Short and long term forecasts

Many Leavers do not believe the economists who say that Brexit would do harm to the UK economy. Leavers can point to the forecasts of short-term harm that did not come true. What do we say in response? There is no single simple rebuttal. London4Europe Committee member and former HM Treasury senior civil servant Michael Romberg works through the arguments.

What HM Treasury’s short term forecast said

On 22 May 2016, HM Treasury published a forecast which said “A vote to leave would cause a profound economic shock creating instability and uncertainty which would be compounded by the complex and interdependent negotiations that would follow. The central conclusion of the analysis is that the effect of this profound shock would be to push the UK into recession and lead to a sharp rise in unemployment.”. That did not happen.

The basis of the Treasury’s forecast was

• A transition effect as economic agents anticipated the economy becoming less open
• Uncertainty would mean that business put off decisions
• These real world effects would affect financial conditions which would in turn feed back into harder real world conditions

The political basis of the forecasts did not materialise

Part of the political basis for the economic forecast was that the Article 50 notification would be sent in “straight away”. In the event, it was not sent in until 29 March 2017, more than 9 months after the referendum.

The Bank of England took counter-measures

The point of forecasts is to enable you to take counter-measures. If the weather forecast is for rain you take an umbrella.

Immediately after the referendum, the Bank offered to lend banks £250bn immediately if their normal sources of funding dried up. 

Soon after the referendum the Governor indicated that the Bank of England would cut the base rate and on 4 August 2016 the Bank did so. That supported the economy.

The short term forecast over-estimated consumers’ prescience

Leave voters mostly did not believe the forecasts that Brexit would harm the economy. Remain voters did believe the forecasts, but did not think the effects would harm them personally.

In my view consumers do not anticipate distant economic problems - until they are actually happening to people like them.

The forecast did come right in part and more slowly

Currency traders of course do anticipate economic effects. The most immediate harm was the fall in the exchange rate. Sterling fell by 12% against the Euro and by 5% against the dollar in the immediate aftermath of the referendum. However, some hold that it had been overvalued before. Here is a ten year graph.

The fall in the value of Sterling is thought to have pushed prices up by about 2% since the referendum. So the forecast of economic harm has come right in part: expected lower economic performance reduced our purchasing power via the exchange rate.

Most economics forecasters did better than HM Treasury

It is also right to say that most economic forecasters were more accurate in their short term forecasts than HM Treasury had been.

Writing in the Financial Times on 15 March 2019 (access the website here or a download of the article here), Economics Editor Chris Giles reminds us that the National Institute for Economic and Social Research, the Institute for Fiscal Studies and the Centre for Economic Performance at the LSE had forecast that a Brexit vote would mean that the economy would be between 1 and 3% smaller by 2020 than if the vote went for Remain. The economy is now 1.5% smaller than the Bank had forecast pre-referendum it would be - even though the world economy has been stronger than expected.

Other forecast measures were also reasonably accurate.

The exception is that the forecast rise in unemployment did not happen – something that has been puzzling the economics profession for several years now. Possible explanations include changes in the number of people on zero- and low-hours contracts, that employment is a lagging indicator, that businesses that have held off capital investment due to Brexit uncertainty have used labour instead – easier to dismiss if a Brexit downturn comes, and that Brexit creates jobs, but alas in no-deal planning and moving business abroad rather than anything productive.

The Office for Budget Responsibility’s post referendum forecast for the size of the economy at the end of 2018 was accurate to within 0.1%. HM Treasury and Economists for Brexit were the outliers in their pre-Brexit forecasts, with an error 25 times larger than the OBR’s – in opposite directions.

Long-Term forecasting is easier

Getting the numbers right is hard. But the basic direction is clear. It’s a bit like your doctor telling you that you will die sooner if you smoke, drink and don’t take exercise, even if s/he cannot tell you in which year you will die.

More trade is good for the economy because it encourages competition and specialisation, which in turn boost productivity. So increasing barriers to trade –  economically Brexit is above all an exercise in protectionism – harms the economy. In addition, Brexit would be expected to lead to a fall in Foreign Direct Investment in the UK which would reduce income. Few economists would dispute those statements – though it is of course all more complicated than that. Josh de Lyon of the Centre for Economic Performance at the London School of Economics reviews the Brexit forecasts here. Together with Swati Dhingra he reviews the performance of the economy since the Brexit referendum here. 

We also need to recognise that the economic effects of Brexit are neither the dramatic stories of huge job losses nor that we would become poorer in absolute terms. Rather, in Chris Giles’ words, Brexit brings “a slow drip of lost opportunities, activity moved elsewhere and income disappointments”. We would become better off than now, but more slowly than if we had stayed.

Conclusion

Brexit would make us poorer. Most short term economic forecasts about the economic effects of the referendum decision were reasonably accurate except on unemployment. The long term forecasts are based on fundamental economic truths. While the numbers will be in doubt, the trend in the forecasts is clear.

The London4Europe blogs page is edited by Nick Hopkinson, Vice-Chair. Articles on this page reflect the views of the author, not necessarily of London4Europe.