Green shoots or weeds

1
Green shoots or weeds?

• Robert Gardner, Head of Macroeconomics

2
What to expect in the next 30 mins an RBS
double-act

• Robert
• A simple framework for thinking about the future
• An evaluation of the options
• Our view....
• Peter
• A closer look at the Nordic region
• QA

3
A simple analytical framework.....
High Policy Traction

Higher Capacity,
Lower Capacity,
Higher Trend Growth
Lower Trend Growth
Low Policy Traction
4
Four potential scenarios......
High Policy Traction
Return of Macro Instability
Goldilocks Returns

Higher Capacity,
Lower Capacity,
Higher Trend Growth
Lower Trend Growth
Slow Grind Higher
Deflation
Low Policy Traction
5
The worst outcome.......
High Policy Traction

Higher Capacity,
Lower Capacity,
Higher Trend Growth
Lower Trend Growth
"Deflation"

• Very deep downturn then stagnation
• Deflation
• No scope for policy normalisation
• De-leveraging frustrated

Low Policy Traction
6

• Disaster Avoided?

7
Not exactly.....
Source Datastream
8
Deflation fears appear to be receding......
Source Datastream
9
Unprecedented policy action stopped the rot
Source Datastream
10
Key asset markets may have found a bottom....
Source Datastream
11
Real activity also appears to be stabilising
Source Datastream
12

• Goldilocks Returns?

13
Straight from despair to elation?
High Policy Traction
"Goldilocks Returns"

• Quick recovery, robust growth
• Plenty of slack
• Low inflation
• Steady Policy Normalisation
• De-leveraging quick and smooth

Lower Capacity,
Lower Trend Growth
"Deflation"

• Very deep downturn then stagnation
• Deflation
• No scope for policy normalisation
• De-leveraging frustrated

Low Policy Traction
14
Investors seem more convinced of the durability
of the upturn
Source Datastream
15
Who said economists werent an optimistic bunch?
Source Datastream
16

• Unfinished Business

17
Our best guess.....
High Policy Traction
"Goldilocks Returns"

• Quick recovery, robust growth,
• Plenty of slack
• Low inflation
• Steady Policy Normalisation
• De-leveraging quick and smooth

Lower Capacity,
Higher Capacity,
Lower Trend Growth
Higher Trend Growth
"Slow Grind Higher"
"Deflation"

• Deep downturn, slow recovery
• Low inflation
• Gradual policy normalisation
• De-leveraging slow and painful

• Very deep downturn (-10) then stagnation
• Deflation
• No scope for policy normalisation
• De-leveraging frustrated

Low Policy Traction
18
Inventory liquidation brutal, but final demand
still lacking
Source Datastream
19
Repairing household balance sheets will take some
time
Source Datastream
20
Mechanisms for balance sheet adjustment

• Asset price growth difficult for policy to gain
  traction
• Inflation erode the real burden of debt, return
  of macro instability
• Widespread default to eliminate debt overhang
  financial devastation
• Debt rescheduling - debt for equity swaps,
  partial mortgage debt forgiveness
• Income growth/debt repayment slow and painful

21
Surplus economies also have to make adjustments
Source Datastream
22
Economic growth where does it come from?
23
There are lots of headwinds

• Labour force growth
• Demographic trends will be a drag
• Pressures to limit immigration wont help either
• Productivity growth
• Lack of investment impacts capital stock
• Cost of capital across the economy will be higher
• Fixing public sector balance sheets crowding out
• Moving resources across sectors is likely to be
  costly

24
Blast from the past?
High Policy Traction
"Return of Macro Instability"
"Goldilocks Returns"

• Quick return to growth,
• No slack, volatile inflation, interest rates
• Return to boom-bust cycle
• De-leveraging disorderly

• Quick recovery, robust growth,
• Plenty of slack
• Low inflation
• Steady Policy Normalisation
• De-leveraging quick and smooth

Higher Capacity,
Lower Capacity,
Higher Trend Growth
Lower Trend Growth
"Slow Grind Higher"
"Deflation"

• Deep downturn, slow recovery
• Low inflation
• Gradual policy normalisation
• De-leveraging slow and painful

• Very deep downturn (-10) then stagnation
• Deflation
• No scope for policy normalisation
• De-leveraging frustrated

Low Policy Traction
25
The return of macro instability?
Source Datastream
26
Key messages/implications

• The worst is over, but were not out of the woods
  yet
• Balance sheets have to be repaired no quick fix
• Sluggish growth for a protracted period
• Policy stimulus likely to remain in place for
  some time
• The post crisis world will be different
• Trend rates of growth will probably be lower
• Taxes will be higher/public spending will be
  lower
• Trade imbalances need to unwind too
• Deficit countries lower consumption, saving
  higher, higher net exports
• Surplus countries higher consumption, lower
  saving, lower net exports
• A tougher environment, but a more sustainable one

27

• Questions

28
Cost of Capital is going to be higher....
Source Datastream
29
Fiscal policy also provided a vital lift...
Source Datastream
30
Return to normality?
Source Datastream
31
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