Recessions, Recoveries, and Leverage

When leverage is low, recoveries from recessions are likely to eventually return the economy to its pre-recession growth path. When leverage is high, recoveries are likely to leave the economy below its pre-recession growth path. In other words, low-leverage recessions are likely to be U-shaped, whereas high-leverage recessions are likely to be L-shaped. The increase in leverage over the postwar period indicates that recent recessions are much more likely to be L-shaped. In particular, there is strong evidence that the Great Recession in the U.S. was L-shaped. We also find similar effects of leverage for several other countries, but not all.