The Macro Report | October 2016

Stopping to think about Brexit


The enactment of U.K. political priorities may exact a high economic cost, but a new approach to macro policy may open the door to meaningful fiscal measures.

In the United Kingdom, we are learning a little more about how the government views Brexit options. Prime Minister Theresa May has said that Article 50 is likely to be triggered by the end of first quarter of 2017, which means real progress has been made in clarifying what the government wants to achieve.

U.K. priorities risk high economic costs

The U.K. government has indicated its priorities are to end budgetary contributions to the European Union, to end free movement of people, to restore the supremacy of U.K. over European law, and to end the jurisdiction of the European Court of Justice (ECJ). Giving priority to the ability to restrict immigration and reduce spending on transfers to the European Union means that the government will have to give up any hope of full access to Europe’s single market.

This has come a shock to London’s financial sector. Loss of “passporting” rights for financial institutions seems to be something the government is willing to risk. The global banks have apparently run to the U.S. government, trying to get U.S. officials to put some pressure on the U.K., which will likely be for naught. But what should we make of these indications from the government?

Political security, economic uncertainty

It’s certainly true that the government looks secure. Theresa May is quite popular, and the opposition Labour Party is not inspiring any fear on the part of the government. Labour has just gone through a leadership election and has re-elected Jeremy Corbyn, a leftist who does not generally appeal with the broader electorate. With UKIP (the U.K. Independence Party) eating away at its electoral base and with upcoming changes to the boundaries of Parliamentary constituencies, Labour is shrinking as a political force.

The fact that the economy looks good so far does not mean the vote was costless, and it is by no means clear that the government’s position is yet settled. Moreover, the exact tradeoffs that will be required, and that will matter greatly to the longer-term outlook, cannot be known yet. They will depend critically on the attitude of the French and German governments, both of which will be determined by next year’s elections. So while the probability of a “hard Brexit” has risen, it is far too early to be confident about what exactly this means.

While the probability of a ‘hard Brexit’ has risen, it is far too early to be confident about what exactly this means.

A new approach to macro policy

The change in government has brought about another important change in economic policy: The new Chancellor has signaled that the old fiscal targets will be dropped and new rules will be put in place that would permit a large expansion in public spending on infrastructure. As one key member of the government is reported to have said: “We can borrow at a zero real rate. Why wouldn’t we?” He went on to say that monetary policy is clearly reaching its limits and a new approach to macro policy was called for.

We believe the United Kingdom has a more flexible macro policy framework than other advanced countries, and it will be interesting to see in the Chancellor’s Autumn Statement, due in November, more details about what the government has in mind. The guidelines will tell us a lot about the size of any fiscal boost being considered, and also whether it will be limited to infrastructure investment spending. The prospect of a shift in the global approach to macro policy is definitely in the air.


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