L-Shaped Recovery

What Is a L-Shaped Recovery?

A L-shaped recovery is a type of recovery characterized by a slow rate of recovery, with industrious unemployment and stale economic growth. L-shaped recoveries occur following a economic recession characterized by a pretty much steep decline in the economy, but without a correspondingly steep recovery. When portrayed as a line chart, graphs of major economic performance may visually resemble the state of the letter "L" during this period.

When alluding to recessions and the periods of recovery that follow, market analysts frequently allude to the general shape that seems when charting relevant measures of economic health. For example, employment rates, gross domestic product and industrial output are indications of the current state of the economy. In a L-shaped recovery, there is a precarious decline caused by plummeting economic growth followed by a more shallow upward slope showing a long period of stale growth. In a L-shaped recession, recovery can here and there require several years.

Recoveries can also be V-shaped, W-shaped, K-shaped, and U-shaped. As in a L-shaped recovery, these names depend on the shape seen on a chart of relevant economic data.

Understanding the L-Shaped Recovery

A L-shaped recovery is the most harmful type of recession and recovery. Because there is an extraordinary drop in economic growth and the economy doesn't recover for a huge period of time, a L-shaped recession is in many cases called a depression.

The main feature that characterizes a L-shaped recovery is a failure of the economy to progress back toward full employment after a recession. During a L-shaped recovery, the economy doesn't readjust and reallocate resources to get workers working and increase business operations very quickly. Large numbers of workers can stay unemployed for extended periods or even leave the workforce entirely. Likewise, capital goods such as factories and equipment might stand idle or underutilized for extended time spans also.

A few economic speculations have been advanced with respect to why and how this can occur. Keynesian financial specialists argue that tenacious cynicism, underconsumption, and excessive saving can produce a prolonged period of sub-normal economic activity, and, surprisingly, that this is normal and there is not a great explanation to anticipate that the economy should have the option to adjust and rebound all alone.

Others point out that L-shaped recoveries can typically be characterized as those in which monetary and fiscal policy interventions actively prevent the economy from adjusting and recovering from the losses of the first recession. These policies seem to facilitate the initial pain of recession and safeguard the financial sector, but slow down the economy's adjustment interaction.

L-Shaped Recovery Examples

Three major examples of L-shaped recoveries hang out in the last century of economic cycles: the recoveries of the Great Depression of the 1930s, the Lost Decade in Japan, and the Great Recession following the 2008 financial crisis. All three of these periods are well known for the massive campaigns of expansionary fiscal and monetary policy that were pursued at that point.

The Great Depression

Following the stock market crash of 1929, the U.S. entered the Great Depression, the worst recession ever seen. U.S. real GDP contracted sharply and unemployment rose to a pinnacle of nearly 25%. Stale growth and high unemployment persevered for over a decade.

In response to the crash and recession, President Hoover increased both spending and taxes and increase unprecedented peacetime federal deficits, hitting a deficit of 4.5% of GDP during his term. Hoover led a deliberate federal campaign to keep wages and prices from falling through new federal lending subsidies, labor legislation, federal funding for unemployment benefits, and influential, though not technically enforceable, requests that businesses not cut workers' pay. The recession continued to develop following these measures.

Expansionary monetary policy was also pursued through this period. The Federal Reserve cut the discount rate and purchased large quantities of Treasury securities to infuse new liquidity into the banking system. Eventually, the U.S. would find the radical way to abandon the gold standard under President Franklin D. Roosevelt to safeguard the interests of the financial system and facilitate more inflationary monetary policy.

After the 1932 election, FDR extended and doubled down Hoover's policies with fiscal policy involving progressing annual federal deficits of 2-4% of GDP to fund massive public works projects and dramatically expanded federal regulation of economic activity. In the wake of these policies, collectively known as the New Deal, high unemployment and lackluster growth would broaden the L-shaped recovery through the whole decade of the 1930s.

Japan's Lost Decade

What is known as the lost decade in Japan is widely viewed as an example of a L-shaped recovery. Leading up to the 1990s, Japan was encountering remarkable economic growth. During the 1980s, the country positioned first for gross national production per capita. During this time, real estate and stock market prices were quickly rising. Worried about an asset price bubble, the Bank of Japan brought interest rates up in 1989. A stock market crash followed, and annual economic growth slowed from around 4 percent to an average of just over 1 percent between 1991 to 2003.

In response to the crisis, the Japanese government would participate in 10 rounds of deficit spending and economic stimulus programs totaling over 100 trillion yen through the decade. On the monetary front, the Bank of Japan cut interest rates over and over, drawing closer 0% by 1999, and accelerated the supply of new reserves to the banking system. During this time, Japan experienced what is now known as the lost decade. It failed to recover from the crash for a very long time and encountered the consequences of a slow recovery for one more decade after that.

The Great Recession

With the collapse of the U.S. housing bubble and the financial crisis of 2008 the U.S. entered the now well known Great Recession. As credit markets evaporated businesses failed and foreclosures and bankruptcies soar. The stock market crashed in the fall of 2008 and unemployment rose to a pinnacle of 10.0% a year later.

In response to the precarious recession that was underway, the Bush administration enacted a $700 billion taxpayer funded bailout of the financial sector as the Troubled Asset Relief Program. The Federal Reserve initiated an unprecedented and massive wave of expansionary monetary policy including an alphabet soup of new lending facilities and several successive rounds of quantitative easing which infused $4.5 trillion in new bank reserves into the financial system. On the fiscal policy side, the Obama administration started off the American Recovery and Reinvestment Act which brought $831 billion in new federal spending.

Subsequent to these massive campaigns of monetary expansion and deficit spending the U.S. economy encountered the slowest recovery of the post-WW2 time. Unemployment stayed above 5% until the beginning of 2016 and real GDP growth averaged a sluggish 2.3% over the next several years.

Highlights

• L-shaped recoveries are characterized by persistently high unemployment, a slow return of businesses investment activity, and a sluggish rate of growth in economic output, and are associated with a portion of the worst economic episodes through history.
• A L-shaped recovery is when, after a precarious recession, the economy encounters a slow rate of recover, which resembles the state of the letter "L" when charted as a line graph.
• A common string in L-shaped recoveries is a massive fiscal and monetary policy response to the first recession, which might slow down the economy's recovery cycle.