The government and the Bank of England have failed to explain the risks properlyby Tony Yates / May 25, 2016 / Leave a comment
Read more by Tony Yates: The worst thing for Iain Duncan Smith’s “have nots” would be Brexit
The Remain campaign have long stressed the economic consequences of a “Brexit shock” following a vote to leave the European Union on 23rd June. Both George Osborne, the Chancellor, and Mark Carney, the Governor of the Bank of England, have warned of the dangers. This week we learned more following the release of a Treasury report.
The nature of the risk is that, following a vote to Leave, investors, firms and consumers decide that the economy is going to be less prosperous in the long term and, along with the other political and economic uncertainties, this causes a sharp drop in confidence and demand. That triggers a fall in Sterling, a temporary spike in inflation, and a contraction—relative to a vote to Remain—in output, employment, and a fall in real wages.
The risk is real enough. That’s why I was one of the now 287 economists who signed a letter to the Times pointing out that we shared the concern. But while they have warned of some danger, neither the Chancellor nor the Governor are coming entirely clear about this risk, nor what they would do about it.
Mark Carney’s Monetary Policy Committee (MPC) chose to publish their quarterly forecast for inflation on the assumption that the UK will vote to Remain. The consequences of a Leave vote were sketched only vaguely, and the conclusion was offered that rates might either rise or fall. This will have struck many—as it did me—as deliberately obscure.
Two forces are likely to put upward pressure on interest rates after a Leave vote and a Brexit shock. First, the drop in sterling will push up on import prices and therefore consumer price inflation. Second, the recession will cut investment, and this will shrink the economy’s potential. The more supply shrinks, the more this forces up prices and inflation.
Yet we can be fairly confident that both of these forces will be more than offset. To start with, the MPC will look through the…