Rebalancing in the Dark Rebalancing in the Dark Bill Martin Centre - - PowerPoint PPT Presentation

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Rebalancing in the Dark Rebalancing in the Dark Bill Martin Centre - - PowerPoint PPT Presentation

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Rebalancing in the Dark Rebalancing in the Dark Bill Martin Centre for Business Research, University of Cambridge HM Treasury seminar, 27 th July 2010 y , y Disclaimer: views expressed are the authors and are not necessarily those of the

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SLIDE 1

Rebalancing in the Dark Rebalancing in the Dark

Bill Martin Centre for Business Research, University of Cambridge HM Treasury seminar, 27th July 2010 y , y

Disclaimer: views expressed are the author’s and are not necessarily those of the CBR

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SLIDE 2

Outline Outline

1 Rumsfeld uncertainty

  • 1. Rumsfeld uncertainty

2 di i

  • 2. Medium-term scenarios
  • 3. Robust rebalancing strategy
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SLIDE 3

How much uncertainty?

  • 1. Recession forecasting errors
  • 2. Credit crunch impact?
  • 3. Lessons from past business cycles
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SLIDE 4

Recession forecast errors

Overprediction of 2009 GDP level, % of outturn HM Treasury Consensus

8.0 10.0 12.0 4.0 6.0 8.0 % 0.0 2.0 Two years ahead One year ahead

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SLIDE 5

Bean’s wealth calculation

  • 1. Fall in consumption in advanced countries due to

wealth shock (banks’ write-offs)

  • 2. But loss of advanced country GDP relative to

potential “more than 10 times bigger” than (1) “ So we cannot come near to explaining the “Great Contraction” purely in terms of wealth effects.”

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SLIDE 6

Credit crunch?

Bank lending to non-financial business & households, % of GDP

12 0 16.0 20.0 4.0 8.0 12.0 %

  • 4.0

0.0 1Q 1980 1Q 1985 1Q 1990 1Q 1995 1Q 2000 1Q 2005 1Q 2010

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SLIDE 7

Recession puzzle of 2009

Percentage points unless stated 2008 2009 Output gap, % (new data)

  • 2.2
  • 9.3

Output gap, % (old data)

  • 1.8
  • 8.9

Identified factors:

  • 2.0
  • 5.2

Export shortfall

  • 0.4
  • 3.1

Wealth & confidence shocks 1 6 3 1 Wealth & confidence shocks

  • 1.6
  • 3.1

Stabilising fiscal policy 0.0 1.1 Unexplained residual 0.2

  • 3.7
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SLIDE 8

Banking crisis “lessons” – two camps

  • Camp 1 – permanent loss

Camp 1 permanent loss (Reinhart & Rogoff & many others)

  • Camp 2 – strong recovery

(C h i M O d) (Cecchetti, Mussa, Ormerod)

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SLIDE 9

Rumsfeld uncertainty

  • Deeply uncertain outlook
  • not fan chartable
  • Credit crunch

large impact? – large impact?

  • Policy makers have to consider a range of sharply
  • Policy makers have to consider a range of sharply

contrasting future economic conditions of seemingly equal prior plausibility

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SLIDE 10

Two medium-term scenarios

  • Fast & slow recovery scenarios
  • updated for June Budget
  • Fast recovery scenario
  • strong export revival, strong competitiveness

di h f d response, credit crunch fades

  • Slow recovery scenario

li it d t i l & titi

  • more limited export revival & competitiveness

response, credit crunch persists

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SLIDE 11

Scenario analysis – three steps

1. Baseline – align with OBR forecast but query

  • productivity assumption

import penetration assumption

  • import penetration assumption

2 Impose alternative assumptions 2. Impose alternative assumptions

  • external trade & competitiveness impact
  • asset prices & credit crunch impact

3. Model “fast” and “slow” recovery profiles

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SLIDE 12

OBR productivity projection

Productivity index (GDP per worker; 2007=100; OBR projection after 2009) mechanical projection: 2.0 % growth p.a. after 2007

100 120 140 40 60 80 20

1949 1959 1969 1979 1989 1999 2009

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SLIDE 13

Import “elasticity” I

Annual import "elasticity" - import growth divided by private TFE growth

25 0 30.0 35.0 40.0 y 1949-2010 10.0 15.0 20.0 25.0 ency, %, yearly 0.0 5.0 below 0.5 0.5 to 1 1 to 1.5 1.5 to 2 2 to 2.5 above 2.5 Freque

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SLIDE 14

Import “elasticity” II

Import "elasticity" - overlapping 5-year intervals

50.0 30.0 35.0 40.0 45.0 arly, 1949-2010 5 0 10.0 15.0 20.0 25.0 quency, %, 5-yea 0.0 5.0 below 0.5 0.5 to 1 1 to 1.5 1.5 to 2 2 to 2.5 above 2.5 Freq

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SLIDE 15

HMT & OBR forecasts for 2010

Forecast for 2010 Volume growth, % Import “elasticity” GDP I t y GDP Imports PBR Dec 2009* 1.3 0.7 0.6 Budget Mar 2010* 1.2 2.3 1.4 Budget June 2010 1.2 5.5 2.3

*Mid-point forecasts. Imports ex. MTIC fraud. Elasticity – p p y import growth divided by private TFE growth (inferred)

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Rebalancing assumed

The forecast is conditioned on the assumption that: “ the shape of the recovery in the UK economy embodies an orderly adjustment in the sectoral financial balances and a rebalancing of domestic financial balances and a rebalancing of domestic and external demand supported by sterling’s

  • depreciation. ”

December 2009 PBR, A.42, page 146 See also March 2010 Budget B 42 page 157 See also March 2010 Budget B.42, page 157

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SLIDE 17

Scenario analysis – three steps

1. Baseline – align with OBR forecast but query

  • productivity assumption

import penetration assumption

  • import penetration assumption

2 Impose alternative assumptions 2. Impose alternative assumptions

  • external trade & competitiveness impact
  • asset prices & credit crunch impact

3. Model “fast” and “slow” recovery profiles

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SLIDE 18

Scenarios – GDP growth

GDP growth projections

Fast Slow Consensus OBR Projection from 2009

2 4

  • 4
  • 2

%

  • 6

2007 2008 2009 2010 2011 2012 2013 2014 2015

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SLIDE 19

Scenarios - unemployment

Unemployment rate, end-year, %

F t Sl P j ti f 2009

10 12

Fast recovery Slow recovery Projection from 2009

4 6 8

%

2

2007 2008 2009 2010 2011 2012 2013 2014 2015

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SLIDE 20

Scenarios – private financial surplus

Private sector financial surplus, % of GDP

Fast recovery Slow recovery Projection from 2009

8 10 12 14 2 4 6 8

% 2007 2008 2009 2010 2011 2012 2013 2014 2015

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SLIDE 21

Private surplus – slow recovery

Private sector financial surplus, % of GDP

14.0 Slow recovery Projection from 2009 4.0 9.0 %

  • 6.0
  • 1.0

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

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SLIDE 22

Scenarios – budget deficit

Budget deficit, % of GDP

Fast recovery Slow recovery Projection from 2009

10 12 14 2 4 6 8

%

2

2007 2008 2009 2010 2011 2012 2013 2014 2015

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SLIDE 23

Scenarios – government debt

Government debt, end-year, % of GDP

Fast recovery Slow recovery Projection from 2009

60 80 100 20 40 60

% 2007 2008 2009 2010 2011 2012 2013 2014 2015

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SLIDE 24

Private financial wealth & public debt

Private financial wealth & government debt, % of GDP

80 100

Private financial wealth Government debt Slow recovery projection from 2009

40 60 80

%

20

2007 2008 2009 2010 2011 2012 2013 2014 2015 2007 2008 2009 2010 2011 2012 2013 2014 2015

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SLIDE 25

Scenarios – balance of payments

Current account of balance of payments deficit, % of GDP

Fast recovery Slow recovery Projection from 2009

2 4 2 2

2007 2008 2009 2010 2011 2012 2013 2014 2015 %

  • 4
  • 2
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SLIDE 26

“Full-employment” financial balances

"Full employment" financial balances, % of GDP in 2015 strong trade performance moderate trade performance

7 0 8.0 9.0 10.0

g p p

3.0 4.0 5.0 6.0 7.0 % 0.0 1.0 2.0 Unemployment Budget surplus Private deficit BoP deficit

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SLIDE 27

Scenario lessons

  • Optimistic OBR
  • Fast recovery with latent balance of

payments problem payments problem

  • Slow recovery trap
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SLIDE 28

Policy challenges

  • Keeping the recovery going
  • is monetary policy enough?

y p y g

  • Encouraging a balanced recovery
  • supporting resource reallocation

supporting resource reallocation

  • raising future competitiveness
  • resisting currency appreciation

resisting currency appreciation

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SLIDE 29