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Analysis

Was Mark Carney wrong? Don’t bank on it

by Sam Ashworth-Hayes | 28.06.2017

Last June Britain decided it had so enjoyed the referendum campaign that it wanted to spend the next 30 years arguing about Europe, and accordingly voted to leave the EU. Brexiters have spent most of the subsequent 12 months crowing that the eggheads at the Bank of England and the Treasury didn’t know what they were talking about. They had predicted that a leave vote would cause the economy to crash, and look, we’re doing fine! Project Fear! Scaremongering! Economists are like Nazi scientists who denounced Einstein, as Michael Gove suggested.

Well, not exactly…

Neither of these august institutions in fact predicted an unconditional economic catastrophe. Both the Treasury and the Bank of England made measured estimates that were in line with those produced by other think-tanks, and both hinged on the type of Brexit we end up getting – a question to which we still do not know the answer.

While growth did not initially suffer as much as forecast, last quarter it slowed to its lowest pace for a year. Meanwhile, the falling pound has pushed inflation to a four-year high, resulting in a decline in real wages for the first time since 2014. And as Chris Giles points out, the Economists for Brexit prediction of low inflation and high wage growth following the vote hasn’t exactly been borne out either.

Although the government’s economists may have been closer to the truth, their performance wasn’t perfect. The fundamental problem with forecasting in this type of situation is that nothing tangible will change until we’ve actually left the EU. Until that day comes, then, the economic swing factor has to do with confidence and people’s best guesses as to what the effects of Brexit will be.

Economists have to build these expectations into their models in a credible way. The dominant methodology uses “rational expectations”; people make an informed judgement about the most likely outcome using the information available at the time. Thus because of the belief that the long-term effect of Brexit is likely to be negative, models assumed people would save for that rainy day, bringing the bad weather forward.

In the event, the initial response was exactly the opposite. People ramped up borrowing. This extra spending has kept consumption buoyant, supporting the British economy. The problem with the Treasury’s forecast was that it failed to account for the politics of a leave vote; people don’t generally opt for things they believe will make them poorer, so on balance they did not behave as if Brexit was going to do so.

The further away a point in time is, the less certain we can be about what the world will look like then. That is why the Treasury’s forecast that the average family would be £4,300 poorer in 2030 rightly drew criticism: it is too far in the distance for any assumptions about policy or the international environment to be credible.

Nevertheless, long-term forecasts on Brexit did have one merit: they highlight the fundamental importance of trade for the economy. For more than 200 years economists have agreed that trade is good for an economy. In such a fractious profession, this strength of consensus is a reason to sit up and take notice.

The latest paper from the Policy Exchange think-tank does not take issue with this. It does not even argue that leaving the EU will reduce trade with the bloc. Instead, it queries the exact size of the trade losses that will result. Swati Dhingra, a trade economist at LSE, says that an earlier paper by the same authors made their methodology clearer. They used “very non-standard” methods for estimating the effect of EU membership which did not properly control for other factors determining trade between countries, Dhingra says.

This cuts to the heart of the matter. By leaving the world’s largest trade bloc, one that negotiates on an advantageous basis with other economies, can the UK really maintain the dynamic pace of trade and economic growth that it would have enjoyed by staying in? Economists for Brexit, under their new name Economists for Free Trade, claim that it can, but only by opting for unilateral and universal free trade, along with radical deregulation. Short of that, we might as well stay in, they have said. Whether or not their policies will be adopted requires a political prediction, not an economic one, but it is not a difficult call to make.

We may all be dead in the long run, but Mark Carney will have the last laugh.

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Edited by Alan Wheatley

One Response to “Was Mark Carney wrong? Don’t bank on it”

  • ” Radical Deregulation” is what we have been trying to do in the UK for years…paying lip service to European Regulation on things like consumer safety .

    The Grenfell tragedy will hopefully be a game changer…..