Scott Sumner  

Brexit is not about Britain, #2

Is "neoliberalism" a menace to... Let Them In...

It's less that 3 months since the Brexit vote, and thus too early to form any firm conclusions. But one recent article points to the growing belief that Britain may have dodged a bullet, which hit the eurozone instead:

Brexit 'shock' threatens to do far more damage to the European economy than to Britain

. . . As is now abundantly clear, the immediate post referendum shock to the economy wasn't nearly as bad as many forecasters, including the Treasury, the Bank of England and the great bulk of City economists, feared it might be.

Thanks in part to a sharp devaluation in the pound, even the manufacturing sector seems to have weathered the storm in much better shape than generally anticipated. The litmus test will be this week's Markit/CIPS Purchasing Managers' Index (PMI) for the much bigger services sector, but anecdotal evidence already suggests that this too will look reasonably encouraging. Only in construction can we be sure of a bad set of numbers.

The upshot is that despite the turmoil of the last several months, it is now eminently possible that Britain will show a higher rate of growth in the post-Brexit third quarter than the Eurozone. Few if any would have predicted such an outcome.

The British economy sails on as if nothing has happened, but the European one continues to stagnate. It is as if the Brexit shock has been more powerfully felt in Europe than in Britain. Both France and Italy showed no growth at all in the second quarter, and now even the data from Germany is starting to look poor. [emphasis added]

"Few if any would have predicted such an outcome"?

I did not predict this precise outcome, but my knee jerk reaction immediately after the Brexit vote is starting too look a bit less crazy:

Brexit is not about Britain

I'm seeing a lot of confusion about the implications of Brexit. Here are two common misconceptions:

1. Some people see it as a real shock, whereas it's primarily a monetary shock.

2. Some see it affecting Britain's economy by disrupting trade, whereas it actually hurts the eurozone more, by depressing expected NGDP growth. The real effects are often overstated; Norway and Switzerland do fine outside the EU.

In some respects, this is quite similar to the British decision to leave the gold standard in September 1931. That decision also hurt the continent of Europe more than Britain (indeed in that case it actually helped Britain.)

This time around the UK was probably hurt somewhat; British stocks are down around 4% as I write. But French and German stocks are down 7% to 8%. The markets in southern Europe are down 10% to 15%. Brexit's most powerful effect is to make the eurozone crisis worse, by increasing doubts as to whether the eurozone will stay together. By analogy, the 1931 UK decision to leave gold made things worse for the rest of the gold standard, indeed a surge of public and private gold hoarding over the next few months drove global commodity prices sharply lower.

Most pundits viewed the Brexit vote as a massive negative "uncertainty" shock. There's nothing the central bank can do about real shocks. In contrast, I viewed Brexit as mostly a monetary shock.

It's beginning to look like the BoE eased policy enough to prevent a recession, at least in the short run. Just to be clear, I'm not claiming any crystal ball here. I think recessions are mostly unforecastable and I won't forecast the next one.

But my view that this was more a monetary than a real shock is beginning to look increasingly plausible. I'll do more updates as new data comes in. You don't get "uncertainty" experiments much more dramatic than the Brexit vote.

Brexit resized.png
PS. As usual, let me remind readers of the difference between Brexit uncertainty, which happened immediately, and the actual Brexit event, which is probably going to occur in 2019 at the soonest. I'm still mildly anti-Brexit, as the UK government has moved modestly away from an "open" stance, with the replacement of Cameron by May. So my fear that this would be tied in with a growing trend toward nationalism and statism has not entirely disappeared. On the other hand I'll keep an open mind on this. Ten years ago I might have favored Brexit, so let's see how it plays out over time.

PPS. My knee jerk reaction was somewhat flawed due to my use of the FTSE100 stock index, which (I didn't know at the time) was driven heavily by overseas profits. This was dumb luck on my part. With the correct stock data, my initial analysis would actually have been a bit less accurate. But even so, the southern European indices were hit the hardest.

Comments and Sharing

COMMENTS (15 to date)
Brian writes:

"It's beginning to look like the BoE eased policy enough to prevent a recession, at least in the short run."


What reason is there to think that there was a recession to prevent, or that the BoE actually did anything meaningful, as opposed to saying that the Brexit uncertainty shock is just too small to have any effect?

ThaomasH writes:

Most economists thought and still think that Brexit will harm the UK because it will result in more restrictions on movement of people, goods and services. [The UK should seek a new arrangement that interferes with the free movement of people goods and services as little as possible but who know if they will and whether the EU will grant it.] That's a supply shock that monetary policy can do nothing about. The resultant uncertainty about what kind of new deal will be achieved is a demand shock and monetary policy CAN prevent it from affecting NGDP growth, but it's an optimistic pundit that monetary authority alway react to demand shocks as they can and should. Fortunately in UK they did. The ECB will not.

John Hall writes:

Just FYI, current forecasts are for a sharp slowdown in 2017 UK GDP growth.

Will writes:

Based on your definitions from the first article, I'm still having trouble understanding why this is a monetary & not real shock. Even if CBs were to maintain NGDP growth expectations, I would expect that to show up as increased inflationary pressures. That we've seen the opposite only tells me NGDP growth expectations haven't been maintained, not that the shock is monetary? What am I missing?

Scott Sumner writes:

Brian, We don't know if there was a major uncertainty shock. But the proponents of the "uncertainty theory" said this was one of the biggest of all time. That seems plausible to me, if you exclude monetary uncertainty.

So if they are wrong, then one of two things are true:

1. Uncertainty shocks don't matter very much.

2. Uncertainty shocks are almost impossible to identify.

In either case, the uncertainty theory would not be very useful.

Thaomas, I tend to agree. But the uncertainty proponents claim it is a real shock.

John, The key variable to focus on is unemployment. That's where I think people may have overestimated the impact. But I certainly agree that we'll have to wait a year or so to get a good read on RGDP growth.

Scott Sumner writes:

Will, I was under the impression that inflationary pressures had increased a bit in the UK. Is that wrong?

Brian Donohue writes:

Hey Scott,

You know who the original Cassandra was, don't you?

That's what it feels like right now.

Benjamin Cole writes:

It may be that national self-determination leads to better macroeconomic policy-making, even in the aggregate. I judge economic policy-making by resulting living standards.

Watching Southern Europe, I cannot imagine joining the EU was a good idea for the southerners, especially joining the ECB.

There is the problem of large government--sheesh, even national governments are too big. Public international organizations are famous for ossification and long lunch breaks.

Would a Balkanized globe be more prosperous?

The orthodox answer is "no," but the idea of Global Central Bank is bad too---even the ECB is a bad idea, and see Milton Friedman.

All in all, I find the internationalists and free traders a little glib, and the nationalists a bit scary.

Scott Sumner writes:

Ben, You said:

"Watching Southern Europe, I cannot imagine joining the EU was a good idea for the southerners, especially joining the ECB."

I strongly disagree, the EU has been a huge boon to southern Europe, dramatically boosting living standards. Certainly the euro was a mistake, but the UK never joined the euro.

Lorenzo from Oz writes:

Scott, you said

I strongly disagree, the EU has been a huge boon to southern Europe, dramatically boosting living standards. Certainly the euro was a mistake, but the UK never joined the euro.

The EEC was a huge boon. If the euro was a mistake, it was a pretension built into the EU, which makes the EU a mistake (one of over-reach).

The British electorate voted very strongly for the EEC in 1975 and narrowly against the EU in 2016 but still (according to opinion polls) very strongly favours free trade with Europe.

If the EU was still the EEC, one doubts that Brexit would even have arisen ...

James Alexander writes:

Divining UK implied inflation is not easy, you have to decide which market interest rate to use and where on the curve you are looking. The BoE look at implied inflation using four different interest rates and along the whole curve:

But, yes, inflation expectations have risen, especially recently.

The BoE has been more innovative than non-market folk think.

James Alexander writes:

Amend that slightly. The BoE derive implied inflation using two rate curves, forward rates and spot rates, then divided into short end up to 60 months, and long end up to 25 years.

Scott Sumner writes:

Lorenzo, I trend to view the EU as the EEC, just further down the road. But I accept your point.

I would point out that the Brexit vote is very likely to make the UK a less open economy, in terms of labor flows and financial services. Maybe even with trade, but that's still to be determined.

James, Thanks for that info.

mbka writes:


agree that (the significance of) Brexit is (much more) about the EU and not so much the UK, because the UK in and by itself is not very significant as a country. And the EU suffers from enhanced uncertainty of its own future due to Brexit. This uncertainty is larger than the uncertainty about the UK, largely confined to when and under what conditions.

But, I'd also say the lackluster performance of the rest of the EU has less to do with Brexit than with whatever the rest of the EU has been doing.

Ironically, going by the press, economists in Germany and Austria claim that the recent influx of displaced refugees boosts their GDPs by 0.5-1% in the short to medium term, if memory serves. So much for the negatives of immigration.

AntiSchiff writes:

Dr. Sumner,

For what it's worth, my model interpreted the drop in the FTSE 250 as predicting a .85% drop in GDP below trend with a related rise in unemployment of .55%. That was taking the market reaction into account 7 days after the Brexit vote. So, I didn't expect a recession, and market forecasts have since improved.

One problem with the above is that the FTSE 250 may not be sufficiently representative of the UK economy, solely.

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