Who Could’ve Known “Crash Brexit” Would Be Problematic?

In the aftermath of the Salzburg summit, where the Chequers plan was dismissed by the EU, and PM May demanded “respect”, the pound has plunged.

Source: TradingEconomics.com.

Deutsche Bank (Harvey, et al., “Deep impact: DB forecasts in a crash Brexit”) yesterday lays out why:

In our analysis, we calculate that UK growth will be around 4% cumulatively lower than under our baseline scenario by end-2020. The UK will enter a two year recession, with output shrinking -0.3% and -0.6% in 2019 and 2020 respectively. The main contributers to the fall in demand are household consumption, which shrinks around 6% relative to our baseline, and business investment which is 13% lower than our baseline. Net trade is assumed to add a moderate boost to GDP, as while trade falls substantially, imports fall slightly more than exports.

While there is considerable debate about the monetary policy response to a crash Brexit, we expect the Bank of England to announce a broad based easing package, including a cut to the base rate to 0%, more QE and corporate bond purchases, a new TFS program and a reversal to rises in the counter cyclical capital buffer. The fiscal response is more politically dependent and less predictable. With a large fiscal response (taken to be GBP 25bn of additional borrowing a year), the loss of output is less severe, with the UK economy growing 0.2% and 0.5% in 2019 and 2020 respectively.

While the difficulties in forecasting the economic performance of the UK economy in the wake of a crash Brexit are manifold, one thing is certain. Crash Brexit is not an end destination for the UK. From day one, negotiations between the UK and EU27 will resume on a future economic relationship.

In other words, the terms of trade for UK drops, the monetary authorities will try to offset some of the demand shock with expansionary policy, both resulting in a currency depreciation; at the same time, policy uncertainty is heightened.

Figure 1: UK Economic Policy Uncertainty index (blue, on log scale). September observation daily average through 9/21. Source: policyuncertainty.com and author’s calculations.

21 thoughts on “Who Could’ve Known “Crash Brexit” Would Be Problematic?

  1. pgl

    “May told EU leaders that she wouldn’t back down and demanded they show her country “respect” in talks.”

    May sounds a lot like Trump. Fearless leader must be respected even as my nation goes down the dumb road of trade protection. The economic scenario you laid out for the UK may also be the fate of the US economy – alas.

  2. Bornagaindem

    This is complete stupidity -I do not even know why brits are posturing. They know exactly what the EU proposal looks like – at best it looks like the deal Norway and the EU have- they must allow the 4 freedoms and give up any say in shaping those laws. The EU can’t make any other deal. So all of this is nonsense and posturing.

    Is this a ploy to hold another referendum I hope so.

  3. 2slugbaits

    None of this should come as news to anyone who follows Simon Wren-Lewis or watches Deutsche-Welle broadcasts from Berlin.

  4. Moses Herzog

    Am I “pro-Brexit”?? Call it “riding the fence” but I have a lot of mixed feelings about it. But if forced to give an answer I would say I am leaning towards the pro-Brexit side. Why?? I can answer that question with another question. Or, answer that question with another three questions. Which would you rather be right now?? Greece or Britain?? Ok, how about Italy or Britain?? Now let’s try Spain or Britain?? Although I try to avoid reading Menzie’s mind (as Menzie is maybe two standard deviations of IQ points above me), I doubt even Menzie could give a satisfactory answer to any of those three specific questions that would support his anti-Brexit stance.

    1. Menzie Chinn Post author

      Moses Herzog: I’d rather be Netherlands than Britain, or Germany than Britain, or Austria than Britain or Sweden than Britain or Denmark than Britain. The latter two are particularly germane as they are not in the eurozone. At the same time, free labor mobility has meant a boon to UK per capita income.

      1. Moses Herzog

        That’s a solid argument, better than I expected. Dagnabit you.

        My only half-hearted “return of serve” would be, what if EU inflation gets disjointed with any of those countries’ individual fiscal policy goals?? I am telling you nothing you don’t already know when I say that gets “messy” real fast. There have been some ideas on sovereign bonds floated there (SBBS they call them??), but those are semi-artificial solutions that no one knows will “really” work.

        1. Menzie Chinn Post author

          Moses Herzog: One-size-fits-all monetary policy is a problem, but I’d say the bank-sovereign debt-aggregate demand doom loop (see Jay Shambaugh, BPEA) is a bigger concern, given the lack of a fiscal and banking union. I think UK did pretty well inside the common market, but outside the eurozone. Getting rid of it (and reverting to WTO on trade, chaos on everything else) is going to hit the UK, by (literally) all formal modeling approaches.

    2. joseph

      “At the same time, free labor mobility has meant a boon to UK per capita income.

      Average income is a blunt measurement. How about median real income? Not so impressive.

      1. Menzie Chinn Post author

        joseph: My guess is that median household income will fall with crash Brexit. Of course, this does not deny the possible (likely) outcome that integration benefitted high income households more than low. But the assertion that Brexit (and accompanying limitations on immigration) will induce a rise in low-skilled native labor in the UK presupposes the view that domestic low-skilled labor and immigrants (even low skilled) are substitutes rather than complements. For me, that’s an empirical question rather than valid priors.

      2. 2slugbaits

        Brexit will also hurt Britain’s productivity, which is already abysmal. And since what’s really driving Brexit is anti-immigrant sentiment from Wales and England (except London), Brexit is likely to hurt National Health as well because immigrants contribute much more to the NHS than they take out. Also, higher education is a significant export industry in Britain. Brexit will hurt that export market. Bottom line is that Brexit is the worst of all possible worlds. You couldn’t design a stupider policy if you tried.

        1. sherparick

          There is a reason that J. S. Mill called the Tory Party the “Stupid Party.”

          Full quote: “I did not mean that Conservatives are generally stupid; I meant, that stupid persons are generally Conservative. I believe that to be so obvious and undeniable a fact that I hardly think any hon. Gentleman will question it.”

      3. Ulenspiegel

        “Average income is a blunt measurement. How about median real income? Not so impressive.”

        Agreed. And it is obvious that the UK lost a lot of ground in the last decade in comparison to France and Germany:


        Here Figure 2 is interesting. The number of Bbrits which are poor in the EU context increased dramatically between 2007 and 2016.
        Was this a result of EU policies or domestic UK policies (austerity)?

  5. SecondLook

    since what’s really driving Brexit is anti-immigrant sentiment from Wales and England (except London)

    And what is bitterly amusing, and would be bewildering to a lot of white ethnic Americans, is that the prejudice is heavily directed towards Poles, many who arrived with strong blue collar job skills.

    1. dilbert dogbert

      I wish I could keep better track of what I read about Polish labor in England. I was reading of a woman who had hired some Poles to do some work. Can’t remember what work. She was very pleased with the price and performance. The next year she asked them again to do a piece of work. The price was not good. She asked why. They said they were charging English rates. I wonder if that is the source of resistance to Polish immigrants? They were learning to quickly.

  6. Moses Herzog

    Hmmmmmmm, I seem to remember some Wisconsin U guy discussing this Rosenstein guy might lose his job as Deputy AG.

    I forgot who it was now. Some sharpie but I forgot his name. I will say this: I know that the discussion of “racial characteristics” has kind of been banned on this blog. And on some levels, hey I “get it”. If I ran a blog, I’d probably have certain topics which are more “sensitive” off limits. (I really don’t like it, but I guess I can accept it).

    I’ll only say this then, since certain topics are off limits—Rosenstein is nobody’s fool—and he’s not going to be anyone’s fool. Could he be canned for invalid reasons?? Yes, Rosenstein could be canned for invalid reasons—-but be it trump or whoever else—-I pity the man who tries to hang Rosenstein out to dry on the laundry line—- THEY WILL RUE THE DAY THEY CROSSED ROSENSTEIN—MARK IT DOWN

  7. Barkley Rosser

    Something the Brexit vote and US Trump politics have in common is that (aside from Scotland in UK), the areas with the fewest immigrants have tended to be the most anti-immigrant, voting for Brexit in UK and for Trump in US.

    Extreme examples of poor areas doing this are Cornwall in UK, a huge recipient of EU financial support, with almost no public investment projects lacking EU money although the locals mostly do not know that. They have been angry at EU rules on fishing, although out of EU they will be blocked from nearly all of their usual fisheries, and the rest being a resentment against London and high income elites. But they will seriously lose from a hard Brexit exit.

    In US similarly we have West Virginia, strongly for Trump even though strongly pro-Dem not too far in the past (coal unions and all that). They may be less deluded than the Cornish as Trump loves coal and they have lots of it. But even he will not bring it back, and many of them voted for him for his anti-immigrant position, just as the Cornish did in the Brexit vote, but neither Cornwall or West Virginia has any immigrants at all. It is like the old wisecrack about Poland in the 60s when they engaged in an anti-Jewish campaign, “How to have anti-Semitic campaign without any Jews.”

    1. Moses Herzog

      @ Barkley Rosser
      I think my only response to this is, there may be a portion of truth as to what you are saying as to “resentment to elites”. And probably the Cornwall–West Virginia analogy is pretty apt as well. However I think this type argument in the last couple years–relating trump fanaticism and Brexit—has been painted with WAY too broad of a brush. There are many intellectually valid reasons for people not wanting to be part of the EU. National sovereignty and out and out Democracy being among them. The idea that people of ALL socioeconomic groups and ALL educational backgrounds saying “I don’t want my democratic vote watered down” is as valid as ANY rationalization for the EU. And to say “pro-Brexit people are low-educated and resentful” is as cerebrally vacant as the 10 year old boy on the playground saying “i am not the dum-dum, you are the dum-dum”. And yet we see a lot of people viewing themselves as “educated” presenting this line of argument continually as it relates to the EU membership.

      If you have a rationalization why ALL European countries should belong to the Eurozone/EU, my suggestion is to come up with an argument more structurally sound than “those guys that don’t want to join EU are just a bunch of dum-dums”, as if that is the best you can do, it doesn’t make the argument for EU membership look that enticing to anyone.

      1. sherparick

        I think first you are confusing two things: 1) one, being part of the EU and 2) being part of the Eurozone single currency. The second part is definitely a bad idea if you don’t want Germany setting your monetary policy and dictating your Fiscal policy. The Sweden, Denmark, Poland, and UK were all part of the EU, with veto on its policies since the EU has to operate by consensus (which is one of the problems with the UK and EU negotiations – Ireland, Spain, France, Poland, and Germany all have a veto and if the UK cannot figure out how to appease Ireland on the border, Spain on fishing, Poland on protection of its citizens in U.K., and Germany, France, and the Benelux’s interest on making an EU exit as painful as possible to discourage Italy, Greece, Spain, and Portugal from getting any ideas), but outside the EU if it wants to export it will still have to conform and adjust to EU standards but no longer will have voice and veto on setting policy.

        Over the next 10 years, the U.K.’s problem will go from having immigrants trying to get in, to emigrants leaving, particularly well educated ones (I expect English media will resurrect the “Brain Drain” meme that arose in the 1950s,60s, and 70s.)

        In the Briexit fiasco, the role played by a few media billionaires led by Murdoch who zealously propagandize for Briexit and demonized immigrants from the EU (Poles, Italians, Greeks, and Romanians being the biggest groups), not because they love “democracy” but because they dream of Randian Libertarian Oligarchic Kingdom ruled by them through creatures such as Boris Johnson, Jacob Rees-Mogg, etc.

        1. Ulenspiegel

          1) There are two deals, the divorce deal and the trade deal. The former only rquires a qualified majority. However, the latter needs 27(31) yes votes.

          2) There is no need to punish UK. UK decided to leave the club and will therefore be treated as a third country. Non of the southern European countries intents to leave the EU, there are however discussion in Italy to leave the EZ.
          Most of the issues of UK with EU-27 are aspects of the trade deal, only the Irish border and the status of EU citizens in the UK and UK citizens in the EU-27 are potenial gamebreakers for the divorce deal.

          3) I do not see a lot of support in the EU-27 for a retraction of article 50 any longer. At the moment the best UK can get is a Norway deal, it becomes a fax democracy. If the UK does not remove some of it red lines a no deal result is quite likely as worst case result. In both cases a regular re-application is the only way to become EU member again.

      2. Barkley Rosser


        Sure, some of those for Brexit are not dum-dums. Most of those are racists instead. Of course there are some who are both dum-dums and racists.

  8. 2slugbaits

    Moses Herzog There are many intellectually valid reasons for people not wanting to be part of the EU. National sovereignty and out and out Democracy being among them.

    Well, if Brexit voters were concerned with sovereignty and democracy, then they sure had a funny way of expressing that concern. The likely result of Brexit will be Britain having to live by all of the EU rules without having any vote or say in those rules. I don’t know if the Brexit voters were “dum-dums” or not, but it’s pretty clear that many of them were low information voters who based their votes on the Murdoch tabloids. The tabloid press garbage about how voting for Brexit would make the NHS stronger was easily shown to be a lie, but yet low information voters fell for it hook, line and sinker. I’ve never heard a pro-Brexit argument that didn’t depend upon some implausible assumption in which the EU was going to just let Britain have its way without having to pay any price. Anyone should have known that the EU was going to make sure Britain suffered pain. If the EU did not do that, then the EU would have been committing suicide. It was always in the EU’s interest to make an example of Britain in order to deter other countries from exiting the EU. This was an obvious problem and I never heard a pro-Brexit argument that didn’t just wish away that problem. And apparently pro-Brexit supporters somehow forgot that Northern Ireland is part of the UK. Now that is “dum-dum”.

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