V-Shaped Recovery

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 addresses the state of a chart of economic measures financial experts make when looking at recessions and recoveries. A V-shaped recovery involves a sharp rise back to a previous top after a sharp decline in these metrics.

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 addresses the general state of the chart of economic metrics that gauge the health of the economy. Financial specialists develop these charts by analyzing 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 encounters a fast and strong rebound. Such recoveries are generally spurred by a huge shift in economic activity caused by fast readjustment of consumer demand and business investment spending. Because of the economy's fast 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.

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Historical Examples of V-shaped Recovery

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

The Depression of 1920 to 1921

In 1920, the U.S. entered a lofty recession that was feared to have the potential to turn into 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 exertion 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 not generally required for the war exertion. The Federal Reserve's monetary policy didn't help since it climbed the discount rate, its primary policy tool at that point, by 244 basis points (or 2.44%). Interest rates in the economy increased to 7% by mid-1920.

As a result, the postwar economy of 1920 saw a decline in production of over 32%, unemployment surged to 12%, while businesses failed and numerous 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 far as we might be concerned didn't yet exist, though state and local advisory groups 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 exacerbate a recession.

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 stumbles 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 positions 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% each year through 1929.

The Recession of 1953

The recession of 1953 in the United States is one more clear example of a V-shaped recovery. This recession was relatively short and mild, with only a 2.2% decline in GDP and an unemployment rate of 6.1%. Growth started to slow in the second from last quarter of 1953, but by the fourth quarter of 1954 was once again at a pace well above the trend. Consequently, the chart for this recession and recovery would address a V-shape.

As in 1920-21, an important factor contributing to the quick recovery was the (by modern standards wildly unseemly) 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 3/4 point drop in the fed funds rate late in the recession. This addresses the weakest monetary policy response in the post-Second World War time. In terms of fiscal policy, the federal government found a way no ways to increase spending and overall fixed fiscal policy during the recession and recovery as measured by the high-employment budget surplus, an indicator of the course of fiscal policy popular among financial experts.

By and by a controlled approach to monetary and fiscal policy in the face of recession facilitated the V-shaped recovery that followed. Defacing the recovery is the way that unemployment continued to rise even after the finish of the declared recession, cresting in September 1954, possibly due to the Fed's policy shift to interest rate cuts in 1954, which might have slowed the recovery.

Highlights

• A V-shaped recovery is portrayed 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.