Global Models & Alternative Scenarios SUNAYANA MEHRA, ECONOMIST

ECONOMIC OUTLOOK CONFERENCE

RUTH STROPPIANA, SENIOR DIRECTOR

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Global Country Macroeconomic Forecast Models 1

3 3

Approach to Forecasting

Data • Quality and quantity of forecasts

• Easy to produce

• Not ideal for scenario analysis

Theory • Quality of forecast and scenarios

• Complex

• Limited quantity of forecasts

Our Models • Intersection of purely data- and

purely theory-based

4 4

Key Features

• Forecasts are based on historical relationships and theoretical a priori

• The model is driven by important and decisive “core variables”

• Standard template makes cross-country comparisons possible…

• …while still allowing some flexibility to factor in country-specific nuances

• “Scenario-driven” approach facilitates alternative scenario analysis

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Model Design: Theory at Work…

Exchange rates

Investment

Wages and salaries

Population

Prices

GDP

Monetary policy rate

Imports

Government

Exports

Global GDP

Unemployment rate

Consumption

Labor force

Employment

Potential GDP

Other deflators

Import prices

10-yr yield

Global prices

6 6

…And Fundamentals Matter

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

02 03 04 05 06 07 08 09 10 11 12

Actual Fundamentals based historic fit

ITALY

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

02 03 04 05 06 07 08 09 10 11 12

Actual Fundamentals based historic fit

GERMANY

Variable Coefficient t-Statistic

Constant 1.850484 5.095945

Monetary policy rate (ECB) 0.67603 7.32807

% change (2-qtr MA, GDP) 0.460633 0.131284

4-qtr (Government budget balance as share of GDP)

-39.0873 -1.67936

Dependent variable: Germany 10-yr yield

R-squared 0.6026

7 7

Core or Tailpipe: A Tale of Two Variables

Monetary policy rate

Lending rate

Money market rate

Core Tailpipe

0

1

2

3

4

5

6

7

8

02 03 04 05 06 07 08 09 10 11 12F 13F 14F 15F 16F

Monetary policy rate

Money market rate

Lending rate

U.K.

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Standard Template: All (Consumption) Functions Are Created Equal

Dependent variable: DLOG (Real consumption of goods and services per person)

R-squared 0.5991

Variable Coefficient t-Statistic

Interest rate -0.0121 -1.2715

DLOG (Real wages and salaries per person) 0.7250 9.2729

DLOG (House prices) 0.0615 3.0216

DLOG (Stock market value) 0.0104 1.8158

DLOG (4-qtr MA, oil prices) -0.0090 -1.2294

Dependent variable: DLOG (Real consumption of goods and services per person)

R-squared 0.5898

Variable Coefficient t-Statistic

Interest rate -0.0023 -0.7271

DLOG (Real wages and salaries per person) 0.5295 2.5857

DLOG (House prices) 0.1486 3.9967

DLOG (Stock market value) 0.0255 1.8164

DLOG (3-qtr MA, oil prices) -0.0024 -0.2888

U.K. South Africa

DLOG refers to the simple difference of a natural logarithm

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Customizing Models: Spot the Difference

Dependent variable: DLOG (Real export of goods)

R-squared 0.7293

Variable Coefficient t-Statistic

Constant 0.0002 0.763 DLOG (Exchange rate: USD/EUR) -0.1302 -2.457 DLOG (2-qtr MA, euro zone GDP) 3.9799 12.758

Dependent variable: DLOG (Real export of goods)

R-squared 0.3340

Variable Coefficient t-Statistic

Constant 0.0144 2.113

DLOG (Exchange rate: CNY/USD) 1.1096 2.599

DLOG (2-qtr MA, world GDP) 4.5139 7.082

Chinese exports

German exports

DLOG refers to the simple difference of a natural logarithm

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Scenario Driven: All's Well That Ends Well

Consider a shock: Oil prices rise by $150 a barrel

Oil importers Oil exporters

Oil prices rise => consumption falls => GDP falls

Oil prices rise => government revenue rises => GDP rises

Importing countries Exporting countries

CHINA FRANCE JAPAN MEXICO NORWAY RUSSIA

% change in GDP (4 qtr after shock)

-0.2286 -0.3801 -0.7085 0.9886 1.2778 2.4437

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Alternative Scenarios 2

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Weaker Economy

Baseline: Trend growth

S3: Deep

recession 1-in-10

S4: Protracted

slump 1-in-25

Alternative Economic Scenarios

S2: Hard landing

1-in-4

» Six standard scenarios updated on a monthly basis: deviations from baseline

» Ad hoc custom macro scenarios: targeted to model specific risk events; for example, sovereign event, euro zone breakup

Healthier Economy

S1: Stronger recovery

1-in-4

Macroeconomic Scenario Development

Euro zone breakup

Sovereign default

shock and deflation

Custom

1:50 1:25 1:10 1:4 Forecast 1:4

S5: Below- trend long-

term growth 1-in-25

S6: Oil price increase,

dollar crash inflation

1-in-10

13 13

40,000

45,000

50,000

55,000

60,000

65,000

70,000

08 09 10 11 12F 13F 14F 15F 16F 17F 18F 19F 20F 21F

Baseline S1 S2 S3 S4 S5 S6

Global Economy Under Six Scenarios

Source: Moody’s Analytics

Real GDP, 2005$ bil, SAAR

14 14

-5 -4 -3 -2 -1 0 1 2 3 4 5

Global

North America

South America

Asia

Mid. East & Africa

Eastern Europe

Other Europe

Euro zone

S4: Protracted slumpS3: Deep recessionS2: Hard landingBaseline

Europe Suffers Across Downside Scenarios Real GDP, 2013, % change yr ago

Sources: National statistical offices, Moody’s Analytics

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Cross-Country Comparison

U.S. Canada Mexico Brazil Asia China Japan U.K. Baseline (2008/09) -4.4 -3.4 -7.9 -5.4 -3.3 Nil -9.8 -6.4

S2 -1.3 -0.6 -1.9 -2.1 Nil Nil -0.4 -1.5

S3 -2.9 -1.8 -3.7 -3.7 -0.4 -0.3 -2.7 -3.8

S4 -4.5 -4.2 -4.8 -5.8 -1.6 -0.9 -4.7 -5.8

EZ Germany France Italy Spain Ireland Portugal Greece Baseline (2008/09) -5.6 -6.6 -4.3 -7 -5 -11.1 -3.4 -23

S2 -1.5 -1.4 -1.2 -2.2 -2.8 -2.5 -3.1 -24.6

S3 -3.8 -4 -4.3 -5.9 -6.3 -4.5 -6 -30.5

S4 -6.1 -6.2 -6.9 -8.8 -9 -7.5 -8.7 -33.1

Peak-to-trough decline in real GDP, %

Sources: National statistical offices, Moody’s Analytics

16 16

65

70

75

80

85

90

95

100

08 10 12F 14F 16F 18F 20F 22F

BL

S2

S3

S4

Real GDP, rebased 2008Q1=100

Big Trouble in Greece

Sources: Eurostat, Moody’s Analytics

Scenario forecasts for selected series

0

10

20

30

40

50

08 10 12F 14F 16F 18F 20F 22F

BL

S2

S3

S4

Unemployment rate, %

100

120

140

160

180

200

220

08 10 12F 14F 16F 18F 20F 22F

BL

S2

S3

S4

Consumer price index, rebased 2008Q1=100

0

10

20

30

40

50

60

70

08 10 12F 14F 16F 18F 20F 22F

BL

S2

S3

S4

10-yr bond yield, %

17 17

8,000

8,500

9,000

9,500

10,000

10,500

08 09 10 11 12F 13F 14F 15F 16F 17F 18F 19F 20F 21F 22F

Baseline

S2: Moderate recession

S3: Deep recession (Greek exit)

S4: Protracted slump (Greek exit)

Euro Zone Would Be Shaken by a Greek Exit…

Sources: Eurostat, Moody’s Analytics

Real GDP, 2005€ bil, SAAR

18 18

7

8

9

10

11

12

13

14

15

16

08 09 10 11 12F 13F 14F 15F 16F 17F 18F 19F 20F 21F 22F

Baseline

S2: Moderate recession

S3: Deep recession (Greek exit)

S4: Protracted slump (Greek exit)

…With Knock-on Effects for Unemployment

Sources: Eurostat, Moody’s Analytics

Euro zone unemployment rate, %

19 19

1.00

1.10

1.20

1.30

1.40

1.50

1.60

08 09 10 11 12F 13F 14F 15F 16F 17F 18F 19F 20F 21F 22F

Baseline

S2: Moderate recession

S3: Deep recession (Greek exit)

S4: Protracted slump (Greek exit)

The Euro Could Plummet

Sources: ECB, Moody’s Analytics

$ per €

20 20

20,000

30,000

40,000

50,000

60,000

08 09 10 11 12F 13F 14F 15F 16F 17F 18F 19F 20F 21F

Baseline S1 S2 S3 S4 S5 S6

China Outperforms Across Scenarios… Real GDP, 2005 CNY bil, SAAR

Sources: National Bureau of Statistics of China, Moody’s Analytics

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60

70

80

90

100

110

08 09 10 11 12F 13F 14F 15F 16F 17F 18F 19F 20F 21F

Baseline S1 S2 S3 S4 S5 S6

...But Asia’s Tech Exporters at Risk Japan industrial production index, rebased 2008Q1=100

Sources: Ministry of Economy, Trade and Industry, Moody’s Analytics

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In Forecast Accuracy, We Trust! In-Sample Forecast Comparison for France (Core Variables)

Forecast root mean squared error, % of Moody's forecast RMSE, 2000Q1-2011Q4

Variable Description Moody's Random walk Trend-stationary Mixed ARIMA

FWCL$Q Household Consumption Expenditures 100.00 376.95 343.44 342.52 301.72

FWGL$Q General Government Consumption 100.00 100.00 106.32 70.88 88.07

FWIFL$Q Gross Fixed Capital Formation 100.00 423.49 474.82 397.34 497.09

FWEXGSL$Q Export of Goods and Services 100.00 206.58 71.15 76.86 188.77

FWIMGSL$Q Import of Goods and Services 100.00 255.95 127.57 125.73 239.71

FWGDPL$Q Gross Domestic Product 100.00 240.84 98.19 211.28 105.18

FWCPIQ Consumer Price Index: All Households - Total 100.00 78.26 127.17 117.39 76.09

FWHPIQ House price index: Existing houses & apartments - Total 100.00 137.44 137.82 123.51 76.30

FWLBEQ Labor force survey: Employed 100.00 111.84 86.84 81.58 117.11

FWLBRQ Labor force survey: Unemployment rate 100.00 96.26 109.81 102.80 124.77

FWRGT10YQ Interest Rate: 10-Year Government Bond Yield 100.00 164.29 97.62 100.00 100.00

FWSTOCKPQ Stock Market: CAC 40 Index 100.00 191.97 198.58 127.96 125.28

FWYPDLQ Gross Disposable Income 100.00 1144.37 413.61 408.57 732.10

FWYPEWSL$Q Compensation of Employees 100.00 1689.53 365.12 358.14 141.86

Mean 100.00 372.70 197.00 188.90 208.15

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