Recession-Specific Recoveries: L's, U's and Everything in Between

Abstract

We relax the assumption that recessions are all alike and propose a new model of output growth that allows for recession-specific recoveries. Output growth is modelled as the weighted average of Markov-switching processes that temporarily alter the level of real GDP (U-shaped) and those with permanent effects (L-shaped), where the recession-specific weight is endogenously estimated. Only the 1969-70 and 2007-09 recessions are characterized exclusively as U and L, respectively. The other 85% of U.S. recessions reflect a weighted combination of the two shapes. Consequently, models that imply only one possible path for a given recession may be insufficient to fully characterize the behavior of output during recessionary periods. With respect to fitting output growth, our model outperforms those that generate either U- or L-shaped recoveries and the model-implied paths closely track the level of actual U.S. real GDP during recessions and recoveries.