At a glance

• Asset price inflation over the past two decades has created about $160 trillion in “paper wealth.” Economic growth was sluggish, inequality rose, and every $1.00 in investment generated $1.90 in debt.
• Current tremors in the financial system may signal a shift in how the world borrows, lends, and accrues value, with a wide range of plausible long-term scenarios. We model four economic scenarios—return to past era, higher for longer, balance sheet reset, and productivity acceleration—to understand what the future might hold for the world’s balance sheet.
• Three of the potential scenarios are far from ideal—two are “pick your poison” and the third a double dose. Volatility may prove temporary and balance sheet expansion may resume as savings bid up the price of existing assets once again rather than flowing to productive investments. Or high inflation and interest rates could persist, resembling the US economy after the 1970s oil shock. The worst case would look more like Japan after its real estate and equity bubble burst in the 1990s, with drawn-out deleveraging and a sharp contraction in asset prices. For instance, US equities and real estate values might drop by more than 30 percent between now and 2030.
• By far the most desirable outcome is to accelerate productivity so that economic growth catches up with the balance sheet. Only this scenario combines strong growth in income, wealth, and balance sheet health.
• Decision makers will need the imagination to prepare for the full range of scenarios while maintaining steadfast determination to achieve the best. Accelerating productivity growth will require countering headwinds, such as aging or more complex supply chains, through well-directed investment to seize the power of both technology and human capital. The die is not yet cast.

Recent turbulence in the banking world comes against a backdrop of higher interest rates colliding with high leverage amid heightened geopolitical tensions. This is a major change in background conditions from the years of loose money and seemingly endless increases in wealth.

Over the past two decades, the global balance sheet expanded much faster than GDP. Debt grew, as did asset prices. But productivity and economic output did not keep pace, and inequality rose (for more detail, see sidebar, “What is the global balance sheet?”.)¹“The rise and rise of the global balance sheet: How productively are we using our wealth?” McKinsey Global Institute, November 2021.

What is the global balance sheet?

To construct a global balance sheet, MGI added up all real assets in the economy (for example, real estate, infrastructure, machinery, commodities, and intangibles) as well as all financial assets and liabilities (for instance, equity, debt, loans, deposits, pension assets, and liabilities). All sectors are included—households, government, and nonfinancial and financial corporations (exhibit). All assets and liabilities are valued at market prices. The global balance sheet has three components that interlock: (1) the financial sector: financial assets and liabilities held by financial institutions, which help intermediate those held by other sectors; (2) the financial system: financial assets and liabilities held by households, governments, and nonfinancial corporations, often used to finance real assets with capital or net worth held by other people or institutions; and (3) the real economy: real assets and the net worth resulting from creating those assets.

By late 2022, instability in the global economy and the balance sheet had become apparent.²“Global balance sheet 2022: Enter volatility,” McKinsey Global Institute, December 2022. In 2022 alone, households lost $8 trillion of wealth.

The future of wealth and economic growth hangs in the balance. How long might stress in the financial system last? Is the world facing a major rebalancing in its balance sheet? How severe could the impact on real estate, equity, and debt become, and what might happen to deposits? What is the optimal course of action for stakeholders, from investors to financial institutions to policy makers?

The future of wealth and growth hangs in the balance

(46 pages)

The range of plausible long-term paths remains wide. Much depends on whether the world returns to an era of weak investment and a glut of savings, entailing slow GDP growth, low interest rates, and unabated expansion of the global balance sheet. On another path, stronger consumption and higher investment requirements for the net-zero transition, supply chain reconfiguration, or defense lead to persistently higher inflation and interest rates. What would the policy response be, and could strong tightening trigger an asset price correction and balance sheet reset? Or could productivity growth come to the rescue, generating higher rates of economic growth as capital is redirected toward productive investment opportunities?

In this paper, the McKinsey Global Institute (MGI) models four scenarios to capture the range of potential outcomes. We call them “return to past era,” “higher for longer,” “balance sheet reset,” and “productivity acceleration.” In the most desirable scenario by far, productivity accelerates so that economic growth catches up with the balance sheet, thereby combining fast GDP growth, rising wealth, and a healthier balance sheet. The three other scenarios are all far from ideal, each in its own way.

The stakes are high. The economic, banking, and investment landscape of the next ten years may look very different from that of the past 20 years. The differential impact of the scenarios on economic output is enormous, and the fallout for the balance sheet an order of magnitude larger still. MGI has developed a model for the economy and the balance sheet for the United States, the United Kingdom, and Germany. A balance sheet reset in the United States would lower annual GDP growth by 1.7 percentage points, compared with an accelerated productivity scenario (Exhibit 1). Likewise, total household wealth would be $48 trillion lower in a reset scenario than in a productivity acceleration one. Beyond a potential decline in wealth, which would likely produce its own scarring effects, a reset with material asset price correction would also mean that many debt-financed assets end up underwater. This would amplify existing stress in the financial system. For this reason, decision makers need to pay close attention to balance sheet impact when making choices for economic policy.

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The past two decades stand in marked contrast to the post–World War II historical trajectory of global wealth (and debt) accumulation. Before the turn of the millennium, growth in global net worth largely tracked GDP growth. But then something unusual happened. Around the year 2000, with timing that varied by country, net worth, asset values, and debt began growing significantly faster than GDP (Exhibit 2). In contrast, productivity growth among G-7 countries has been sluggish, falling from 1.8 percent per year between 1980 and 2000 to 0.8 percent from 2000 to 2018.

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Between 2000 and 2021, asset price inflation created about $160 trillion in “paper wealth.” Valuations of assets like equity and real estate grew faster than real economic output. And each $1.00 in net investment generated $1.90 in net new debt. In aggregate, the global balance sheet grew 1.3 times faster than GDP. It quadrupled to reach $1.6 quintillion in assets, consisting of $610 trillion in real assets, $520 trillion in financial assets outside the financial sector, and $500 trillion within the financial sector.

Balance sheet expansion accelerated during the pandemic as governments launched large-scale support for households and businesses affected by lockdowns. During 2020 and 2021, global wealth relative to GDP grew faster than in any other two-year period in the past 50 years. The creation of new debt accelerated to $3.40 for each $1.00 in net investment.

Values of all major asset types grew relative to GDP as real interest rates declined

By 2021, four types of assets made up 80 percent of the three interlocking global balance sheets (financial sector, financial balance sheet of nonfinancial sectors, and the real economy): real estate (27 percent), equity (21 percent), debt (20 percent), and currency and deposits (12 percent). All four have risen relative to GDP since 2000, including real estate by 33 percent more, equity by 100 percent more, and debt by 90 percent more. Currency and deposits grew 124 percent faster than GDP.

The broad pattern of growing asset value holds across economies, but with variations in timing and relative pace of growth across asset types. Taking the United States as an example, the four largest balance sheet items outgrew GDP by between 50 percent (real estate) and 200 percent (equity) at market values relative to 1995 values (Exhibit 3). In the United Kingdom, growth was faster still in real estate and debt, and slower in equity. In Germany, balance sheet expansion was less pronounced across asset classes.

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A structural decline in real interest rates underpinned the expansion of the balance sheet, all while economic growth remained sluggish. For example, in the United States, forward-looking expectations for real interest rates steadily declined between 1995 and 2021. Low interest rates encouraged borrowing, lowering the cost of loans and bonds and spurring commercial banks to collect—and create—deposits. In highly simplified terms, an overhang of capital chased too few productive investment opportunities, and much of it flowed to real estate and equity, driving up prices. Debt rose faster than net investment, and paper wealth grew.

In the rest of this section, we explore the drivers of balance sheet growth across the four asset classes.

Falling real interest rates fueled the rise of real estate values

The decline in real interest rates has played a remarkable role in driving real estate valuations (Exhibit 4). Investors could afford to pay more for a property with a given rent, and therefore value-to-rent multiples rose. The cost of equity for real estate also fell, amplifying the effect. This meant that the effective yield of real estate, or cap rates, dropped.

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Despite this marked decline in yields, rents (including imputed rents on owner-occupied buildings) kept growing. The rent share of GDP expanded (in the United States) or declined (in the United Kingdom and Germany) modestly while growth in the number and quality of buildings trailed GDP growth by a wide margin. Scarcity of supply—particularly in superstar cities—played a role.³“Superstars: The dynamics of firms, sectors, and cities leading the global economy,” McKinsey Global Institute, October 2018. Almost one-third of the global value of real estate is concentrated in those cities, where further densification faces political difficulties and prices have been high and rising over the past several decades. This trend has slowed over the past few years, and prices have gone up less in these cities than elsewhere as the pandemic increased work-from-home arrangements and some people moved farther away from work.

There are some country variations. In the United States, for example, the market value of real estate expanded 1.5 times faster than GDP from 1995 to 2021. While there was a significant correction after the global financial crisis, the rise quickly resumed. Declining real interest rates drove almost the entire increase.

In the United Kingdom, real estate grew even more strongly relative to GDP than in the United States. Declines in the real estate cost of equity played a comparatively larger role. As investors felt prices could only go up, risk perceptions and the cost of equity declined sharply before the global financial crisis. After correcting upward as a result of that crisis, the cost of equity fell again.

Global balance sheet 2022: Enter volatility

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In Germany, real estate values experienced a long period of decline relative to GDP in the late 1990s and early 2000s as a real estate bubble in eastern Germany following reunification corrected. As a result, the German real estate industry went through the global financial crisis relatively unscathed and then began to catch up rapidly as interest rates declined.

Declining real interest rates drove growth in equities, and in the United States, increasing returns on capital also played an important role.

Falling real interest rates boosted equity values across economies as future earnings were discounted at a lower rate. In both the United Kingdom and Germany, falling rates were responsible for all of the growth in equity values relative to GDP between 1995 and 2021. In the United States, they contributed about one-third of this growth (Exhibit 5).

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However, another powerful factor was also at work in the United States: a rising GDP share of corporate earnings, which contributed two-thirds of the growth in equity values versus GDP. The earnings share of GDP rose by 80 percent from 1995 to 2021 to 12.3 percent—the highest share in a century (Exhibit 6). The earnings share grew despite the fact that the stock of corporate capital, as is common, closely tracked GDP.

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A number of factors contributed to this increase in earnings relative to GDP, as past MGI research shows.⁴“A new look at the declining labor share of income in the United States,” McKinsey Global Institute, May 2019. One was company-level superstar effects, particularly in the digital economy. Others include rising automation and a decline in labor bargaining power in some sectors, including from globalization, offshoring, and shifts in production to less unionized states. Changes in corporate tax rates may also have played a role.

Our analysis suggests that investors did not—and do not—expect the earnings share to rise further. Yet investors do seem to build in an expectation for the earnings share to remain at today’s high levels and for long-term real interest rates to stay low, judging by current US equity valuations.

For each $1.00 of net new investment, $1.90 of new debt was created

With equity values climbing, debt rose sharply, too, and, with it, equivalent wealth for lenders and bond holders. By the end of 2021, in the United States, Japan, China, and all major European economies other than Germany, debt was not only higher relative to GDP than in 2000 but even increasing from the peak following the 2008 global financial crisis. In the United States the figure climbed from 2.5 to 2.8 times GDP, in the United Kingdom from 2.5 to 2.8, in Japan from 3.4 to 4.3, and in China from 1.6 to 2.7. In Germany, debt remained stable at about 2.0 times GDP.

Globally, for every $1.00 of net investment, $1.90 of additional debt was created. Much of this debt financed new purchases of existing assets. Rising real estate values and low interest rates meant that households could borrow more against existing homes. Rising equity values meant that corporates could use leverage to reduce their cost of capital, finance mergers and acquisitions, conduct share buybacks, or increase cash buffers. Governments also added debt, particularly in response to the global financial crisis and the pandemic. Interestingly, rising bond prices as interest rates declined played only a minor role driving the debt-to-GDP ratio, as the time range used is much longer than typical bond maturities.

Currency and deposits in commercial and central banks have expanded

Growth in deposits exceeded GDP growth in the United States, the United Kingdom, and Germany. In the United States, the volume of currency and deposits in commercial and central banks expanded from 0.6 times GDP in 1995 to 1.2 times GDP in 2021; it is now 80 percent higher relative to GDP than the average of the past century. In the United Kingdom deposits grew from 1.9 times GDP in 2000 to 3.5 times GDP in 2021, and in Germany from 1.4 times GDP to 1.9 times GDP.

In the United States, the rise unfolded in three waves, with varying drivers. Loose mortgage lending before the global financial crisis in 2008 triggered the first wave. At the financial system level, every new loan requires a corresponding new deposit. A second wave came with quantitative easing and thus the creation of central bank (or “outside”) money in response to the crisis. Finally, a third wave occurred with another round of quantitative easing in response to the pandemic. Moreover, the support for households and firms during the COVID-19 pandemic led to excess saving as households spent less during lockdowns.

Weak investment and excess saving have prevailed over the past several decades, underpinning expansion of the global balance sheet. There was a relative paucity of productive options for savers—retail as well as institutional—and the price of existing homes and shares duly rose. GDP growth remained below its structural potential. Central banks kept interest rates low to stimulate economic activity, aiming for their inflation targets. This was classic “secular stagnation.”

Might this be changing? Much in the world certainly seems to be shifting, from geopolitics to technology, energy systems, and demographics.⁵“On the cusp of a new era?” McKinsey Global Institute, October 2022. It is possible that the more structural forces behind high savings and weak investment will themselves shift, although this remains a matter of uncertainty and debate.

Will investment requirements and demand for capital grow after decades of decline?

Over the past several decades, there has been too little productive investment. In advanced economies, net investment has declined as a share of GDP. In the 2010s, this ratio was roughly 50 percent lower than before the 2008 financial crisis in Europe, and 40 percent in the United States (Exhibit 7). Markedly, in the aftermath of the global financial crisis, private-sector investment plummeted in the face of uncertainty and weak demand outlooks. Capital deepening (growth in capital stock per worker) dropped to the lowest rate in the post–World War II period. Public investment has also lagged, including in infrastructure and affordable housing. In infrastructure, for example, past MGI analysis showed that the United States invested about 0.4 percent of GDP less than the estimated amount needed to support economic growth between 2010 and 2020.

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Uncertainty is high and decisions can yet determine the path ahead, but overall, investment, and thus demand for capital—and its cost—could well rise substantially. Even if not all incremental investment is productive, economic growth could accelerate.

• Infrastructure investment rises. Particularly in the United States, a shift appears to be emerging after decades of underinvestment in infrastructure. For example, the Infrastructure Investment and Jobs Act, signed into law in November 2021, provides for an incremental $550 billion in government spending focused on public transit, high-speed broadband, clean drinking water, and electric vehicle charging infrastructure. Higher infrastructure investment will accelerate productivity growth.
• Energy transition gains momentum. MGI research suggests that the net-zero transition alone will need incremental investment equivalent to about two percentage points of GDP in the 2020s.⁶“The net-zero transition: What it would cost, what it could bring,” McKinsey Global Institute, January 2022. This will likely initially dampen productivity growth at first but could accelerate it in the long run.
• Intangible assets continue to grow. Investment in intangible assets, such as in digitization and R&D, has risen and will continue to rise steadily as they become structurally more important for the economy. However, two factors have limited the speed of this growth. First, the skills needed to deploy intangible assets have been in short supply. This could change with increased investment in skill building and deployment of easier-to-use AI technology. Second, intangible assets have struggled to serve as a vehicle for long-run savings. Because of their shorter life cycles, they can absorb savings only for a more limited period before becoming obsolete or passing value on to consumers as competition picks up. While regulation could limit such spillovers, this would be negative for growth.
• Geopolitics drive a stepping up in investment related to defense, supply chains, and industrial policy. More fractured geopolitics may increase investment in supply chain reconfiguration, industrial policy initiatives, and defense—with mixed outcomes for productivity. New business investment is rising in areas like chips and clean tech, and supply chains are being reconfigured. Done well, this can lead to more resilient and still productive local economies, but it can also lead to less efficiency at a global scale. In the case of defense, European economies have tended to not invest in line with their NATO commitments, but in the wake of Russia’s invasion of Ukraine, they are stepping up. While some of these investments may generate productivity, especially at the national level, politically induced investments do generally face the risk of unproductive capital allocation.

Are the forces behind the savings glut on the wane?

Three factors that drove a glut of savings in the past stand out. Each of them may be shifting:

• Rising inequality and declining labor share of income: Reversal under tight labor markets? For decades, inequality rose and the labor share of income declined.⁷“A new look at the declining labor share of income in the United States,” McKinsey Global Institute, May 2019. This has reduced consumption by channeling a disproportionate share of value creation to the wealthy, who tend to save more than the population overall.⁸“Solving the productivity puzzle: The role of demand and the promise of digitization,” McKinsey Global Institute, February 2018. Rising saving by the wealthy has bid up prices for assets, particularly those with expected higher returns. At the same time, corporate earnings have grown rapidly, particularly in the United States, driving equity valuations and thus balance sheet growth further.

  Some of the factors underpinning income inequality and declining labor shares may shift in the longer term, boosting consumption relative to savings. In the United States in recent years, the trajectory on both, labor share and inequality, has already become much flatter (again, see Exhibit 7). Workers’ bargaining power could rise if the labor market remains tight and unions regain influence, particularly in the United States. Superstar dynamics and globalization, which lifted incomes for all but not in the same way for everyone, are being exposed to changing domestic and global politics and rules. Talent shortages have boosted wages in general, particularly for higher-skill workers. At the same time, automation has undermined the wages of low- and medium-skill workers. The advent of generative AI may affect the wage premium for skills. For now, it is too soon to know where we are going. In 2022 and early 2023, wage growth did accelerate markedly, but in most economies it remained below inflation, and earnings have grown faster.

• Aging: Shift from saving for retirement to spending in retirement? An aging population has consequences for an economy’s aggregate savings rate. The conventional view holds that households accumulate wealth to prepare for retirement and then run down savings in retirement. But, with some variation across countries, households have not been spending savings as much as the conventional argument suggests, rather keeping capital as precautionary savings and to be inherited by their offspring; this is the so-called retirement savings puzzle.

  Do demographics therefore imply a continuous savings glut, or are we more likely to experience a “great reversal”? The mainstream view’s answer is that the savings surplus is set to continue for an extended period. But a minority position holds that the trend is about to break, that consumption expenditure (such as old-age healthcare costs) could rise substantially, and aggregate savings could fall. In addition, a rising dependency ratio means that the number of people dissaving in retirement relative to those saving during working life will grow (again, see Exhibit 7). Balance sheet expansion—asset valuation effects—also may play a role. If retirees no longer benefit from the same rate of asset price appreciation as in past decades, they will have to consume more of their savings.

• Savings glut from net exporters: Retreating? Particularly after the 1997 Asian financial crisis, economies in the region built up large foreign reserves to self-insure as a buffer against future shocks, which repeatedly led to sudden stops in capital flows. Much of this pool of reserves was invested in US Treasuries, bidding up their prices, which is tantamount to lowering their yields. The stunning net exports of China, but also of other net exporters like Japan and oil-exporting countries, added to this trend. China’s foreign reserves peaked at nearly $4 trillion in 2014, of which more than $1 trillion was directly invested in US Treasuries. But those holdings have since declined. Amid rising geopolitical tensions, the future path remains to be seen.

Can supply respond?

If the balance between investment and savings does shift, headwinds from demographics and geopolitics may make it difficult to meet the demand generated. Global labor supply grew rapidly in recent decades, adding capacity to an economy with soft demand. In advanced economies, rising participation by women has so far compensated for a rising share of the population in retirement age. However, as the population continues to age, the relative number of working-age people will continue to fall. In addition, about 60 million workers around the world ultimately serve North American demand, and about 50 million European demand. Geopolitical forces may affect these global flows and increase supply pressures locally.

On the upside, technology promises to generate tailwinds for supply. Could they move the economy from productivity stagnation to more innovation in and diffusion of technology? Past decades were characterized by slow productivity growth across advanced economies. So far, digitization has not translated into increasing productivity growth. But this could change as adoption spreads and technologies such as artificial intelligence add new capabilities.

To provide a window into an uncertain future, MGI developed four scenarios for how the economy and the global balance sheet might evolve in the period to 2030 (Exhibit 8). They differ in how forcefully and persistently the balance of desired savings and investment described in the previous section will shift, and in choices about monetary and fiscal policy as well as productivity investments. Each of the pathways is plausible; none were developed using extreme or low-probability assumptions (for more detail, see sidebar, “Development of macroeconomic scenarios”.)

Each scenario—return to past era, higher for longer, balance sheet reset, and productivity acceleration—includes a pathway to 2030 for GDP growth, inflation, and interest rates, the aim being to explore the longer-term trajectory rather than to make short-term predictions for the next year or two (Exhibit 9). MGI built a quantitative scenario model for the United States, United Kingdom, and Germany, but the characteristics are applicable more broadly.

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Return to past era scenario: Unsustainable balance sheet expansion at the expense of GDP growth

It remains possible that shocks will prove temporary, the structural overhang of savings will prevail, low interest rates will return, and balance sheet expansion will resume. At first blush, this scenario may appear attractive because wealth continues to grow. But that growth comes at the expense of real economic output, accentuates inequality, and continues to raise the risk of financial stress and future corrections (all numbers in this and the three other scenarios are for the United States).

• What happens: Secular stagnation returns. In this scenario, inflation comes down over the next couple of years to well below 2 percent. Labor market tightness subsides, and unemployment settles at previous or slightly elevated rates. Demand is weak and mediocre GDP growth resumes, averaging roughly 1 percent between now and 2030. The earnings share of GDP continues to grow. Smart money chases opportunities in capital appreciation, such as real estate, rather than productive investment. Real interest rates turn slightly negative again. Capital is misallocated, and productivity growth remains low.
• Balance sheet outcomes: Continued expansion and vulnerability. The balance sheet continues its secular expansion relative to GDP, but, as before, remains vulnerable to future shocks and disruptions. The total market value of equity, adjusted for inflation, grows roughly in line with past rates as the tailwinds of strong earnings and low interest rates continue. The value of real estate continues to benefit from low interest rates. The total value of bonds grows as leveraging resumes. Only deposits modestly retreat as central banks reduce the size of their balance sheets. Real household wealth grows by a cumulative 28 percent, or $40 trillion on paper, with rising wealth inequality.

Higher for longer scenario: Using inflation to lower balance sheet vulnerabilities at the expense of price stability

If investment picks up and the savings glut wanes in a meaningful and persistent way despite headwinds impeding GDP growth, inflationary pressure may become entrenched. Then if policy tightening remains moderate due to financial stability risks, the economy may experience a higher for longer scenario. This scenario has parallels with 1970s stagflation in the United States, albeit with somewhat lower inflation (4 percent rather than 9 percent). While the lack of price stability in this scenario is problematic, it comes with solid income growth, positive (if not impressive) growth in wealth, and improved balance sheet stability.

• What happens: Persistently elevated inflation and rates. In this scenario, inflation settles at roughly 4 percent as tight labor supply continues and the net-zero transition, supply chain reconfiguration, and national defense add two to three percentage points to the investment share of GDP. Nominal wages rise quickly, and consumption is strong. Policy rates rise in response but, with rising stress in the financial system, not by enough to bring inflation down to target. Strong demand and higher investment—even if not all of it is productive—support GDP growth somewhat above the recent trend. With bargaining power shifting in favor of workers and more forceful competition policy, corporate earnings grow more slowly than labor income and GDP. Risk premiums rise by one to two percentage points relative to averages over the past decade as volatility stays high.
• Balance sheet outcomes: Stagnation in real values and balance sheet contraction relative to GDP. The size of the balance sheet overall starts to revert toward historic averages relative to GDP, due to the combination of inflation and somewhat stronger GDP growth. As earning growth slows, the total market value of equity (adjusted for inflation) contracts in absolute terms and as a multiple of GDP. The market value of real estate falls in real terms as higher interest rates weigh more strongly for investors than inflation protection benefits and additional construction. Debt and deposits grow to finance higher investment, but more slowly than inflation; their ratios to GDP also decline. Real household wealth contracts by a cumulative 8.5 percent or $12.6 trillion.

Balance sheet reset scenario: A drawn-out recession is the worst case for wealth, income, and financial stability

Tighter policy, perceptions of rising risk, and stress or even failures in financial systems could lead to a sharp correction in asset values as well as a prolonged recession and a period of deleveraging. Monetary and fiscal policy cannot come to the rescue as they did in the global financial crisis because balance sheets are already large. This scenario bears some resemblance to what happened in Japan in the 1990s.

• What happens? A very hard landing and an almost-lost decade. Forceful monetary and fiscal tightening ends the bout of inflation. But higher real interest rates expose elevated debt levels and asset prices, which drop significantly. Financial institutions come under pressure with potential additional bank closures; value losses in bonds as well as in commercial and other real estate bite strongly into capital buffers. In the worst case, liquidity crunches force a fire sale of assets, further depressing values and triggering more systemic financial stress. Affected countries—and even the global economy—face debt restructuring or a drawn-out period of deleveraging. Uncertainty and risk premiums rise materially, and monetary and fiscal policy softens again to stabilize economic activity. Balance sheet adjustment drags down economic growth via deleveraging and thus weak demand as consumers pay back debt rather than spending. The supply side sees zombification of firms, banks, and assets, as well as capital starvation and weak investment. Deleveraging could last for a decade, and GDP growth would be one percentage point lower than in the previous decade. What makes the situation particularly difficult is that almost all sectors and countries are affected simultaneously at this stage, but deleveraging of one sector or country typically requires another one to add debt. Socializing the losses could accelerate the adjustment, but it is more difficult to achieve with already-high public debt and long central bank balance sheets.
• Balance sheet outcomes: Asset correction and deleveraging. Overall, the size of the balance sheet corrects relative to GDP. The total market value of equity declines in real terms and as a multiple of GDP. Equities are negatively affected by a brief spike in real interest rates (but then supported as rates come down again), increased uncertainty and risk premiums, and muted GDP growth and earnings expectations. For instance, US equities and real estate values might drop by more than 30 percent between now and 2030. Real estate values fall in real terms and relative to GDP, driven primarily by higher rates as well as falling tolerance for risk. Bond premiums grow, and debt and deposits come under pressure from deleveraging, although the public sector is assumed to have to further grow its debt to stabilize the economy. Real household wealth declines by a cumulative 20 percent—as in the case of total net worth in Japan in 1990 to 2000—or $30 trillion by 2030.

Productivity acceleration scenario: The Goldilocks outcome; rapid GDP growth improves wealth and balance sheet health

The scenario decision makers should strive toward is the one in which investment strengthens and is productive, accelerating productivity growth. This scenario somewhat resembles the period of very rapid productivity growth in the late 1990s and early 2000s. The balance sheet grows, but less quickly than GDP, and therefore is healthier and more sustainable.

• What happens? Productive investment and technology adoption step up to drive productivity. The forces outlined in the previous section lead to continued strong demand and an abundance of attractive investment opportunities. New investment materially accelerates productivity growth and GDP growth by one percentage point compared with the past decade. Faced with tight labor markets, firms accelerate investment in and adoption of digital and automation technology, fostering productivity growth. Reimagined supply chains remain efficient, and a new wave of emerging economies provides ample global labor. Industrial policy successfully drives innovation and technology. Fast supply growth moderates inflationary pressure. Inflation declines to target while real interest rates rise to about 1 percent on average, further supporting productive capital allocation.
• Balance sheet outcomes: Sustainable growth. Thanks to rapid GDP growth, the size of the balance sheet overall as a multiple of GDP declines slightly. The total real market value of equity grows only modestly more slowly than in the past, but it declines relative to accelerating GDP. Faster economic growth nearly compensates for losing tailwinds from a growing earnings share of GDP and a slight headwind from rising real interest rates. The value of real estate (adjusted for inflation) broadly stagnates, and it therefore declines relative to GDP. The total value of bonds grows to finance higher investment despite headwinds from interest rates. In a stable economy, deposits shrink in real terms as central banks roll back their balance sheets with quantitative tightening. Real household wealth grows by a cumulative 11 percent or $16 trillion.

The divergence of asset values and debt from GDP may end, reshaping the economic, banking, and investment landscape

Decision makers have become used to a balance sheet, both debt and asset values, that outgrew GDP for decades, but the next decade could see the world heading in a materially different direction. In all but one scenario—the return to past era—current asset price and financial system volatility prove to be only the early signs of a fundamental shift in how the balance sheet grows relative to GDP. In three of the four scenarios, the balance sheet contracts relative to GDP, be it via asset correction and deleveraging, inflation higher than nominal asset and debt growth, or faster GDP growth (Exhibit 10).

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Growth in equity, real estate, bonds, and deposits looks markedly different than in the past two decades. For instance, during the past 20 years, the total market value of the equity of listed as well as unlisted companies has grown by 5 percent annually in real terms; in the period to 2030, rates vary between minus four percent in a balance sheet reset scenario and plus six percent in a return to past era scenario. (Note that these numbers represent total market value growth, not performance, nor price.)

There are similarities and variations depending on the country. Notably, equities decline less in Germany and the United Kingdom than in the United States in the higher for longer and balance sheet reset scenarios, largely reflecting the fact that they did not experience as large a run-up in corporate earnings. In real estate, Germany and the United Kingdom experience a smaller decline relative to GDP than the United States in the higher for longer and productivity acceleration scenarios as interest rates rise less amid somewhat slower growth.

Decision makers will need to adjust their thinking to potentially a very different world economy and global balance sheet in the decade ahead, and indeed for an unusually wide range of potential outcomes. This calls for longer-term thinking, and a much broader set of indicators—including the global balance sheet itself—to be accounted for in strategy and planning than arguably they have been used to. Governments and corporations alike should collectively strive toward accelerated productivity growth, the only one of MGI’s modeled scenarios that achieves strong growth in income and wealth over the long term and a healthy global balance sheet. At the same time, however, they should actively prepare for less favorable outcomes.

Striving toward higher productivity is vital

Productivity growth and the choices made to achieve it are of preeminent importance in the current environment. Only an acceleration of productivity growth can underpin economic growth in the long term—and a healthy, sustainable global balance sheet. The situation has become much more urgent and important. Typically, policies to drive productivity achieve a few tens of basis points of additional economic growth. Now, the difference in household wealth between a productivity acceleration and a balance sheet reset scenario amounts to $48 trillion in the United States alone. Monetary and fiscal policy makers face a predicament: fail to tighten enough, and inflation stays uncomfortably high; tighten too much, and wealth and the financial system face stress. Without faster GDP growth, the line between these outcomes may be very thin.

What is needed to achieve a productivity acceleration scenario? First and foremost, it requires productive capital allocation and investment as well as more rapid adoption of digital tools, MGI research has shown. Reshaping the financial system to focus capital allocation toward new, productive capital formation could also help. What could shift the relative attractiveness of financing new businesses and projects in energy or infrastructure versus financing existing asset transactions like mortgages for existing homes at ever-rising prices or leveraged buyouts?

Moving toward higher productivity growth also requires decision makers to believe that it is achievable and to translate it into a credible outlook. If firms prepare for a slowdown in GDP growth or a recession, they are less likely to invest. Instead, waiting becomes attractive. Real estate developers, for instance, expecting lower prices, will delay developing new projects. Banks focused on strengthening their balance sheets will tighten lending standards, reducing the production of loans. All this might set the scene for a self-fulfilling prophecy of doom and gloom. Leadership from both public and private sectors will need to articulate the basis for the acceleration scenario in order to make it happen.

Firms will need to develop strategies to get ahead of a broad range of long-term outcomes

Since uncertainty may persist for at least some time, firms will need to plan for multiple scenarios. Past strategies may work well in a return to past era. Yet the other possibilities, and particularly the higher for longer and balance sheet reset scenarios, involve ruptures that arguably need a material shift in thinking, particularly among investors and financial institutions. Reacting to shifts in the macro environment will no longer suffice. Firms should identify markers for which scenario the world is headed toward, plan for a sufficiently broad set of scenarios, and test risk management approaches, as well as adjusting business models and seeking new growth opportunities.

• Identify markers for which scenario the world is headed toward. Many players still emphasize short-term financial indicators such as the latest inflation readings, an interest rate decision by the US Federal Reserve or Bank of Japan, and the reaction to any of these in the financial markets. Longer-term structural shifts generally attract less attention.

  Given today’s high uncertainty and structural forces shaping possible futures, decision makers need to look further ahead.⁹Dominic Barton, Dezsö Horváth, and Matthias Kipling, eds., Re-imagining capitalism, Oxford University Press, 2016. This means tracking indicators on the factors that might drive investment and savings, which are now shifting. They should also look at long-run drivers of supply and productivity growth, as well as the political and economic constraints that may shape the trajectory of fiscal and monetary policy.

• Plan for a sufficiently broad and long-term set of scenarios. What consequences would business bear, for instance, if interest rates and inflation stayed high for a decade or, in contrast, if GDP growth were to materially accelerate? To provide some examples:
  • How can investors and asset managers develop foresight and adjust asset portfolios? “Everything will be fine if you take a ten-year perspective” may apply less than in the past, whether for asset prices, financing conditions, or economic parameters. The scenarios have significantly different outcomes for different asset classes, and these need to be accounted for. For instance, in a higher for longer scenario, asset managers will want to contemplate reducing their relative weighting of growth equity funds. In several scenarios, cap rates would rise and stay higher, affecting investment cases for real estate developers.
  • How can banks rethink deposit models and secure liquidity and longer-term funding in the transition to a new interest rate regime? In several scenarios, deposits will fall at a systemic level, not only for individual banks.
• Test and strengthen risk management approaches. This might include bolstering equity buffers, strengthening balance sheets, or offloading macro risk. Stress-testing business models and balance sheets to these scenarios—or reverse stress-testing which parameters and thresholds would expose the largest vulnerabilities—should be a priority.
• Adjust business models and seek new growth opportunities. A sustained shift in the macro environment can make some business models partially obsolete and others newly attractive. To provide some examples for the questions that may be asked:
  • For investors, how to prioritize opportunities to capture value creation, including earnings and rent growth in scenarios where multiples no longer expand? Even with market headwinds, there will, of course, be opportunities in individual investments, from neighborhood redevelopment in postpandemic real estate to new business models in corporations. And in any case, increasing fiscal support, with rising investment in defense, energy, automation, and AI, could be available.
  • For financial institutions, how to restructure business models that often are still hardwired into an expanding balance sheet, abundant liquidity, and substantial maturity transformation of liabilities? What sources of revenue beyond net interest income could be most promising across scenarios? Examples for fee-based income include payments, advisory transaction pricing and facilitation, the origination and financing of new capital projects, and ecosystem services such as real estate brokerage and moving services. Mortgages (even more so in commercial real estate) and Lombard loans may require a critical reappraisal.
  • For banks, how to anticipate substantial shifts of product, customer segment, and geographic attractiveness? Increasing the speed of capital and business reallocation could pay off and capture money in motion ahead of competitors. In a higher for longer scenario, for instance, lower- and middle-income and -wealth quintiles could make up some of the ground they lost to higher-income and wealth quintiles. M&A opportunities will abound.

The turbulence of recent times is a shock to the system after a period of relative calm for the global economy and uninterrupted decades of rising wealth (and debt) on paper. The path ahead is highly uncertain, the range of possible scenarios unusually wide. The situation demands that assumptions be revisited and planning, strategy, and business models adjusted. The adjustment from what went before may well be prolonged.