What is a V-shaped recovery?
An economic recession and recovery that resembles a “V” shape in charting is known as a “V-shaped recovery.” A V-shaped recovery explicitly represents the format of a chart of economic indicators that economists use to analyze recessions and recoveries. After a sharp decline in these metrics, a V-shaped recovery entails a sharp rise back to a prior peak.
Understanding V-Shaped Recovery
A recession and recovery chart can take on many shapes, such as L-shaped, W-shaped, U-shaped, and J-shaped, in addition to the V-shaped recovery. Each type of recovery represents the overall shape of the graph of economic indicators used to assess the state of the economy. Economists create these charts by looking at pertinent indicators of the state of the economy, such as GDP, employment rates, and industrial production indexes.
An economy that has experienced a severe economic downturn experiences a quick and robust recovery in the form of a V-shaped recovery. These recoveries are typically triggered by a significant change in economic activity brought on by a quick readjustment of business investment spending and consumer demand. A V-shaped recovery is a best-case scenario for an economy in recession due to the economy’s quick adjustment and recovery in significant macroeconomic performance metrics.
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Historical Illustrations of V-Shaped Recuperation
The United States has experienced two distinct periods of recession and recovery that exemplify V-shaped recoveries.
The 1920s and 1921 Depression
The United States experienced a severe recession in 1920, raising concerns that it might become a major depression. Following significant changes in government spending, industrial output, and inflationary monetary policy to support the war effort during World War I, the U.S. economy was still getting used to these new norms. The effects of the 1918–1920 Spanish Flu Pandemic were also felt.
After World War I ended in 1919, over 1.5 million soldiers returned home, bringing a large influx of new workers into the economy. Concurrently, there was a 65% reduction in federal spending, which involved shutting down munitions factories that were no longer required for the war effort. The Federal Reserve’s monetary policy didn’t help because it hiked the discount rate, its primary 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 experienced a decline in production of more than 32%, and unemployment surged to 12% as some 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 needed to be revised to address the deep downturn. Unemployment insurance as we know it still needs to 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 1920 recession, which would today be called contractionary fiscal policy, was virtually guaranteed to worsen the recession.
On the monetary policy front, the Federal Reserve increased rates in 1919 and early 1920, which was contractionary because it led 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 reverse 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, enterprises, and industries. Prices and wages fell and adjusted to reflect the unique structure of production and consumption in post-war, post-pandemic, and increasingly urbanizing societies.
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% yearly through 1929.
The Recession of 1953
The 1953 U.S. recession is another clear example of a V-shaped recovery. This recession was 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, it 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 essential 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 fall in the Fed funds rate late in the recession.
This represents the weakest monetary policy response in the post-World War II era. In fiscal policy, the federal government took no steps to increase spending. According to the high-employment budget surplus, a popular economic indicator of the direction of fiscal policy, it tightened budgetary policy overall during the recession and recovery.
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 was 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.
File Photo: V-Shaped Recovery: Definition, Characteristics, and Examples
What Do Chart Patterns Look Like During an Economic Recovery?
Economic recoveries can last for many years—the shapes of the chart patterns that typically form range from sharp bounces to softer, gradual curves. Many factors influence economic recoveries, so no two patterns are alike. Traders often look to common formations such as a double bottom, V-shape, or U-shape when positioning themselves during these critical inflection points.
What is a Double-Dip Recession?
A double-dip recession occurs when another recession follows a short-term recovery. Active traders sometimes use a V-, W-, or U-shaped chart pattern to mark the reversal in a primary trend. It is worth noting that a double-dip recession is a non-zero probability that can lead to severe losses for those relying on reversal patterns to try to time a market or economic reversal.
What Is a Double Bottom Pattern?
A double bottom is a reversal pattern that followers of technical analysis use to mark a significant shift in the price of a security. More broadly, active traders also use chart patterns such as a double bottom, or V-shape, to mark essential shifts in broad market indexes and changes in economic sentiment.
What Is a Reversal Pattern?
Followers of technical analysis use reversal patterns on charts to indicate a change in the direction of the dominant trend. Common examples include double top, triple bottom, and triple bottom. Reversal patterns often follow a V-, W-, or U-shape, depending on the conviction of market participants.
The Bottom Line
A V-shaped recovery is a type of economic recession and recovery that resembles a “V” shape in economists’ and traders’ charting. This type of recovery involves a sharp rise back to a previous peak after a sharp decline in these measurements. It is considered a best-case scenario because of the speed of adjustment and recovery in macroeconomic performance.
The rapid readjustment of consumer demand and spending on business investments typically drives such recoveries.
Conclusion
- 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 the best-case scenario given the recession.
- The recoveries that followed the 1920–21 and 1953 recessions in the U.S. are examples of V-shaped recoveries.
