23 May 2018

Bruegel: The effects of Brexit on UK growth and inflation

[...] For most of the period that followed the start of the European phase of the Great Recession, which was ignited by revelations about the misreporting of Greek fiscal data, the euro area has grown at a slower rate than the UK. Since the beginning of last year, however (i.e. some six months after the referendum), the ranking has changed, with the euro area growing more than the UK. This is no conclusive proof that it was Brexit that slowed down the UK economy with respect to that of the euro area. However, the coincidence needs an explanation: if the cause was not Brexit, what was it?

While the effects of Brexit on GDP might not have been immediate, the June 2016 referendum immediately impacted the pound’s exchange rate and thus the terms of trade of the UK: in the post referred to above, I assumed that these terms deteriorated by the same amount as the effective exchange rate depreciation: 13%. This loss in the terms of trade was thus more than half of what had followed the 1973-1974 oil shock – so, I concluded, in terms of trade deterioration:“British voters caused more than half of the damage imparted by sheiks.”

As after the oil shock, the way for terms of trade to recover was, assuming no change in the exchange rate, for domestic inflation to exceed foreign inflation. [...]

UK inflation has been practically always higher than in the euro-area since 2011 and this pattern could be seen, until recently, as consistent with the higher growth: the UK economy experienced more buoyant economic conditions that manifested themselves in both higher inflation and higher growth. This consistency seems to have been lost since sometime after the Brexit referendum: inflation has continued to be higher in the UK than in the euro area, but growth has been lower.

Again, this is no proof that Brexit caused a deterioration of macroeconomic conditions in the UK, but the coincidence is remarkable. My conviction that borders are bad for the economy, and the fact that Brexit means establishing a border where there was none previously, leads me to a guilty verdict.

I think the burden of proof falls on Brexit supporters to show that the vote to leave was innocent.

Full analysis on Bruegel

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