Global Economic Perspectives：Fiscal consolidation won’t kill the recovery

Global 21 July 2010 Global Economic Perspectives Fiscal consolidation won’t kill the recovery Deutsche Bank Securities Inc. All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 007/05/2010 Economics Table of Contents Key Economic Forecasts .................................. Page 02Fiscal consolidation won’t kill the recovery...... Page 03How big is the “Greece premium” in US Treasuries ................................................... Page 08Central Bank Watch .......................................... Page 10Global Data Monitor ......................................... Page 13Charts of the Week .......................................... Page 14Global Week Ahead .......................................... Page 15Financial Forecasts ........................................... Page 17Main Deutsche Bank Global Economics Publications ........................ Page 18 Research Team Peter Hooper (+1) 212 250-7352 peter.hooper@db.com Thomas Mayer (+49) 69 910-30800 tom.mayer@db.com Torsten Slok (+1) 212 250-2155 torsten.slok@db.com Michael Biggs (+44) 20 754-55506 michael.biggs@db.com Christine Dobridge (+1) 240 994-4716 christine.dobridge@db.com Macro Global Markets Research Economics „ Conventional economics inspired by the simple Keynes-Hicks IS-LM model assumes that cuts in government budget deficits, especially when they are achieved through government spending reductions, exert contractionary effects on aggregate demand and hence GDP. This relationship has inspired a number of observers to warn that plans to start reining in deficits in major countries could jeopardise economic recovery and trigger a “double-dip” recession. „ A closer look at the relationship between changes in the fiscal stance and economic activity raises serious doubts about the validity of the IS-LM model. Correlations between changes of cyclically adjusted primary budget balances and GDP growth for the US, Japan, and the euro area calculated over the last few decades are zero or positive, suggesting that improving structural balances (i.e., a contraction of the fiscal stance) are unrelated to growth or associated with rising growth. „ Recent economic research offers an explanation for this seemingly counterintuitive result: positive confidence and interest rate effects on private demand triggered especially by government spending cuts can offset or even exceed the direct effect of lower government deficits on aggregate demand. „ We expect the planned reduction in structural deficits in major countries to be measured. Moreover, fiscal adjustment on balance seems to rely more on reductions in government spending than on tax increases (which should be positive for growth). As a result, we do not expect the economic recovery to be jeopardised by the planned fiscal adjustment. To the contrary, we believe there is a good chance that fiscal adjustment may even bolster the recovery. How big is the “Greece premium” in US Treasuries (2nd article) „ Uncertainty about the situation in Europe has generated a substantial flow of “safe haven” money into US Treasuries. In this piece we estimate a weekly and a quarterly model of 10-year treasuries and find that the “Greece premium” is between 60bps to 100bps. In other words, 10-year treasuries are 60bps to 100bps lower than what is predicted by short rates, the business cycle, the fiscal stance, and inflation expectations. As the worries about Europe start fading among global investors – including later this week when the stress tests are released – we would expect the Greece premium in 10-year Treasuries to start shrinking. Correlation between changes in primary structural budget balances and GDP growth US 1) Japan 1) euro area 2) contemporaneous 0.58 0.33 0.17 1 year lag 0.12 0.06 0.28 1) 1971-2010, 2) 1992-2010 Source: Deutsche Bank 21 July 2010 Global Economic Perspectives Page 2 Deutsche Bank Securities Inc. Key Economic Forecasts Real GDP % growthb Consumer Prices % growthc Current Account % of GDPd Fiscal Balance % of GDP 2009 2010F 2011F