A lot of economic commenters have used letters as a shorthand to describe potential economic scenarios of what might happen after the covid-19 outbreak is controlled. They are great as visual aids, but what exactly is the difference between them? What do they mean in practice? After all, we want to adapt our trading and money management strategies, so we need a little more concrete information.
There isn’t a consensus definition. So, the description of each scenario ought to be considered more as guidelines rather than fixed timetables. However, they can be helpful to clarify just what we are talking about.
The scenarios, starting with the most optimistic:
A V-Shaped Recovery:
This type is was what most people were hoping for initially when the outbreak only affected China. The measures to control the virus would have a rather harsh impact on China, with some minor issues around the world. In its original form, it foresaw the economic impact being over in the first quarter.
However, the virus spread around the world and countries started locking down during March. The underlying scenario changed, and we were looking at a world-wide recession and recovery.
Now a V-shaped recovery scenario anticipates the large economic impact currently seen, followed by almost just as quick recovery.
The idea is that the infrastructure, orders, and jobs are all still there; we just paused the economy for a few weeks to sort out the virus. Then, we will quickly go back to usual, with most of the negative impact confined to the second quarter. By the third quarter, it would all be long forgotten.
A U-Shaped Recovery:
This type Is similar to the prior scenario but considers a longer lockdown period. As major countries hesitate to reopen their economies, the time that we are at the bottom of the decline increases. Naturally, the longer businesses are closed, the more lasting an economic impact will be.
The hope is that in the time when most people were virtually confined to their homes, there has been pent up demand. This will help push a fast economic recovery. In this scenario, the economy is shut through most of the second quarter. We will see a spring back in growth during the third quarter. Hopefully, by the end of the year, we are back to normal.
An L-Shaped Recovery:
This is the dreaded scenario. If businesses are required to stay closed for a long time, even with subsidies they won’t survive. A cure or a vaccine potentially takes months, if not years to develop. Social anxiety keeps people from returning to shops and supporting the economy. The massive debt accumulated keeps the economy from growing, and inflation skyrockets. There are many ways that the economy might not recover.
The L implies that lack of growth becomes the new normal, and the economy struggles to recover after the already large drop. Some people point to the slow recovery after the 2008 crash (with the return of a crisis in 2011) as a potential outcome. In this scenario, it could take years for the economy to return to the growth level we saw just a couple of months ago.
Basically, the longer the economy is shut down, the more likely we are to transition from a V-shape, through a U-shape, and finally end up in an L-shape scenario.