Brexit
In November
the Bank published some scenarios, https://www.bankofengland.co.uk/report/2018/eu-withdrawal-scenarios-and-monetary-and-financial-stability. Here’s a summary.
1. Channels
Figure 2A
sets out the channels. We move from
right to left.
a. The scenarios modelled and
assumptions.
On the left
we see the three scenarios modelled and next to it, the various assumptions,
involvesd. These scenarios were requested by the TSC. They are set out in Table 3.1.1, 3.2.1, 3.3.1 and I summarise here
Scenario
|
Barriers
|
Preparedness
|
Econ Partnership
|
No
customs checks, no goods barriers, some service barriers, no new trade deals. Non-tariff barriers. Loss of passporting.
|
Transition
to 2020 sufficient for all to prepare
|
No deal,
no transition
|
Customs
checks, All apply common customs tariff, regulatory checks needed. WTO means services barriers: lost
passporting, lost broadcasting, transport licences needed. In disorderly, UK loses access to existing
trade agreements with EU and 3rd countries
|
Delays at
border,
|
Transition
to WTO
|
Gradual
transition to WTO terms, about 3 ¼% tariff on goods. Customs checks.
|
Within each
scenario, more and less severe variants are modelled, such as in no deal, no
transition (p.6), “the UK loses existing trade arrangements that it currently
has with non-EU countries through membership of the EU. The UK’s border
infrastructure is assumed to be unable to cope smoothly with customs
requirements. There is a pronounced increase in the return investors demand for
holding sterling assets. There are spillovers across asset classes.”
b. Evidence.
The middle column
shows the range of evidence used to model the scenarios. There are few case studies to go on, with some
work on New Zealand who lost access to the UK in the 1970s, but in the middle
of an oil crisis. So the main work
relies on (a) gravity equations and a trade/GDP elasticity and (b) a FDI and
productivity.
The gravity
equations model trade between countries with like GDP and controlling for
distance, finding that more trade is with richer countries nearby. To simulate the effects of Brexit, the idea is
to look for how much more or less trade there is between similar countries
(distance, relative GDP) who are and are not in trade agreements. Note that leaving a trade agreement might
stop trade between A and B, but it might be taken up between A and C, so this
has to be controlled for. After these
terms are estimated, the loss of trade is multiplied by the elasticity of GDP with
respect to trade. This is taken from studies
like Feyer which are in turn reduced form estimates of episodes, such as the
closure of the Suez canal on GDP per person.
The FDI
link is that FDI might boost domestic productivity via spillovers to the host
country.
As a matter
of data, most of the work is done in by the gravity equations since the trade
elasticity is much larger. We don’t however,
have much a model for services.
There are
other effects such as exchange rates and financial conditions, perhaps due to
uncertainty. These are harder to pin down.
Still harder is the timing of these events.
c. Prospects
The prospects
for GDP and inflation etc. are scenarios via some modelling. There is an interesting paragraph, p. 4 on the
difficult issue of timing
“Speed of
adjustment:
Given the
lack of precedents, there is uncertainty over the speed of adjustment to
reduced
openness….
- A range of evidence suggests that the impact
of introducing frictions such as tariffs and customs
checks at
the border comes through quickly. A substantial number of firms have little
experience
with
customs checks and, for many, business models and supply chain management could
be
significantly
disrupted by delays at the border. Intelligence from the Bank’s Agents suggests
that
uncertainty
has deterred some companies from investing in preparatory actions, and it is
likely that
the
corporate sector is generally not yet well equipped to cope were the UK to leave
the EU
without a
transition period.
- The discrete nature of some non-tariff
barriers means that they have the potential to have a rapid
effect on
trade. One example is in financial services where, if the relevant regulations
do not allow
for the
service to be provided cross border, then the impact on the supply capacity of
the economy
may be
immediate and coincident with the direct effect to demand.
- Sectoral evidence points to a need to
reallocate capital and labour as patterns of production
change in
response to changes in the cost of trade. If resources are unable to move
seamlessly this
will
quickly disrupt supply.”
The report
goes on
“The level
of preparedness of businesses and infrastructure (such as ports, excise and
customs systems and
transport
operations) will be important in determining how the economy adjusts to new
barriers. The
extent of
any disruption at the border and to transport and financial services will
depend on preparations
made by
firms, the authorities and on policy decisions yet to be taken by both sides.”
In this
way, we can understand the scenario modelling in Chart A.
It sets out
two broad scenarios, partnership and no deal.
Around those scenarios are different versions, as set out above, with the
lowest scenario the no deal, no transition.
As can be seen the lower
scenario with no deal and no transition shows a steep fall in GDP with then a
recovery but with an endstate 10% below the May 2016 trend.
Some other points.
1. Non-tariff barriers have risen a
good deal, see below.
And as the report
notes:
“NTBs are
particularly important because they have the potential to have a rapid effect
on trade. This is
because the
discrete nature of some barriers means an exporter can either supply the goods
or services, or
they
cannot. One example is financial services, where if the relevant regulations do
not allow for the service
to be
provided across borders, then the NTB could impact on trade immediately and
fully following the UK’s
exit from
the EU. Similarly, under current regulations some services – such as
broadcasting – cannot be
exported to
the EU without direct authorisation within member states.”
2. Different sectors
You might
think that different sectors are differently exposed. One is via EU labour
The other
is via exposure to possible changes in border and behind border arrangements. The
heat map suggests agriculture is particularly exposed.
3. Direct effects on inflation from
exchange rates and food tariffs
The long
run contributions depend on both shares in spending and also changes in
prices. Changes in prices are mostly in
food and transport as are the contributions:
