An L-shaped recovery is a type of recovery characterized by a slow rate of recovery, with persistent unemployment and stagnant economic growth. L-shaped recoveries occur following an economic recession characterized by a more-or-less steep decline in the economy, but without a correspondingly steep recovery. When depicted as a line chart, graphs of major economic performance may visually resemble the shape of the letter “L” during this period.
When referring to recessions and the periods of recovery that follow, economists often refer to the general shape that appears when charting relevant measures of economic health. For instance, employment rates, gross domestic product and industrial output are indications of the current state of the economy. In an L-shaped recovery, there is a steep decline caused by plummeting economic growth followed by a more shallow upward slope indicating a long period of stagnant growth. In an L-shaped recession, recovery can sometimes take several years.
Recoveries can also be V-shaped, W-shaped, K-shaped, and U-shaped. As in an L-shaped recovery, these names are based on the shape seen on a chart of relevant economic data.
Understanding the L-Shaped Recovery
An L-shaped recovery is the most harmful type of recession and recovery. Because there is a drastic drop in economic growth and the economy does not recover for a significant period of time, an L-shaped recession is often called a depression.
The most important feature that defines an L-shaped recovery is a failure of the economy to progress back toward full employment after a recession. During an L-shaped recovery, the economy does not readjust and reallocate resources to get workers working and ramp up business operations very quickly. Large numbers of workers can remain unemployed for extended periods or even leave the workforce entirely. Likewise, capital goods such as factories and equipment may stand idle or underutilized for extended time-frames as well.
A few economic theories have been advanced as to why and how this can occur. Keynesian economists argue that persistent pessimism, underconsumption, and excessive saving can produce a prolonged period of sub-normal economic activity, and even that this is normal and there is no strong reason to expect the economy to be able to adjust and rebound on its own.
Others point out that L-shaped recoveries can typically be characterized as those in which monetary and fiscal policy interventions actively prevent the economy from adjusting and recovering from the losses of the preceding recession. These policies appear to ease the initial pain of recession and protect the financial sector, but slow down the economy’s adjustment process.
L-Shaped Recovery Examples
Three major examples of L-shaped recoveries stand out in the last century of economic cycles: the recoveries of the Great Depression of the 1930s, the Lost Decade in Japan, and the Great Recession following the 2008 financial crisis. All three of these periods are well known for the massive campaigns of expansionary fiscal and monetary policy that were pursued at the time.
The Great Depression
Following the stock market crash of 1929, the U.S. entered the Great Depression, the worst recession ever seen. U.S. real GDP contracted sharply and unemployment rose to a peak of nearly 25%.1 Stagnant growth and high unemployment persisted for over a decade.
In response to the crash and recession, President Hoover increased both spending and taxes and ramped up unprecedented peacetime federal deficits, hitting a deficit of 4.5% of GDP during his term.2 Hoover led a concerted federal campaign to keep wages and prices from falling through new federal lending subsidies, labor legislation, federal funding for unemployment benefits, and influential, though not technically enforceable, demands that businesses not cut workers' pay. The recession continued to deepen following these measures.
Expansionary monetary policy was also pursued through this period. The Federal Reserve cut the discount rate and purchased large quantities of Treasury securities to inject new liquidity into the banking system. Eventually, the U.S. would take the radical step to abandon the gold standard under President Franklin D. Roosevelt in order to protect the interests of the financial system and facilitate more inflationary monetary policy.
After the 1932 election, FDR extended and doubled down Hoover’s policies with fiscal policy involving ongoing annual federal deficits of 2-4% of GDP to fund massive public works projects and dramatically expanded federal regulation of economic activity.2 In the wake of these policies, collectively known as the New Deal, high unemployment and lackluster growth would extend the L-shaped recovery through the entire decade of the 1930s.
Japan's Lost Decade
What is known as the lost decade in Japan is widely considered to be an example of an L-shaped recovery. Leading up to the 1990s, Japan was experiencing remarkable economic growth. In the 1980s, the country ranked first for gross national production per capita. During this time, real estate and stock market prices were quickly rising. Concerned about an asset price bubble, the Bank of Japan raised interest rates in 1989. A stock market crash followed, and annual economic growth slowed from around 4 percent to an average of just over 1 percent between 1991 to 2003.3
In response to the crisis, the Japanese government would engage in 10 rounds of deficit spending and economic stimulus programs totaling over 100 trillion yen through the decade. On the monetary front, the Bank of Japan cut interest rates over and over, approaching 0% by 1999, and accelerated the supply of new reserves to the banking system. During this time, Japan experienced what is now known as the lost decade. It failed to recover from the crash for 10 years and experienced the consequences of a slow recovery for another decade after that.
With the collapse of the U.S. housing bubble and the financial crisis of 2008 the U.S. entered the now well known Great Recession. As credit markets dried up businesses failed and foreclosures and bankruptcies skyrocketed. The stock market crashed in the fall of 2008 and unemployment rose to a peak of 10.0% a year later.4
In response to the steep recession that was underway, the Bush administration enacted a $700 billion taxpayer funded bailout of the financial sector in the form of the Troubled Asset Relief Program.5 The Federal Reserve initiated an unprecedented and massive wave of expansionary monetary policy including an alphabet soup of new lending facilities and several successive rounds of quantitative easing which injected $4.5 trillion in new bank reserves into the financial system.6 On the fiscal policy side, the Obama administration kicked off the American Recovery and Reinvestment Act which brought $831 billion in new federal spending.7
Subsequent to these massive campaigns of monetary expansion and deficit spending the U.S. economy experienced the slowest recovery of the post-WW2 era. Unemployment remained above 5% until the beginning of 2016 and real GDP growth averaged a sluggish 2.3% over the next several years.
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