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 • Q&A

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 weren’t 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 won’t 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 we’re 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

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