THINKING: Perspectives

Looking for L, U, or V in a COVID-Impacted Economy

(April 27, 2020) – Social distancing restrictions and behavioral shifts due to the coronavirus pandemic have led to sharp declines in business activity and consumer spending worldwide. A popular exercise for economists forecasting the expected global economic slowdown has been to debate about the shape the recession will take, a verbal shorthand for describing the shape of the ups and downs of GDP and the broader economy. Will it be a quick “V,” a painful yet relatively short period of time where economic activity rebounds to pre-pandemic levels?  A prolonged “U,” indicative of a recession that drags out for a year or more? Or perhaps a dreaded “L,” signaling an economy that experiences a severe recession, or even a depression, and does not return to trend line growth for many years.

The Economic Impact of COVID-19

The speed and magnitude of this decline is truly unprecedented. As the world economy balances mitigating the health risks of COVID-19 with the economic risks, extraordinary measures are being taken. This includes quarantines and the closure of non-essential businesses as well as the fiscal and monetary measures aimed at cushioning the blow. The impacts of these moves include the following:

  • Job Losses- Over 26 million jobs were lost in the U.S. in five weeks beginning in mid-March. This compares to 8.6 million jobs lost over 23 months during the global financial crisis of 2007-2009. This number is expected to grow, as many companies may not be able to wait for fiscal assistance to arrive.
  • Financial Uncertainty– The ripple effect of job losses of this magnitude will take time to recover from, even with the significant size of the CARES act recently passed by Congress. While unprecedented and swift action from the Federal Reserve has helped, more fallout is expected to come in both fixed income and equity markets as the reality of job losses and the health tragedy play out.
  • Debt Levels– The level of debt in many sectors of the economy has exploded, from the passage of fiscal stimulus packages to the drawdown of corporate credit lines. According to Bloomberg, governments alone have dedicated over $8 trillion to fight the pandemic.[i] Consumer debt is expected to grow as well as individuals resort to credit cards and personal lines of credit to sustain themselves. Additional fiscal stimulus is likely on the table to bridge the economy past COVID-19 recovery.

Best Case Scenario: A V-shaped Recession

In general, V-shaped recessions are those that last for only a few quarters. This is what happened after the bust in the early 2000’s: gross domestic product bounced back in a period of months rather than years. V-shapes are the normal shape for recession, as the strength of economic recovery is typically closely related to the severity of the preceding recession

A dramatic turnaround in economic fundamentals has to happen for a V-shaped recovery to happen in 2020. Large portions of the U.S. would need to start “bending the curve” with regards to coronavirus infections sometime in April, resulting in businesses reopening, and thus people returning to work, in May or June. New claims for unemployment would need to dramatically start to decline as well. Lastly, the Federal government’s rescue programs would work have to work quickly and seamlessly and stem the flood of layoffs.

Under this scenario, economic growth would drop by only 5-10 percent in the second quarter of 2020, then start to rebound sharply in the third and fourth quarters as pent-up demand is unleashed, and people return to their jobs.

Most Likely Scenario: A U-shaped Recession

A U-shaped recession is what the U.S. experienced between November 1973 and March 1975, and then again from July 1981 to November 1982: a pair of 16-month slogs characterized by the Economic Reports of the President as “severe.”[ii] Simon Johnson, former chief economist for the International Monetary Funds, describes a U-shaped recession as a bathtub: “You go in. You stay in. The sides are slippery. You know, maybe there’s some bumpy stuff in the bottom, but you don’t come out of the bathtub for a long time.”[iii]

Job losses decimate demand. In a V-shaped recession, non-discretionary spending for such items as food, housing, utilities, and health care falls, but not as quite as much as discretionary spending for such things as vacations, car purchases, eating out and buying clothes. In a U-shaped recession, both fall sharply and are slow to recover.

A U-shaped recession is also accompanied by the collateral damage associated with the unwinding of financial leverage. As investors sell good assets to fund non-performing assets, the prices of all assets decline. The role of the Federal Reserve as lender of last resort plays a critical component of mitigating the damage from this unwind, but it most likely does not prevent the unwind from happening. The sharp decline in economic growth results in bankruptcies and all of the spillover effects of a slow or no-growth economy.

Currently, medical professional across the U.S. say it will take longer than one month to “bend the curve” as new infectious hot spots emerge. This by itself would extend the lockdowns into the summer. There is also the issue of testing and how safe workers feel about their job safety before returning to work. Absent a nationwide testing program, jobless claims would continue to rise, and the unemployment rate would quickly reach double-digits. Meanwhile, the infusion of cash from the federal government would not be able to keep up. State and local budgets would also start cratering under the weight of falling revenues from precipitous declines in sales taxes. Consumer confidence, a rising barometer for the past three years, would continue to plunge. Washington would have to intervene again with additional stimulus packages, though there might not be the urgency to pass huge spending bills as there was in the spring. Economic growth would drop over 20% in the second quarter and not recover for the balance of 2020 and could spill over into 2021.

Worst Case Scenario: An L-shaped Recession

An L-shaped recession is when the economy falls off a cliff and stays there for a long as several years. Economic growth is dormant or non-existent, entire industries go bankrupt, and joblessness exceeds 20% of the workforce. If this were to happen, the resulting economy would more closely resemble the Great Depression of the 1930’s or the deflationary Japanese economy during the “lost decade” of the 1990’s. Both are considered the only examples of L-shaped recessions/depressions to have occurred in the twentieth century.

The CARES Act passed by Congress most likely prevents an economic depression from happening during the coronavirus crisis. While extraordinary financial pain from social distancing restrictions are being felt across most sectors of the U.S. economy, safeguarding those with little discretionary income is key to preventing an economic disaster. According to a recent report by KPMG Economics, the CARES Act targets the bottom 80% of incomes, thus ensuring some measure of relief for those with little or no savings.[iv] Moreover, bank capital buffers, built up after the global financial crisis, are a point of strength for the financial system, as is the Federal Reserve’s liquidity support to keep financial markets functioning.


According to the National Bureau of Economic Research (NBER), there have been eleven recessions, with an average duration of eleven months, since 1945.[v] Of those post WW II contractions and recoveries in the business cycle, six are considered U’s, three are V’s, and a pair of V-shaped recessions from the early 1980’s arguably form a W.

While the probability of a quick V-shaped recession following the coronavirus pandemic is low, the most likely scenario of a U-shaped will still be beholden to the magnitude of the collateral damage from the debt unwind, and the interconnectivity of the capital markets and the global economy, to prevent this recession from turning into an L-shaped depression.

[i] “When $8 Trillion in Global Fiscal Stimulus Isn’t Enough,” Bloomberg, April 22, 2020.

[ii] “Economic Report of the President: 1975,” St. Louis Federal Reserve Bank.

[iii] “Deciphering the Shape of Economic Recovery.” PBS, June 23, 2009.

[iv] “A Bridge Past COVID-19: The Path for the Economy,” KPMG Economics, April 1, 2020.

[v] “U.S. Business Cycle Expansions and Contractions,”

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