There’s already quite a wide consensus around the basic assumption of the Treasury’s latest report that there would be a short-term economic shock from leaving the EU. However, it’s nigh on impossible to credibly foresee the size of this shock. And by going too far on such estimates the Treasury risks undermining the consensus already in its favour.
Contrary to what one may be tempted to assume, short-term economic forecasts are often harder to make than longer-term ones. Making reasonable assumptions about how policy choices a few years down the line shift economic growth from a baseline is a slightly easier exercise than trying to predict short-term market movements – especially without any historical precedent, as in the case of Brexit.
Looking at some of the predictions in more detail, one important point to keep in mind is that all headline estimates (e.g. GDP between 3.6 per cent and 6 per cent lower after two years) are calculated against a baseline where the UK’s economy continues to grow – not against current levels. This means the Treasury’s forecast of recession under its central scenario ultimately boils down to four consecutive quarters of -0.1 per cent GDP growth.
The Treasury also assumes that, during the post-Brexit negotiation between the UK and the EU, businesses and investors would start positioning for a “less open, less productive and poorer” UK. Crucially, however, this is based on the Treasury’s own analysis of the long-term impact of Brexit. It’s hard to believe all businesses would see things this way, not least because the openness or not of the UK economy will depend on UK government policies which remain to be seen.
That said, there would be a significant amount of uncertainty around the negotiations. This could hamper business investment and consumer spending – and the Treasury is right to point that out. Another valid assumption is that Brexit would trigger volatility on the financial markets. On the other hand, claims that unemployment would go up by between 1.6 per cent and 2.4 per cent sound exaggerated – especially given that, following the financial crisis, unemployment in the UK only rose by 2.9 per cent.
Coming to house prices, the fall of between 10 per cent and 18 per cent envisaged by the Treasury is of the same magnitude of the 18.7 per cent drop seen in the wake of the financial crisis. However, again it seems unlikely that the fall from the uncertainty surrounding Brexit would be comparable to the financial crisis. Furthermore, one has to question how concerned people would actually be by such a drop – given the recent rise in prices and the structural shortage of housing in certain areas of the country. Lower prices may also quickly attract foreign investors.
As for the Treasury’s assumption that the pound would drop by between 12 per cent and 15 per cent; that is not unprecedented. However, it’s big stretch to predict how exactly this would feed through to food and clothing prices – not least because this also dependent on whether the devaluation would be temporary or more permanent, again near impossible to say.
Finally, perhaps one of the biggest shortcomings of the Treasury’s new report is that it assumes that there would not be any policy response from the Government or the Bank of England to try and mitigate the shock after Brexit. This is simply unrealistic.
Overall, it is therefore fair to say that there would likely be a short-term economic shock following a vote to leave the EU – but the Treasury is ultimately overdoing it by making some overly pessimistic assumptions.
Raoul Ruparel is co-director of Open Europe