Balance of Payments -and Power- Crises

 This report argues DSGE economic models fail to capture our now geopolitical world  Such models assume shocks, such as higher import prices flowing to the balance of payments, are resolved by reallocating labour and capital, currency depreciation, and higher net exports, so returning GDP growth to its long-run trend  We propose an adapted economic model that assumes: no guarantee of key input supply; or markets for new exports; or rapid labour rebalancing; or open-ended fiscal and monetary support  This alternative approach results in large-scale structural deterioration in economic and market performance, matching the structural rise in geopolitical tensions  We model two scenarios: 1) governments extend current energy support measures to 2027; and 2) a part of the industrial base is eroded by the crisis. Results are relatively benign for the first, but the second shows UK and Eurozone GDP respectively 7.2% and 7.4% smaller by 2027, unemployment rising by around 4 percentage points, and a large impact on both inflation and the exchange rate. This mirrors the experience of some emerging markets (EM) rather than developed markets (DM)  In short, we believe our geopolitical world implies real ‘DM > EM’ risks