Green shoots or weeds? Robert Gardner, Head of Macroeconomics

Slide 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

Slide 3 A simple analytical framework..... Higher Capacity, Higher Trend Growth Lower Capacity, Lower Trend Growth High Policy Traction Low Policy Traction

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

Slide 5 The worst outcome "Deflation" Very deep downturn then stagnation Deflation No scope for policy normalisation De-leveraging: frustrated Higher Capacity, Higher Trend Growth Lower Capacity, Lower Trend Growth High Policy Traction Low Policy Traction

Slide 6 Disaster Avoided?

Slide 7 Not exactly..... Source: Datastream

Slide 8 Deflation fears appear to be receding Source: Datastream

Slide 9 Unprecedented policy action stopped the rot Source: Datastream

Slide 10 Key asset markets may have found a bottom.... Source: Datastream

Slide 11 Real activity also appears to be stabilising Source: Datastream

Slide 12 Goldilocks Returns?

Slide 13 Straight from despair to elation? "Goldilocks Returns" "Deflation" Very deep downturn then stagnation Deflation No scope for policy normalisation De-leveraging: frustrated Lower Capacity, Lower Trend Growth High Policy Traction Low Policy Traction Quick recovery, robust growth Plenty of slack Low inflation Steady Policy Normalisation De-leveraging: quick and smooth

Slide 14 Investors seem more convinced of the durability of the upturn Source: Datastream

Slide 15 Who said economists weren’t an optimistic bunch? Source: Datastream

Slide 16 Unfinished Business

Slide 17 Our best guess..... "Slow Grind Higher" Deep downturn, slow recovery Low inflation Gradual policy normalisation De-leveraging: slow and painful "Goldilocks Returns" "Deflation" Very deep downturn (-10%) then stagnation Deflation No scope for policy normalisation De-leveraging: frustrated Higher Capacity, Higher Trend Growth Lower Capacity, Lower Trend Growth High Policy Traction Low Policy Traction Quick recovery, robust growth, Plenty of slack Low inflation Steady Policy Normalisation De-leveraging: quick and smooth

Slide 18 Inventory liquidation brutal, but final demand still lacking Source: Datastream

Slide 19 Repairing household balance sheets will take some time Source: Datastream

Slide 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

Slide 21 Surplus economies also have to make adjustments Source: Datastream

Slide 22 Economic growth – where does it come from?

Slide 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

Slide 24 Blast from the past? "Slow Grind Higher" Deep downturn, slow recovery Low inflation Gradual policy normalisation De-leveraging: slow and painful "Return of Macro Instability" Quick return to growth, No slack, volatile inflation, interest rates Return to “boom-bust” cycle De-leveraging: disorderly "Goldilocks Returns" "Deflation" Very deep downturn (-10%) then stagnation Deflation No scope for policy normalisation De-leveraging: frustrated Higher Capacity, Higher Trend Growth Lower Capacity, Lower Trend Growth High Policy Traction Low Policy Traction Quick recovery, robust growth, Plenty of slack Low inflation Steady Policy Normalisation De-leveraging: quick and smooth

Slide 25 The return of macro instability? Source: Datastream

Slide 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

Slide 27 Questions

Slide 28 Cost of Capital is going to be higher.... Source: Datastream

Slide 29 Fiscal policy also provided a vital lift... Source: Datastream

Slide 30 Return to “normality”? Source: Datastream

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