The measures taken by the United States and nations worldwide to manage the COVID-19 pandemic—restricting travel, shuttering nonessential businesses, and implementing universal social distancing policies—have severe economic consequences.
On June 8th, the The National Bureau of Economic Research (NBER) declared a recession, noting that the U.S. economy had fallen into contraction starting in February 2020. This marks the first U.S. recession since the Great Recession, which began in December 2007 and lasted until June 2009.
Today nearly 22 million Americans are receiving unemployment benefits or about 13% of the labor force. By some measures, the total unemployed could be nearly double that figure. April retail sales fell nearly 22% yearly, the most significant monthly decline in the index’s history. Meanwhile, the Atlanta Fed’s GDPNow Survey sees the median consensus estimate for second-quarter GDP at -53.8%, which would be the worst reading in U.S. history.
The duration of the coronavirus recession will only be evident in hindsight. Past recessions and recoveries have followed four standard shapes: V, U, W, and L, where the letters describe the trajectory of GDP, employment, and other vital metrics tracking economic conditions.
What is the Shape of a Recession?
The NBER defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
Thankfully, recessions do not last forever, nor will a coronavirus recession. At some point, the economy will reopen and start growing again, although what the recovery might look like is unclear. Let’s look at how V, U, W, and L-shaped recessions compare and how they might apply to the COVID-19 crisis.
V-Shaped Recession: Steep Decline, Quick Recovery
The best-case scenario for the COVID crisis is a V-shaped recession. If this happens, the economy will rebound as quickly as it has declined, with minimal long-lasting financial damage. A sharp downturn followed by a quick rebound in growth defines the V-shaped recession.
In the early 90s, the U.S. went through a V-shaped recession. The recession lasted only eight months, from July 1990 to March 1991, and the economy started growing reasonably quickly. It was less severe than other recent recessions, like the oil crisis recession of 1973 to 1975 or the Great Recession.
For the COVID-19 recession to be V-shaped, we would need to set up enough coronavirus testing so that people could safely go back to work without creating another surge in cases and effectively treat existing cases.
In addition, the economic damage must be limited by rapid government intervention to protect jobs and businesses, plus aid for consumers. More programs like the $1,200 COVID-19 stimulus payment will be needed to help consumers stay afloat.
Is a V-Shaped Recession Likely?
A V-shaped recession could be possible. Reports suggest that China has its COVID-19 outbreak under control, and the Chinese economy seems to be rebounding quickly. In the U.S., the federal government has passed a stimulus package worth over $2 trillion to prop up businesses and consumers during the crisis.
Some executives are hopeful about the prospects for a V-shaped recession. Around 38% of companies believe that the recovery will be V-shaped, with the economy rebounding by the third quarter of 2020, according to a survey from EY.
Dr. Tenpao Lee, Professor of Economics at Niagara University, also believes that V-shaped recovery is possible, thanks to our globally connected economy.
“Once we are in recovery mode, the recovery will be very fast as global supply chains could be reconnected instantly,” said Lee.
However, the timing of the recovery depends on how we manage the virus over the next few months.
“If we can contain COVID-19 quickly, we will have a V-shaped recession. If we cannot contain COVID-19 shortly, we will have a U-shaped recession,” said Lee.
U-Shaped Recession: Long Period Between Decline and Recovery
In a U-shaped recession, it takes many months, if not years, for the economy to recover. The long, flat stretch of sideways growth comprises the bottom of the U shape. The Great Recession is an excellent example of a U-shared recession. The formal recession lasted 19 months, from December 2007 to June 2009, and even after growth resumed, it took years before employment recovered to pre-crisis levels.
If COVID-19 causes a longer, U-shaped recovery, the economy won’t begin recovering until the end of 2020 or even early 2021. There are a few reasons this could happen. First and foremost, if it takes longer to get the surge in coronavirus cases under control, it could delay when states and regions can begin reopening their economies.
In addition, if many businesses go bankrupt during the economic shutdown or cannot reopen, there will be fewer jobs when the stay-at-home orders end, creating more economic dislocation. Finally, consumers might not be ready to start spending when things reopen, especially if they are still scared to go out or do not get enough financial assistance.
Is a U-Shaped Recession Likely?
EY found that 54% of companies believe that a U-shaped recession is likely. So does Jim Cahn, chief investment officer from the Wealth Enhancement Group.
“Those arguing for the V-shaped recovery are making two wildly unrealistic assumptions. First, we re-open the economy pretty much all at once, and second, consumers won’t change their behaviors. For example, they start going back to bars and baseball games immediately,” he said.
Cahn doesn’t see either happening, which is why he thinks a slow, gradual U-shaped recovery is more likely.
“The economy re-opens at a measured pace, people gradually return to their normal behavior patterns, and social distancing continues in varying degrees until a vaccine is achieved,” predicted Cahn.
W-Shaped Recession: Quick Recovery, Second Decline
In a W-shaped recession, the economy begins to recover rapidly, but then falls into the second period of decline. This is also known as a double-dip recession—the two economic declines create the shape of a W.
The U.S. experienced a W-shaped recession in the early 1980s. After weathering the second oil crisis and elevated inflation in 1979, the economy fell into a brief recession in 1980 but rapidly started growing again. The Federal Reserve was still worried that inflation was too high and raised interest rates to fight it. This pushed the country back into another recession in July 1981, which lasted until steady long-term growth resumed in late 1982.
Is a W-Shaped Recession Likely?
Robert Johnson, professor of finance at Creighton University, fears that the COVID-19 crisis could turn into a W-shaped recession.
“Americans may end social distancing prematurely and that a secondary coronavirus outbreak could force another round of social distancing, stalling the recovery,” said Johnson. If this happens, Johnson believes the recovery could be much longer than most people anticipate—a matter of years, not months, as the country battles new rounds of infection.
He is also pessimistic about the recent stock market rebound.
“The recent rise in the equity indices appears based more on FOMO (fear of missing out) than on medical developments for dealing with the pandemic,” he said. Johnson predicts that markets could test previous lows set in March.
L-Shaped Recession: An Extended Downturn
The worst-case economic scenario for the COVID-19 crisis is that it causes an L-shaped recession — also referred to often as an L-shaped recovery. In this outcome, growth falls and does not recover for years, creating the long shape of the L. The official recession may end within a few quarters, but the recovery to a pre-recession level of economic output may take years.
Japan went through an L-shaped recession in the 1990s. There was a steep market crash at the beginning of the decade, followed by a credit crunch, government missteps, and other global economic problems, including the 1990-91 U.S. recession. The country saw more than 10 years of slow economic growth today as Japan’s lost decade.
Is an L-Shaped Recession Likely?
If everything goes wrong in dealing with the COVID-19 crisis, there is the potential for an L-shaped recession. This could happen if we cannot control coronavirus outbreaks, leading to years-long shutdowns and sluggish growth, if not outright stagnation.
While an L-shaped recession is possible, most experts do not think it will happen. According to EY, only 8% of companies predict that an extended recession that lasts until 2022 or longer will happen.
Cahn also believes we will avoid the worst.
“I am too optimistic about the world to predict an L-shaped recovery,” he said. Cahn noted that the economy’s fundamentals remain strong, even now. “Expanding productivity, a well-trained workforce, the rule of law, and efficient capital markets are still intact, which will drive growth long into the future.”
The Steps Needed for a Recovery
If there was a constant theme among the financial experts we spoke to, the country must get the COVID-19 health crisis under control before it can prepare for any type of economic recovery. The U.S. must avoid opening the economy too early, as that could lead to another surge in coronavirus cases. Federal and state governments must heavily invest in more testing to prevent future outbreaks.
It buys the research community time to develop a vaccine or treatment if they do. At the same time, the federal government must continue supporting companies with initiatives like the small business loan and grant programs, so they can survive the shutdown and eventually reopen.
By taking these steps now, the country can limit both the health and economic damage from COVID-19 and avoid the prospect of an extended downturn.