Alphabet soup that can spell how the recession is shaping up

Hugo Duncan
12 May 2009

Hopes that the worst of the recession may have passed have fuelled talk about what form the recovery will take when it finally comes.

The alphabet soup of ideas includes the bullish “V-shaped recession” targeted by Gordon Brown and Alistair Darling — although even this may not be enough to save the Prime Minister, the Chancellor or the Labour Government. There is also a “U”, an “L” and a “W” as well as variations cooked up by businessmen and economists trying to forecast what path the economy will take over the next few years.

Here is a guide to some of the possibilities — a number of which serve as stark reminders that although the rate of economic decline may have slowed, recovery could still be a long way off:

V-shaped

The Bank of England will tomorrow predict a powerful V-shaped recovery where the short, sharp decline is quickly followed by a period of vigorous growth.

Gordon Brown is gambling on exactly this sort of scenario so that by the time of a spring 2010 General Election the economy is on the up.

In the Budget last month, Alistair Darling forecast gross domestic product to shrink by 3.5% this year before growing 1.25% in 2010 and 3.5% in 2011. The Chancellor was widely mocked for being far too optimistic about the pace of recovery and, in the inflation report tomorrow, Bank Governor Mervyn King is likely to forecast a somewhat deeper recession before a V-shaped recovery takes hold. It could still, however, prove optimistic.

U-shaped

The U-shaped recession involves a longer trough and more subdued start to the recovery than the V-shaped one hoped for in Downing Street. However, once the bottoming-out period has passed and growth returns, it does so in style.

The downturn could be prolonged by the shortage of cash flowing around the economy. The financial hurricane has left nervous banks reluctant to lend to consumers and businesses, starving them of the funds needed to stimulate growth. The Government has stepped in to ease the tension in the credit markets but it will take time before money is flowing freely through the system again, prolonging the downturn.

Nouriel Roubini, the New York University professor known as Doctor Doom for predicting the financial crisis, warned the response by governments around the world was “too little, too late” and said the global economy faces a U-shaped slump.

L-shaped

A disaster. L-shaped recessions are protracted periods of economic stagnation such as that experienced by Japan during its “lost decade” of the 1990s.

An L — where there is no recovery after a steep decline — would see recession turn into Depression and bring deflation, mass unemployment, thousands of business failures, wage cuts, further house-price falls, negative equity and so on.

It would leave the already creaking public finances in disarray and send Government debt soaring, and could even result in a bailout by the IMF.

Such an outcome is unlikely. Banks are no longer on the brink of collapse and the economy should benefit from quantitative easing, low interest rates, tax cuts and increased spending, at least in the short-term.

W-shaped

A W-shaped recession would involve a nasty double-dip where the economy relapses into negative territory after a temporary recovery over the summer.

George Buckley, chief UK economist at Deutsche Bank, reckons the pick-up could come as soon as next month but warns it may prove to be short-lived.

The main danger is that the Bank of England stops printing money too soon and the Government raises taxes and cuts spending to reduce debts, taking the wind out of the recovery's sails.

The 1970s was plagued by false dawns between the start of recession in 1973 and start of the sustained recovery in 1976. Norman Lamont also cited green shoots in the autumn of 1991 but it was not until the following spring that the recession ended.

Bath-shaped

Advertising boss Sir Martin Sorrell famously coined the phrase “bath-shaped recession” to describe the last economic slowdown after the dot-com boom.

Longer than a U-shaped recession but not as bad as an L, the bath-shaped recession sees a period of sharp economic decline followed by stagnation and then eventual recovery.

A feature of the bath-shaped recession is its corrugated bottom, according to the WPP chief executive, meaning a series of small peaks and troughs before the real recovery kicks in.

This time around, Sir Martin reckons there will be “a recovery of sorts” in 2010.

Hook-shaped

Rating agency Moody's has introduced a “hook-shaped” scenario for the current recession after deciding the V is “fantasy” and the U “unrealistic”.

Chief international economist Pierre Cailleteau said the economic slump will be followed by some growth before flattening off. He warned the “gradual and painful economic recovery” will “leave lasting scars” in the way of unemployment and corporate profits. The forecast is similar to that made by George Soros, who described the current slump as an “inverted square root sign” where the bottom is followed by a small bounce and then stagnation.

Green shoots there may be, but a full-blown recovery is a long way off.