Blog Post

The effects of Brexit on UK growth and inflation

The full consequences of Britain’s vote to leave the European Union were never going to be immediately perceptible. As we approach the second anniversary of the UK’s Brexit referendum, we can compare the subsequent economic data for the UK and the euro area and see how it diverges from the trends established before the vote.

By: and Date: May 23, 2018 Topic: European Macroeconomics & Governance

Ben Bernanke, former president of the US Federal Reserve, had an interesting exchange with a US senator on September 24th 2008, just after the failure of the Lehman Brothers investment bank. The senator “had spoken to small-town bankers, auto dealers and others in his district with knowledge of the ‘real’ US economy. So far, he said, they had not seen any meaningful effects of the Wall Street troubles. ‘They will’, I said to him, ‘they will’.”[1]   Of course, subsequent developments fully vindicated the “they will, they will” view, as what followed was the most serious economic crisis since the Great Depression.

In a post I published in November 2016,[2] I took a view similar to Bernanke’s about the effects of Brexit: while Brexiters back then had noted that income losses were nowhere to be seen, I just suggested to add the two words “so far” to this remark. Now, nearly two years have passed since Brexit and we can ask whether we have started seeing the effects of Brexit on economic activity. Of course, nobody thought Brexit would cause a crisis comparable to the one that followed the failure of Lehman Brothers. Still, it is interesting to detect possible incipient consequences of the June 2016 referendum. Chart 1 looks at UK real growth, comparing it with that of the euro area.

 

Chart 1. Real growth in the UK and the euro-area. Q1 2011 – Q1 2018

Source of data: OECD data, Quarterly National account. Note: (*) – Market forecast. Real growth of each quarter on the same quarter of the previous year.

 

In the chart we see UK and euro-area real growth in the upper part, and the difference between the two on the lower part, with green signalling higher UK growth and red denoting higher euro-area growth.

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. Chart 2 reports CPI price inflation in the United Kingdom and the euro area. Again, the difference between the two is on the lower part of the figure, with green signalling higher UK inflation and red denoting higher euro-area inflation.

 

Chart 2. Consumer price inflation in the UK and the euro area. Q1 2011 – Q1 2018

Source of data: OECD data, Quarterly National account. Rate of growth of Consumer Price Index of each quarter on the same quarter of the previous year.

 

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.

This post was prepared with the assistance of Alessandra Marcelletti.

[1] Bernanke, The Courage to Act.

[2] Brexit has made the UK poorer: fact, no forecast from a “citizen of the world” expert. Money Matters? Perspectives on Monetary Policies. Nov 28th 2016.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic More by this author
 

External Publication

Brexit and European finance: Prolonged limbo

It will take longer than many had anticipated for the dust to settle on the post-Brexit financial landscape and its respective implications for the EU and the UK.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: September 24, 2021
Read article Download PDF More on this topic
 

Working Paper

Can climate change be tackled without ditching economic growth?

The notion of degrowth to reduce greenhouse gas emissions appears unrealistic; decoupling of emissions from growth is in principle possible but requires unprecedented efforts.

By: Klaas Lenaerts, Simone Tagliapietra and Guntram B. Wolff Topic: Energy & Climate Date: September 16, 2021
Read article More on this topic More by this author
 

Blog Post

Banks post-Brexit: regulatory divergence or parallel tracks?

Post-Brexit UK bank regulation is not likely to compromise on international standards, but will place greater emphasis on competition, making close UK-EU dialogue essential.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: July 6, 2021
Read article Download PDF More by this author
 

External Publication

European Parliament

UK banks in international markets

Implications of UK-euro area divergence in regulation and supervisory practice

By: Alexander Lehmann Topic: European Parliament, Finance & Financial Regulation, Testimonies Date: June 25, 2021
Read article Download PDF More on this topic
 

Working Paper

Stability of collusion and quality differentiation: a Nash bargaining approach

How do incentives to collude depend on how asymmetric firms are? For low levels of differentiation, an increase in quality difference makes collusion less stable. The opposite holds for high levels of differentiation.

By: Thanos Athanasopoulos, Burak Dindaroglu and Georgios Petropoulos Topic: Innovation & Competition Policy Date: June 15, 2021
Read article More on this topic
 

Blog Post

The coming productivity boom

AI and other digital technologies have been surprisingly slow to improve economic growth. But that could be about to change.

By: Erik Brynjolfsson and Georgios Petropoulos Topic: Innovation & Competition Policy Date: June 10, 2021
Read article More by this author
 

Opinion

Inflation, inequality and immigration: Spelling the digital recovery with three “I”s

The digital transition offers us a new opportunity to reach out across the global economy - hopefully we will find the strength to use it.

By: Rebecca Christie Topic: Global Economics & Governance, Innovation & Competition Policy Date: June 3, 2021
Read article More on this topic More by this author
 

Blog Post

New EU insolvency rules could underpin business rescue in the COVID-19 aftermath

Corporate bankruptcies are set to rise in the context of COVID-19. EU countries should speed up adoption of recent insolvency reforms and, in addition, offer consistent treatment to restructuring finance.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: March 24, 2021
Read article More on this topic
 

Blog Post

How has COVID-19 affected inflation measurement in the euro area?

COVID-19 has complicated inflation measurement. Policymakers need to take this into account and should look at alternative measures of inflation to understand what is actually happening in the economy.

By: Grégory Claeys and Lionel Guetta-Jeanrenaud Topic: European Macroeconomics & Governance Date: March 24, 2021
Read about event More on this topic
 

Past Event

Past Event

The impact of COVID-19 on productivity: preliminary firm evidence

Online event organised in the framework of MICROPROD, a research project to improve our understanding of productivity, its drivers and the way we measure it.

Speakers: Carlo Altomonte, Agnès Bénassy-Quéré, Maria Demertzis, Filippo di Mauro and Steffen Müller Topic: European Macroeconomics & Governance Date: March 18, 2021
Read article More on this topic More by this author
 

Blog Post

Financial services: The Brexit dust begins to settle

The phase of greatest Brexit-related uncertainty for the European financial sector ended on 1 January. Although too early to discern more than the broadest contours of the future landscape, it is increasingly apparent that London will be less dominant than before.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: March 11, 2021
Read article More on this topic More by this author
 

Blog Post

Continuing fiscal support and the risk of inflation

Ongoing fiscal support in the United States is not expected to provoke inflation risks. There are no immediate inflationary risks in the euro area either.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: February 17, 2021
Load more posts