Is the UK economy really heading for a V-shaped recovery?

The Bank of England’s chief economist thinks we’re getting one. But what actually is a V-shaped recovery? And what does it mean if we get one? Ben Chu explains

‘It is early days, but my reading of the evidence is so far, so V,’ says Andy Haldane (Rex)

The chief economist of the Bank of England, Andy Haldane, sounded a note of optimism about the UK economy in a speech this week.

Though the Office for National Statistics estimates that the UK economy collapsed by a stunning 20 per cent in April alone, Mr Haldane said more recent data on consumer spending patterns had led him to believe the UK’s recovery was now “materially faster” than the Bank of England had expected in May.

“It is early days, but my reading of the evidence is so far, so V,” he said, referring to a V-shaped recovery.

But what actually is a V-shaped recovery, and how likely is it that the UK will experience one?

What does it mean to talk of a recovery’s shape?

When economists and forecasters talk of the shape of the recovery they are talking about the level of aggregate economic activity, or Gross Domestic Product (GDP).

In normal times, economies grow every year. Sometimes the growth is faster than at other times. But the activity line, when plotted on a time chart, generally rises.

But in recessions the activity line falls.

Recessions end as growth returns, but a key question is how quickly the level of activity gets back to where it was before the slump.

A V-shaped recession is generally talked of as the most positive of scenarios because the activity line bounces back as quickly as it fell, making a V-shape on the chart.

What other recovery shapes could there be?

There are numerous possibilities. Some talk of an “L” shape, where activity falls and then flatlines, never actually recovering, though this has been historically unprecedented.

In reality an “L” would turn into a “U” where growth falls and flatlines for a prolonged period before finally recovering.

Another damaging recovery shape is a “W”.

This implies a V-shaped recovery followed by another sharp dip down.

This might occur in the current context because a second outbreak of disease forces another lockdown or another collapse in consumer spending.

So why would we be in a V-shaped recovery?

Some point to surveys of firm managers which, visually at least, suggest a very V-shaped bounceback in May after a stunning fall in April.

But these surveys are supposed to capture managers’ sense of activity relative only to the previous month, so a bounceback should, in theory, only indicate that things are not getting worse, not that they are improving. Some, though, think managers may also be comparing activity to normal levels.

Andy Haldane builds his case on various new forms of high-frequency data such as internet search terms, restaurant bookings etc and says they suggest a pretty powerful bounce back in activity.

So the V signs are strong?

While the UK economy might indeed rapidly recover the activity lost during the lockdown it’s important to note that this does not mean that the economy will then be healed and healthy.

With a V-shaped recovery the level of GDP might be back to where it was before the lockdown, but it would still be below where it would have been if the crisis had never happened.

That would suggest that the economy was still functioning below potential.

The economist Julian Jessop believes a V-shaped recovery is now “nailed on”.

Yet his own rough forecast of the path of the economy suggests a level of activity by the end of 2021 below where it would have been if the crisis had never hit.

Moreover, when we’re thinking about the recovery we also need to consider the longer term impact of the crisis, the damage to people’s skills due to a long spell of unemployment and also corporate bankruptcies and weaker investment that harm the economy’s productive capacity.

This is the “scarring” that economists fear.

Even if the recovery looks V-shaped, that does not necessarily mean the crisis has not done serious and lasting damage to our prosperity.