I’ve done a number of posts over at Econlog on the massive uncertainty shock that hit the UK in June. Most experts expected real GDP growth to immediately slow sharply, perhaps leading to a recession. I had an agnostic view, and thought any negative effects were more likely to show up in lower RGDP than higher unemployment. I still feel that way, although I’m starting to think that even RGDP will do better than I assumed:
The UK’s first official growth figures since the Brexit vote have confounded the government’s warnings of an immediate recession if Britain voted to leave the EU.
The economy was 0.5 per cent larger between July and September than three months earlier, according to the Office for National Statistics. The Treasury had predicted it would shrink 0.1 per cent.
[Those are quarterly figures, roughly a 2% annual rate.] Why is the UK doing better than predicted? I can’t be sure, but one possibility is that the BoE’s monetary offset was more effective than expected. The British pound has depreciated sharply, even more than people expected:
“We would not get too carried away,” said Ruth Gregory of Capital Economics. “It could be that the economy is in a post-referendum ‘sweet spot’, whereby some of the positive developments since the vote, such as action by the MPC [BoE] have been felt before the major adverse consequences, such as a rise in inflation.”
I think that’s right, and I also still believe the actual Brexit (which will occur in about 2 1/2 years) will be modestly negative for growth. But I can’t help pointing out that the only reason I think she’s right is because I totally reject the consensus of the economics profession on long and variables lags in monetary policy. I believe that monetary policy affects NGDP within a month or two. If I agreed with the consensus on lags I would have thought Ruth Gregory’s explanation was nonsense, and I would have looked for another explanation. Those who do agree with the consensus on long and variable lags need to figure out how the UK economy held up after the Brexit vote.
1. Brexit is an uncertainty shock, followed in 3 years by a real shock.
2. The uncertainty shock might depress the economy by reducing AD (NGDP) or by reducing AS. The central bank can prevent any reduction in NGDP.
3. It appears that the impact of severe uncertainty shocks on AS is rather modest, although we’ll need another 6 months of data to have confidence in that preliminary judgment.
If the UK economy holds up, it will be further evidence that monetary policy drives the business cycle, especially in terms of changes in the unemployment rate.
That does not mean AS is not important, indeed in the long run it’s 10 times more important. I.e. the US in a recession is more than 10 times better off than India in a boom. Brexit still may have a long run negative supply-side impact on the UK; the size of the impact will depend partly on the sort of treaty they negotiate with the EU, and partly on how the political changes in the UK triggered by Brexit affect its economy. My hunch is that the latter effect will be larger. That is, the damage to Britain from May’s statist policies will exceed the damage from losing free access to the EU.
PS. It would be nice if the UK government had a NGDP prediction market, so that we’d know what the markets expected immediately after Brexit.