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: 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 Download PDF More on this topic
 

External Publication

Diversification and the world trading system

Diversification is important because it is associated with economic growth and reduced volatility.

By: Uri Dadush, Niclas Poitiers, Abdelaaziz Ait Ali, Mohammed Al Doghan, Muhammad Bhatti, Carlos Braga and Anabel González Topic: Global Economics & Governance Date: September 16, 2020
Read article More by this author
 

Opinion

The EU’s Opportunity to Turn Its Markets Toward the Future

Meeting the fiscal demands of COVID-19 will require the European Union to borrow on capital markets more than ever, and for European pension funds and households to look more widely for ways to build their nest eggs safely. The EU should take the challenges of the pandemic and Brexit as a chance to get its financial infrastructure house in order.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 16, 2020
Read article More by this author
 

Podcast

Podcast

One rule to ring them all? Europe's financial markets after Brexit

What effect will brexit have on Europe's financial markets?

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 26, 2020
Read article More on this topic More by this author
 

Opinion

Reading tea leaves from China’s two sessions: Large monetary and fiscal stimulus and still no growth guarantee

The announcement of a large stimulus without a growth target indicates that China’s recovery is far from complete.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: May 25, 2020
Read article Download PDF More by this author
 

Policy Contribution

European Parliament

The European Central Bank in the COVID-19 crisis: whatever it takes, within its mandate

To keep the euro-area economy afloat, the European Central Bank has put in place a large number of measures since the beginning of the COVID-19 crisis. This response has triggered fears of a future increase in inflation. However, the ECB's new measures and the resulting increase in the size of its balance sheet, even if it were to be permanent, should not restrict its ability to achieve its price-stability mandate, within its legal obligations.

By: Grégory Claeys Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: May 20, 2020
Read article More on this topic More by this author
 

Opinion

How will COVID-19 impact Brexit? The collision of two giant policy imperatives

The United Kingdom left the European Union on Jan. 31, 2020. Now, the U.K. must decide whether and how to extend the transition period, currently set to expire at the end of 2020.

By: Rebecca Christie Topic: European Macroeconomics & Governance Date: May 19, 2020
Read article Download PDF More on this topic
 

Policy Contribution

The European Union’s post-Brexit reckoning with financial markets

In the negotiations between the European Union and the United Kingdom over their future relationship, we see a high probability of a weak contractual outcome, given the dominance of politics over considerations of market efficiency.

By: Rebecca Christie and Thomas Wieser Topic: European Macroeconomics & Governance Date: May 13, 2020
Read article More on this topic More by this author
 

Opinion

Depression, and not stagflation, could haunt China in 2020

This opinion piece was originally published in Asia Times and Medium China’s GDP in the first quarter of the year has surprised nobody but the devil is in the details. Local retail sales continued to fall in March (-16%), marginally better than during the peak of the Covid19 outbreak in January and February. The continuation […]

By: Alicia García-Herrero Topic: Global Economics & Governance Date: April 17, 2020
Read article More on this topic
 

Blog Post

The case for a derivative market programme

The implementation of a Derivative Market Programme could reaffirm the ECB’s credibility and strong commitment to price stability.

By: Sybrand Brekelmans and Francesco Papadia Topic: Finance & Financial Regulation Date: March 18, 2020
Read about event
 

Past Event

Past Event

ONLINE ROUND TABLE: Future of the EU-UK science cooperation

How do we rebuild and keep the science cooperation between the EU and the UK?

Speakers: Michael Leigh and Beth Thompson Topic: European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 17, 2020
Read article More on this topic
 

Blog Post

Three macroeconomic issues and Covid-19

COVID-19 raises a number of serious issues of a sanitary, social and economic nature. While recognizing the difficulty of giving definitive answers at this early stage, we attempt to shed light on three critical macroeconomic topics.

By: Leonardo Cadamuro and Francesco Papadia Topic: European Macroeconomics & Governance Date: March 10, 2020
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live - The Brussels effect: How the European Union rules the world

This was a live recording of an episode of the Sound of Economics, Bruegel's podcast series. The discussion centered around the book of Anu Bradford, The Brussels Effect.

Speakers: Anu Bradford, Ashoka Mody, Giuseppe Porcaro and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 3, 2020
Load more posts