, and unemployment falls as the economy rebounds.

During an economic recovery, the economy undergoes a process of adaptation and adjustment to new conditions, including the factors that triggered the recession in the first place and the new policies and rules implemented by governments and central banks in response to the recession.

The labor, capital goods, and other productive resources that were tied up in businesses that failed and went under during the recession are re-employed in new activities as unemployed workers find new jobs and failed firms are bought up or divided up by others. Recovery is an economy healing itself from the damage done, and it sets the stage for a new expansion

Key Takeaways

  • Economic recovery is the process of reallocating resources and workers from failed businesses and investments to new jobs and uses after a recession.
  • An economic recovery follows after the recession and leads into a new expansionary business cycle phase.
  • Leading indicators—such as the stock market, retail sales, and business startups—often rise ahead of an economic recovery.
  • Government policies can sometimes help or interfere with the economic recovery process. 
  • During an economic recovery, central banks may enact monetary policies aimed at increasing the money supply and encouraging lending.

Understanding an Economic Recovery

Market economies experience ups and downs for several reasons. Economies can be impacted by all kinds of factors, including revolutions, financial crises, and global influences. Sometimes these shifts in markets can take on a pattern that can be thought of as a kind of wave or cycle, with distinct stages of an expansion or boom, a peak leading to some economic crisis, a recession, and subsequent recovery.

An economic recovery occurs after a recession as the economy adjusts and recovers some of the gains lost during the recession. The economy then eventually transitions to a true expansion when growth accelerates and GDP starts moving toward a new peak.

Not every period of slow growth or even contraction is severe enough to be designated as a recession. In the United States, the most common rule of thumb for a recession is if there are two consecutive quarters of negative GDP growth.

The Process of Recovery

During a recession, many businesses fail and go out of business, and many of those that survive cut back activities to reduce costs in the face of decreased demand for their output. Workers often get laid off and business assets get sold piecemeal. Sometimes business owners are forced to liquidate an entire business.

Some of these capital assets end up in the hands of other businesses, sometimes even brand new businesses, that can put them to productive use. Sometimes these are very similar to their previous uses, and sometimes these are totally new lines of business. This process of sorting capital goods into new combinations, under new ownership, at new prices after they have been released from failed businesses or business cutbacks in the recession, is the essence of economic recovery.

As entrepreneurs re-organize productive labor and capital into new businesses and activities, they must account for changes in the economy that have occurred. In some business cycles, real economic shocks have helped trigger the recession, such as the oil price spikes of the 1970s and 2008.

Businesses usually need to deal with a leaner credit environment relative to the easy credit days of the boom that preceded the recession. They may need to implement new technologies and organizational forms. Almost always, the government fiscal and regulatory environment that businesses operate under changes from the boom to the recession and recovery.

In the end, the recovery can change the patterns of economic activity in an economy, sometimes drastically and sometimes in barely noticeable ways. The economy heals the damage during the preceding parts of the business cycle by reallocating, reusing, and recycling resources into new uses, in an analogous way to how the body breaks down dead and damaged tissue in order to produce new, healthy cells and tissues after an injury.

Importantly, in order for the process of recovery to proceed, it is critical that the business and investment liquidations of the recession are carried out and the resources tied up in them are allowed to flow to new uses and new businesses. 

Eventually, this process of recovery leads to a new phase of growth and expansion once resources have been mostly or fully reallocated across the economy.

Economists will often create charts that measure different components of an economic recovery, such as GDP and employment rates. These recovery charts are named after the shape they form, such as a V-shaped, W-shaped, or K-shaped recovery.

Indicators of Recovery

Economists often play a big part in defining an economy’s business cycle phase as well as the stages of economic growth or contraction it may be experiencing. To assess the economy, economists look at both leading and lagging economic indicators in their analysis.

Leading indicators can be things such as the stock market, which often rises ahead of an economic recovery. This is usually because future expectations drive stock prices. On the other hand, employment is typically somewhat of a lagging indicator. Unemployment often remains high even as the economy begins to recover because many employers will not hire additional personnel until they are reasonably confident there is a long-term need for new hiring.

GDP is usually the key indicator of an economic phase. Two quarters of consecutive negative GDP growth indicates a recession. Other economic indicators for consideration can include consumer confidence and inflation.

Special Considerations

Fiscal and monetary policy actions taken by regulators are often guided by an economy’s business cycle. With the onset of a recession, these policies are generally aimed at helping businesses, investors, and workers who have been impacted. Governments may implement direct assistance and they may stimulate demand by easing interest rates to encourage lending. They may provide funding aimed at propping up threatened financial institutions.   

Unfortunately, these policies can also have the effect of delaying the recovery by preventing the liquidation of failing businesses. These policies may encourage businesses and workers to not adjust the prices and arrangements of business ventures and employment conditions to the new realities revealed by the recession.

Similarly, propping up business arrangements, investments, and institutions that do not reflect economic reality delays the process of reallocation of resources to new uses, new owners, and new jobs for unemployed workers. It can also do permanent damage to society by encouraging people and businesses to continue to destroy capital and waste real resources by engaging in economic activities that are not profitable or efficient under the new economic conditions.

28 Years

The longest recovery and expansion period on record is held by the economy of Australia.

Examples of Economic Recovery

A recovery and expansion period can last for years. The economic recovery from the 2008 financial crisis and recession began in June 2009. Real GDP had contracted by 5.5% in the first quarter of 2009 and another 0.7% in the second quarter. The economy showed signs of recovery by the third and fourth quarters of 2009. The Dow Jones Industrial Average, a popular proxy for economic performance and a leading indicator, had already been rising for four months after bottoming out in February 2009.

In July 2020, the Congressional Budget Office (CBO) reported a record timeframe for recovery and expansion over the next 10 years. In the wake of the massive disruption to supply chains, closures of businesses, and lay-offs of workers due to the public health mandates and social distancing orders, the CBO projects the economy will rebound at a modest pace with a projected real GDP growth of 2.2% for the U.S. in 2024.