Brexit = lost jobs + inflation + low wages + big deficit etc

The Treasury’s report on the short-term cost of leaving the European Union raised hackles on Eurosceptic necks even before it was published. Vote Leave didn’t even wait for the paper to be released before smearing the Treasury’s economists, accusing them of fixing forecasts under political pressure.  

The Treasury’s analysis looks credible – although its conclusions should only be viewed as ballpark estimates. The headline figures are that a Brexit could see the economy 3.6%-6% smaller in 2017/18 than if we remained. Along with lower GDP, a Brexit vote would bring higher unemployment, higher deficits, lower wages, lower house prices and a steep fall in the value of the pound.

Three factors feed into this. First, a vote to leave the EU would increase uncertainty. It would lead to two years of frenzied negotiations as Britain and the EU attempt to cobble together deals on trade, information sharing, travel, and a whole host of other subjects. It could take a decade or more to conclude matters. It would also effectively hit the reset button on our trade deals with the rest of the world, requiring their renegotiation on possibly less favourable terms.

Second, a vote to leave means that in the long run the UK is on a path to a permanently smaller economy. The transition to this state would begin straight away: businesses would cut investment, and households would cut spending.

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These effects would feed into financial markets – lowering asset prices, increasing volatility, and increasing the cost of borrowing for the government, companies and households.

The Treasury’s estimates are based on the assumption that the UK neither loosens nor tightens fiscal and monetary policy. This is far from certain.

One option would be to try to cushion the shock with higher government spending or more monetary stimulus by the Bank of England. The snag is the budget deficit would rise even further and the pound would fall even more sharply.

Another option would be to try to restore Britain’s credibility with investors by cutting spending and pushing up interest rates. But that would lead to as deeper recession.

Given that it is hard to say which would be the more rational course of action, the Treasury’s “no change” assumption isn’t unreasonable.

The Treasury’s central estimate of an economy 3.6% smaller in 2017-18 is slightly more pessimistic than that of other credible forecasters – but not out of line. The OECD thinks the economy will be 3% smaller in 2020, while the National Institute for Economic and Social Research thinks it will be 3.5% smaller in 2019.

What’s more, the Treasury hasn’t modelled some scenarios: for example, that international investors may stop buying government bonds; or that David Cameron may be kicked out of Downing Street and replaced by a populist prime minister who engages in a massive fight with our European partners. In these situations, the economic damage could be even worse.

This piece was amended shortly after publication to remove the passage about a Brexit damaging our trading partners in a way that boomerangs on us. The Treasury modelled this scenario in its severe shock scenario, but not in its central estimate.

Edited by Hugo Dixon