The Treasury’s Brexit short-term impacts analysis: A bit high, a lot political

The Treasury's analysis of the short-term impact of Brexit offers us two scenarios for the two years following the referendum: a base ‘shock’ and a ‘severe shock’ scenario. The base case means 3.6pc less economic growth in the two years following Brexit, with inflation up 2.3 percentage points and house prices down 10pc.

A first thing to grasp is the connection between the scenarios in this report and those in the previous Treasury report on the longer-term impact of Brexit. In its long-term impacts, the Treasury had three scenarios, for each of three options it claimed the UK had for its trade arrangements post-Brexit (all of which were very unlikely): an ‘EEA’ option; a ‘Canada’ option (the base case); and a ‘WTO’ option. The short-term impacts ‘shock’ scenario is the one in which the economy is in transition to the Canada option over the longer-term. The ‘severe shock’ scenario goes with the WTO option.

‘But what happened to the EEA option?’ I hear you ask. But you know the answer to that already: the EEA option scenario would not have produced a recession (as we’ll see below, the ‘shock’ scenario only just got there) so the headlines would have been bad. Indeed, the EEA option scenario might not have produced any non-trivial losses in the short-term at all. So it’s been dropped. Let us never talk of these matters again…

The ‘recession’ claimed for the ‘shock’ scenario consists of four quarters in a row for which output contracts by 0.1 per cent, allowing the claim that there would be a ‘year-long recession’. If, instead, output dropped by 0.2pc, then zero, then 0.2pc then zero we’d have had exactly the same lost output growth but no recession at all. GDP isn’t even measured to the nearest 0.1 per cent. The ‘Recession’ claims, luridly pushed by Remain campaign posters, are nothing to do with the neutral results of technical analysis and everything to do with raw politics.

HM Treasury Analysis – The Immediate Economic Impact of Leaving the EU by The Spectator

Indeed, they only get to the 0.1 per cent contractions by assuming that the impact would be felt in 2016 and 2017. But most of the negative short-term impacts of Brexit would be likely to be felt in the year before and year after we actually left, which would probably not be until the end of the EU’s current budget framework in 2020 (no-one is going to have any appetite to unpick that, with the UK being a large net contributor). So why are the impacts placed in 2016 and 2017?

Simples: because in 2016 and 2017, with the world economy slowing because of China, US interest rate rises and the rest of that ‘dangerous cocktail’ of global economic risks Osborne warned us about when he still did economics instead of referendum campaigning, UK GDP growth is likely to be fairly weak. That means, since UK growth will be weak anyway, if you add in a small negative impact from Brexit that can tip you from low positive quarterly growth into low negative quarterly growth and, Hey, presto!, you can warn of a recession.

I (as a Leave supporter) believe there will be some transitional costs, in terms of lost GDP growth, from Brexit. I expect something of the order of 2-3 per cent – so if GDP would have grown 2.5 per cent in each of 2020 and 2021 it might grow only 1.5 per cent. The Treasury’s 3.6 per cent isn’t absurdly high, but it is a bit high. There are three key reasons.

First, it is predicated on far too high a loss in GDP by 2030, of around 6 pert cent. I’ve published my own 2030 estimates today, of between a 1 per cent loss and 2 per cent gain in GDP by 2030. If I’m right and we aren’t transitioning to so low a new equilibrium, there wouldn’t need to be as much short-term loss.

Second, it assumes monetary policy wouldn’t change in response to Brexit, but it would. The Bank of England would have been raising interest rates in 2016 and 2017 without a referendum, and certainly by 2020. If we Brexit it could raise them slower.

Third, it’s assuming a 12 per cent depreciation in sterling. But sterling depreciations should be expected to provide a short-term boost to output, not a drop.

Overall, this Treasury analysis seems much more sensible to me than the long-term study, but there are many clearly political things about it, rather than its being any kind of neutral technical analysis. Is there some kind of campaign going on?