Carney downplays long term impact of Brexit

Carney downplays long term impact of Brexit

The long-term impact of Brexit on the UK economy will probably be “very modestly negative”, according to Bank of England governor Mark Carney.

Speaking before the Treasury select committee in parliament on 22 May, Mr Carney said Brexit has caused a “supply shock” in the UK economy, the impact of which will be to modestly reduce the natural rate of GDP growth in the years ahead.

As FTAdviser had previously reported, Mr Carney also said Brexit has so far cost each UK household £900. 

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A supply shock happens in an economy when there is a sudden decline in the supply of goods and services, reducing the level of GDP.

The most obvious way this occurred in the UK was in the immediate aftermath of the referendum, when international investors sold sterling and sterling based assets. This led to a reduction in the supply of money, which caused the spike in inflation seen in the year after the vote.

That higher inflation led to a slowdown in economic growth. The Bank of England’s response was to cut interest rates, as that makes money cheaper, and so should increase its supply.

Jeremy Lawson, chief economist at Aberdeen Standard Investments, said the reason so many economists were wrong about the UK economy in the immediate aftermath of the Brexit referendum because the consensus was that there would be a “demand shock”, rather than a supply shock.

A demand shock happens when consumers and businesses fear for their short-term economic prospects and so stop spending, reducing the level of demand in the economy, and causing a recession.

Mr Carney said UK domestic consumption has been growing at a pace half of that seen prior to the Brexit vote, but consumers did continue to spend, so a demand shock didn’t happen.

Mr Lawson said the reason is “economists, because most economists are in favour of remain, forgot that if a majority voted to leave, well, that majority were not shocked by the outcome, so they didn’t stop spending or change their behaviour”.  

Demand shocks tend to have a more immediate impact on the economy as people stop spending, while supply shocks lead to lower growth over the longer term.

As FTAdviser has previously reported, Andy Haldane, chief economist at the Bank of England, has said the lower immigration and productivity into the UK mean the normal rate of economic growth in the UK in the years ahead will be lower.

Mr Carney told MPs he expects the UK economy to grow at about 0.4 per cent in each quarter of this year, helped by rising wages.

He said the risk to the short-term economic growth outlook is that consumers use the extra wages to pay down debt acquired during the years when real wages were falling, rather than “boost consumer spending.”

But Mr Lawson said the long term effects can only be assessed after it becomes clear what the terms of any exit are. He said leaving without a deal having been agreed would likely cause another supply shock as sterling would fall.