September 16, 2009 World Economic and Market Developments Olivier Blanchard Economic Counsellor Research Department

2 Will the Recovery be Sustained? Where we are now. The nascent recovery. Where we are now. The nascent recovery. What does a “typical” recovery look like? What does a “typical” recovery look like? How can the global recovery be sustained? How can the global recovery be sustained? Problems on the supply side. Level and growth of potential output. Problems on the supply side. Level and growth of potential output. Problems on the demand side. The two rebalancing acts. Problems on the demand side. The two rebalancing acts.

3 1. Where We Are

4 Recovery is Gaining Momentum, Particularly in Asia

5 Real GDP Growth (in percent; qoq; saar) Improving Confidence Now Seen in Real Activity 09Q2 Advanced World Emerging

6 Exports and Manufacturing Helped by a Turn in the Inventory Cycle Industrial Production (percent change; 3mma; annualized) Jul. 09 Advanced Emerging Merchandise Exports (percent change; 3mma; annualized) Emerging Advanced Jul. 09 World

7 Consumer Confidence Slowly Recovering, but Unemployment Still Rising Consumer Confidence (January 2005=100) Aug. 09 Unemployment (percent change; weighted by labor force) Emerging Advanced Jul. 09 World

8 Credit Market Stress is Continuing to Ease Corporate Spreads (basis points) 9/14 Three-month Libor – OIS Spreads (basis points) 9/15

9 Financial Market Conditions are Improving and Risk Appetite is Returning Asset Class Performance (September 1, 2008 = 100)

10 Emerging Market External Bond and Equity Issuance (billions of U.S. dollars) BIS Banks: External Claims (percent change, exchange rate adjusted) Emerging Market Issuance is Up, but Not (yet?) Bank Flows

11 2. What a Normal Recovery Looks Like Looking at previous U.S. recoveries Looking at previous U.S. recoveries The role of inventory investment at the start The role of inventory investment at the start The role of private demand later The role of private demand later Looking at the current recovery Looking at the current recovery Inventory investment, fiscal policy Inventory investment, fiscal policy Will private demand take the baton? Will private demand take the baton?

12 Following the 1991 Recession U.S. GDP Growth Contributions 1/ (in percent; qoq saar) 1/ For the seven quarters following the trough. Real GDP

13 Current Forecast for the U.S. Recovery U.S. GDP Growth Contributions 1/ (in percent; qoq saar) 1/ For the seven quarters following the trough. Real GDP

14 3. The Supply Side. How Much Has Potential Output Gone Down? Evidence from 88 banking crises Evidence from 88 banking crises

15 Figure reports mean difference from pre-crisis trend (over t-10 to t-3); t=-1 normalized to 0; crisis begins at t=0. Inner shading indicates 90% confidence interval for the mean; outer shading indicate inter-quartile range. Following Banking Crises, Output Losses are Significant and Sustained Output Losses (per capital GDP; percent deviation from pre-crisis trend)

16 Figure reports mean difference from pre-crisis trend (over t-10 to t-3); crisis begins at t=0; t=-1 normalized to 0; observations limited by data availability. Post-Crisis Output Losses Reflect Capital, Employment and Productivity Factors Output Decomposition (in percent; deviation from pre-crisis trend) Total factor productivity Employment rate Capital per worker

17 Histograms report five-year average growth ending at t+8 relative to pre-crisis trend, where crisis begins at year t. Growth Tends to Recover Eventually But Country Experiences Vary medium-run growth relative to pre-crisis trend Frequency (in percent)

18 4.Shift from Public to Private Spending. Fiscal Space?

19 G-20 Fiscal BalanceG-20 Government Debt Public Finances will Need to be Consolidated (percent of GDP) Source: IMF, World Economic Outlook.

20 Primary Balances (percent of GDP) Huge Adjustment Needed to Stabilize Public Debt at Comfortable Level 1/ Primary balances required to reduce debt/GDP ratio to 60 or 80 percent by / Debt/GDP ratio in 2014; net debt for Japan and gross debt for all others.

21 Euro Area – Bond Yield Spreads and Public Debt Average general government debt, (percent of GDP) Average 10-yr government bond yield spread over Germany, (bps) Euro Area Shows that Higher Debt Can Lead to Higher Bond Yields Slovenia Ireland Spain Finland Netherlands Cyprus Greece Italy Belgium Portugal Austria France

22 Net Present Value of the Fiscal Costs of the Crisis and Age-Related Spending (percent of GDP) Entitlement Reform: Path Toward Fiscal Sustainability

23 5. Will Private Spending Take the Baton?

24 Banks Continue to Delever Private Sector Credit Growth (in percent of outstanding) U.S.. U.K. Euro area Lending Officer Surveys (net percentage) Net percentage tightening standards on business loans Net easing

25 Securitization Remains Impaired Securitization Issuance (billions of U.S. dollars) United States Data annualized for Europe

26 Equity Market Real Total Returns over 10-year Periods (percent; annualized) Uncertainty about Long-run Rates of Return on Equity? Jun. 09

27 U.S. Household Saving Ratio (ratio to disposable income) What will U.S. Consumers Do?

28 Higher Uncertainty Hurts Consumption Response of VolatilityResponse of Real GDP Response of Real Household WealthResponse of Real Consumption

29 What are the Prospects for Investment Demand? Capacity Utilization (percentage point deviation from long-run average) U.S. Corporate Sector Cash Holdings Jul Q1 Sources of Financing for Non-Financial Corporations (percent; Avg )

30 6. Rebalancing World Demand

31 The Current State of Global Imbalances Current Account Balances (percent of world GDP)

32 Composition of China’s GDP GDP Composition (in percent)

33 7. Back to Projections

34 Recovery Will Be Sluggish (percent; quarter-over-quarter, annualized) Advanced World Emerging

35 Some alternative scenarios (more in EWE) US domestic and foreign demand do not pick up. US domestic and foreign demand do not pick up. Fiscal stimulus maintained. Debt sustainability? Fiscal stimulus maintained. Debt sustainability? Fiscal stimulus phased out. Recovery? Fiscal implications? Fiscal stimulus phased out. Recovery? Fiscal implications? Potential output much lower. Tight limits on growth. 70’s style policy mistakes? Even if not, fiscal implications? Potential output much lower. Tight limits on growth. 70’s style policy mistakes? Even if not, fiscal implications? Of the essence: World demand rebalancing, entitlement reforms, recapitalization of banks. Of the essence: World demand rebalancing, entitlement reforms, recapitalization of banks.