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Understanding V, U, W, and L-Shaped Recessions |
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by S. Wade Hansen
What Shape is the Recession?
The two most important questions you will hear during any recession are "When will it end?" and "How quickly will we recover?" The answers to both of these questions can be found by analyzing the shape of the recession. [Learn who defines a recession and how they do it.] 
Recessions come in many shapes and sizes. However, economists tend to refer to the following four shapes the most:
- V-shaped recession
- U-shaped recession
- W-shaped recession
- L-shaped recession
V-Shaped Recessions
V-shaped recessions are recessions that begin with a steep fall but then quickly find a bottom, turn back around and move immediately higher. A V-shaped recession is a best-case scenario.
The recession of 1990 to 1991 and the recession of 2001---both of which only lasted eight months---are considered to be V-shaped recessions.
U-Shaped Recessions
U-shaped recessions are recessions that begin with a slightly slower decline but then remain at the bottom for an extended period of time before turning around and moving higher again.
The recession from 1971 through 1978---when both unemployment and inflation were high for years---is considered a U-shaped recession.
W-Shaped Recessions
W-shaped recessions are recessions that begin like V-shaped recessions but then end up turning back down again after showing false signs of recovery. W-shaped recessions are also called "double-dip recessions" because the economy drops twice before a full recovery is achieved.
A W-shaped recession is painful because many investors who jump back into the markets after they believe the economy has found a bottom end up getting burned twice---once on the way down and then once again after the false recovery.
The recession of 1980 that double dipped in 1981 and 1982 is a great example of a W-shaped recession.
L-Shaped Recessions
L-shaped recessions are recessions that fall quickly and fail to recover. An L-shaped recession is a worst-case scenario because they offer no hope of recovery.
The Japanese recession that began in the early 1990s is considered an L-shaped recession.
What Shape is The Recession that Began in 2007?
Obviously, it is too early to tell what shape this current recession will be, but two leading economists have made some predictions.
According to Nouriel Roubini: My view is ... a U-shaped recession as I expect that the economic contraction will last at least 12 months and possibly as long as 18 months through the middle of 2009. This view is based on the fact that the last two recessions – in 1990-91 and 2001 – lasted 8 months each and today the macro and financial conditions are worse – relative to those two previous recessions - in at least three dimensions:
1. We are experiencing the worst US housing recession since the Great Depression ...
2. In 2001 it was the corporate sector (10% of GDP or real investment) to be in trouble. Today it is the household sector (70% of GDP in private consumption) to be in trouble. ...
3. The US is experiencing its most severe financial crisis since the Great Depression. This is not just a subprime meltdown. ...
Could the US recession end up being W-shaped, i.e. a double-dip recession? This view is presented by those who argue that the recent fiscal stimulus – that will provide a tax rebate to US households in May-June – could lead - after negative growth in Q1 and Q2 - to a positive economic growth in Q3 and possibly part of Q4 to be followed by a relapse into a second recession by year end or early 2009 when the effects of such fiscal stimulus fade out. Such a W-shaped recession – effective a U-shaped recession with a small temporary upward blip in the middle of it (thus a W-shaped one) cannot be ruled out. ...
Finally, could the US experience an L-shaped recession, i.e. a protracted period of economic stagnation like the one experienced by Japan in the 1990s after the bursting of its housing and equity bubble? My view is that a protracted economic stagnation – bordering on an economic depression – is unlikely in the case of the US as the policy response of the US is already more aggressive than the one of Japan. ...
This will turn out to be the most severe recession and financial crisis that the US has experienced for decades. Thus, the current conditions and valuations in US equity and financial markets – that currently price a mild and shallow recession – will be proven wrong as the bottom of the real economic contraction and the bottom of the financial and credit losses are ahead of us rather than behind us. ...
According to Paul Krugman: It looks to me now as if the markets are now pricing in a rapid recovery, that they’re pricing in a V-shaped recession, which I consider extremely unlikely.
The market seems to be looking as if this is going to be an average recession, but it’s not.
NEXT: Learn more about The Federal Reserve's Response to the Credit Crisis and Recession
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