What Is V-Shaped Recovery?

V-shaped recovery is a type of economic recession and recovery that resembles a "V" shape in charting. Specifically, a V-shaped recovery represents the shape of a chart of economic measures economists create when examining recessions and recoveries. A V-shaped recovery involves a sharp rise back to a previous peak after a sharp decline in these metrics.

Key Takeaways

  • A V-shaped recovery is characterized by a quick and sustained recovery in measures of economic performance after a sharp economic decline.
  • Because of the speed of economic adjustment and recovery in macroeconomic performance, a V-shaped recovery is a best-case scenario given the recession.
  • The recoveries that followed the recessions of 1920-21 and 1953 in the U.S. are examples of V-shaped recoveries.

Understanding V-Shaped Recovery

V-shaped recovery is one of the countless shapes a recession and recovery chart could take, including L-shaped, W-shaped, U-shaped, and J-shaped. Each type of recovery represents the general shape of the chart of economic metrics that gauge the health of the economy. Economists develop these charts by examining the relevant measures of economic health, such as employment rates, gross domestic product (GDP), and industrial production indexes.

In a V-shaped recovery, an economy that has suffered a sharp economic decline experiences a fast and strong rebound. Such recoveries are generally spurred by a significant shift in economic activity caused by rapid readjustment of consumer demand and business investment spending. Because of the economy's rapid adjustment and quick recovery in the major metrics of macroeconomic performance, a V-shaped recovery can be thought of as a best-case scenario for an economy in recession.

Historical Examples of V-shaped Recovery

Two periods of recession and recovery in the U.S. stand out as examples of V-shaped recoveries.

The Depression of 1920 to 1921

In 1920, the U.S. entered a steep recession that was feared to have the potential to become a major depression. The U.S. economy was still adjusting from large shifts in government spending, industrial activity, and inflationary monetary policy that had been directed to the war effort during the First World War. It was also reeling from the impact of the Spanish Flu Pandemic of 1918–1920.

By 1919, World War I had ended, and more than 1.5 million soldiers returned home from the war, flooding the economy with new workers. Simultaneously, the federal government slashed spending by 65%, including closing munitions factories that were no longer needed for the war effort. The Federal Reserve's monetary policy didn't help since it hiked the discount rate, its main policy tool at the time, by 244 basis points (or 2.44%). Interest rates in the economy rose to 7% by mid-1920.

As a result, the postwar economy of 1920 saw a decline in production of more than 32%, unemployment surged to 12%, while businesses failed and many others saw a 75% drop in profits. The impact on the financial markets was devastating as the Dow Jones Industrial Average (DJIA) plummeted by 47% that year.

By modern standards, the monetary and fiscal policy responses were wholly inadequate to address the deep downturn. Unemployment insurance as we know it did not yet exist, though state and local committees to provide some relief were set up late in the recession. The federal government's cut in spending throughout the recession, which would today be called contractionary fiscal policy, virtually guaranteed to make a recession worse.

On the monetary policy front, the Federal Reserve increased rates in 1919 and early 1920, which is contractionary since it leads to fewer loans, reducing the money supply in the economy. The Fed then lowered interest rates late as the economy recovered in 1921, and by 1923, interest rates were 3%. The 1919–1923 monetary policy would be the reverse of what policymakers would likely do today.

These apparent policy missteps resulted in a sharp, V-shaped recovery as failing businesses were quickly liquidated and their assets reallocated to new uses, businesses, and industries. Prices and wages fell and adjusted to reflect the new structure of production and consumption in the post-war, post-pandemic, and increasingly urbanizing society.

Workers found new jobs in the new businesses and industries, and the economy quickly recovered and entered a renewed period of expansion known as the Roaring Twenties. As a result, the unemployment rate fell to 2.4% and Gross National Product (GNP) rose 4.2% per year through 1929.

The Recession of 1953

The recession of 1953 in the United States is another clear example of a V-shaped recovery. This recession was relatively brief and mild, with only a 2.2% decline in GDP and an unemployment rate of 6.1%. Growth began to slow in the third quarter of 1953, but by the fourth quarter of 1954 was back at a pace well above the trend. Therefore, the chart for this recession and recovery would represent a V-shape.

As in 1920-21, an important factor contributing to the quick recovery was the (by modern standards wildly inappropriate) policy response, or rather the lack thereof. The Fed's monetary policy response was underwhelming, with a half percentage point drop in the discount rate and a three-quarters point drop in the fed funds rate late in the recession. This represents the weakest monetary policy response in the post-Second World War era. In terms of fiscal policy, the federal government took no steps to increase spending and overall tightened fiscal policy during the recession and recovery as measured by the high-employment budget surplus, an indicator of the direction of fiscal policy popular among economists.

Once again a restrained approach to monetary and fiscal policy in the face of recession facilitated the V-shaped recovery that followed. Marring the recovery is the fact that unemployment continued to rise even after the end of the declared recession, peaking in September 1954, possibly due to the Fed's policy shift to interest rate cuts in 1954, which may have slowed the recovery.

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