L-Shaped Recovery

Article byJyotsna Suthar
Reviewed byDheeraj Vaidya, CFA, FRM

What Is L-shaped Recovery?

L-shaped recovery, in economics, refers to a transition or phase with a very slow, declining growth rate while forming an L-shape pattern on the graph. It usually occurs when the economy is in severe recession with low levels of growth and development.

L-Shaped Recovery Meaning

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: L-Shaped Recovery (wallstreetmojo.com)

During an L-shaped recovery, the economy faces a huge downfall in its growth. At the same time, this sharp decline results in stagnant, contracted growth. In turn, it leads to poverty and unemployment. But, if it is not corrected, the situation could worsen, so getting back on track can be hard.

Key Takeaways

  • An L-shaped recovery is a graphical curve that forms an L-shape during a recession. In such cases, there is a sharp decline followed by stagnant or near-to-zero growth. 
  • It belongs to a group of economic recovery based on its shape. However, unemployment, excessive savings, and less expenditure are major features of this recovery. 
  • The three major events of this recovery include the Great Depression of 1929, the Lost Decade of Japan, and the Great Recession of 2007-08. 
  • The government adopted various monetary and fiscal measures to recover from this crisis to encourage expenditure and reduced savings.

L-shaped Recovery Explained

An L-shaped recovery is a graphical representation of the economy during a recession that shows a declining economic growth rate. As the name suggests, an L-shaped curve forms on the graph. This slope indicates a sudden and deep decline followed by a slow steep growth in the economic parameters. Although the growth rate is near zero, the Gross Domestic Product (GDP) has a steady pace. Thus, the slope is very shallow and steep compared to other recoveries.

Some various indicators or metrics decide the wave of L-shaped recovery. However, the most important feature of L-shaped recovery is majorly due to unemployment. As consumers keep their savings in the bank, they are left with nothing. In other words, they keep a minimum percentage to themselves to avoid excess expenditure. However, in this case, the aggregate demand for goods reduces.

Furthermore, even the supply acts similarly. In return, the firms cut certain factors of production. And in this process, the labor remains unemployed for a long period. Likewise, the vicious cycle of money flowing in the economy discontinues.

Every economy faces a recession, but faster recovery is also important. The situation worsens if there is a very sharp decline in the growth and still not recovering. And that gives rise to the L-shaped curve. For instance, if the country is already in recession, the chances of an L-shaped recovery rise. Therefore, it is equally crucial to notice the initial symptoms of downfall.

Various Keynesian economists carved reasons for such a recovery. Of these, a drop in unemployment levels, an increase in savings, and reduced expenditure are the prime ones. However, they also suggested that updating the monetary and fiscal policies will soothe the situation.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Real-Time Cases

L-shaped recovery has been operational in the market for a long time. In the past decades, three major incidents witnessed the L-shaped recession. Let us look at them:

#1 – The Great Depression of 1929

With the stock market crash, the entire United States was witnessing the great depression. The GDP rate slipped by 29%, causing a sharp decline in the graph. Likewise, industrial production also fell by 47%. During such times, former President Herbert Hoover encourages expenditure. In 1933, the GDP rate dropped from a surplus of 0.8% to a negative figure of 4.5%. Besides, various new monetary policies were adopted.

Later on, in 1939, the New Deal program was implemented under the Presidency of Franklin Roosevelt. As per the deal, measures were taken to improve the condition of the citizens caused due to depression.

#2 – Lost Decade of Japan

Among Asian countries, the Lost Decade of 1991 was very popular. Until 1990, Japan was in a tremendous growth phase. Despite the damage caused by the Second World War, the nation excelled. However, there was a formation of a bubble. Concerned about the rising prices in real estate, the Bank of Japan raised interest rates. But, in 1991, the stock market crashed, and the economy fell. From 1991 to 2003, there was stagnant or no growth leading to the “Lost Decade.”

But the worst happened when the Bank of Japan had almost reduced the interest rate to 0% in 1999. Various monetary and fiscal reforms were undertaken to recover from the crisis.

#3 – Great Recession Of 2007-08

As the US housing sector started defaulting, the stock market bubble busted. Plus, the banks also faced penniless investments in mortgages. It also led to an L-shaped recovery pattern in the graph. In that year, unemployment rose by 10%. The government infused $4.5 trillion as new reserves in response to the crisis.

Examples

Let us look at the examples of L-shaped recovery to comprehend the concept in a better way:

Example #1

Suppose Happyland is a country located in the West. In the last quarter of 2022, the government had increased the interest rates by 55 points. By the beginning of 2023, the country had started witnessing a slow demand. Likewise, even the technology firms had started laying off amid the recession. In a few months, the economy saw a huge drop in its growth rate. Various economists predicted Happyland to see a faster recovery. But the growth rate formed an L-shaped recovery.

The government reduced the interest rates later on. As a result, people started removing their money from the deposits and increasing their expenditures. In addition, there were discounts and offers put on sale. Due to this, in a few months, the steep slope finally saw a recovery.

Example #2

As per a recent note on June 11, 2023, Goldman Sachs states that China’s property market may witness an L-shaped recovery in the upcoming years. Analysts predict that the slowdown of the property sector in the past years has been a major reason. However, they expect the government to take corrective measures to improve the sector.

L-shaped Recovery vs V-shaped Recovery

Although L-shaped and V-shaped recovery occurs during the recession, they have different characteristics. Therefore, it is vital to look at their differences:

BasisL-shaped RecoveryV-shaped Recovery
MeaningL-shaped recovery refers to the graphical curve with a sudden decline followed by a steep slope. A V-shaped recovery is a slope that has a sharp downfall and a sudden rise in the growth rate of a particular country or sector. 
OccurrenceThis recovery stays for a long period during a recession. It usually occurs when the post-effect of recession is not prolonged. 
Shape of Curve It forms a L-shape curveIn this case, the graph forms a V-shape curve. 
Type of Recession Here, the recession remains for many years.  V-shaped recovery has a short recession period. 
Examples The Great Depression of 1929, the Lost Decade of 1991, and the Great Recession of 2007-08. For example, the recession that occurred in 1953 in the US saw a V-shaped recovery.

Frequently Asked Questions (FAQs)

1. What is the difference between a Z-shaped and an L-shaped recovery?

The major difference between Z and L-shaped recovery is based on their shape. Economists have described this relatively new term in the past few years. Here, there is a rising slope, but it has certain corrections. The curve will rise, have a slant fall, rise again above the average, and slightly fall. At the same time, the L-shaped recovery will suddenly fall and rise slowly.

2. What is the difference between an L-shaped and a K-shaped recovery?

The only difference between both is that the K-shaped recovery forms a shape of K, and the former creates an L-shaped curve. But, K-shaped recovery has more occurrences in certain industries.

3. Why is L-shaped recovery important?

There is a huge significance of L-shaped recovery in economics. Nations near recession look out for this recovery because it is the most dangerous. If the economy fails to uplift, it can destroy the entire circular flow of money. It will detect any excess deposits in the banks or limited loans granted.

This article has been a guide to what is L-Shaped Recovery. We explain the topic with its examples, real-time cases, and comparison with V-shaped recovery. You may also find some useful articles here –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *