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National Institute of Economic and Social Research
NIESR Economists’ Briefing – NIESR August 2016 Review – After the EU Referendum
Wednesday 3rd August 2016 5-6.30pm
Chair: Professor Jagjit Chadha, Director •
17.00 Jagjit Chadha: Opening remarks •
17.05 Dr. Angus Armstrong: Brexit and the World Economy •
17.15 Dr. Rebecca Piggott: Recession Probabilities •
17.25 Dr. James Warren: Brexit - The short term implications for the rest of the EU
17.35 Q&A
18.00 Drinks
National Institute of Economic and Social Research
Brexit and the world economy
National Institute Economic Review
Issue 237, August 2016
Dr Angus Armstrong
National Institute of Economic and Social Research
Key ‘Brexit’ assumptions
Article 50 requires:
o ‘Consistent with constitutional requirements’
o ‘Account of the framework of its future relationship with EU’
Working assumption is UK re-joins European Free Trade Assoc. (so-called ‘Swiss model’):
o Goods market access and negotiate services market access
o Outside of customs union (so, ‘take back control’)
o Lower EU contribution for limited Single Market access
National Institute of Economic and Social Research
Four sets of trade negotiations
Share of UK total trade
EU
WTO/ uncovered
EU FTAs
EU FTAs pending
CU and EEA (ex EU)
National Institute of Economic and Social Research
• World GDP to grow at 3.0 per cent in 2016
• 2017 growth forecast revised down to 3.3 from 3.5 per cent
• A number of financial risks remain such as the ‘balkanisation’ of wholesale EU finance and banking sector fragility
• Inflation in OECD countries to remain below target
• ECB and Bank of England stand ready to provide more monetary stimulus
World Overview
National Institute of Economic and Social Research
Importance of value-added in trade
Global trade, measurement and policy have been transformed by technology and fragmentation of production process
o ‘Value added’ is a better measure than total trade
o UK Services are more important than goods trade
o Distance’ has become more, rather than less, important
Arguably, this makes the impact of Brexit even greater
National Institute of Economic and Social Research
Gross Value Added (GVA)
Projected reductions in GVA from leaving the European Union (per cent)
Share of UK total EU share Reduction in GVA (EFTA scenario)
value-added of exports OPT PESS
Goods 11.0 49.1 1.7 2.3
Manufacturing 9.4 46.2 1.3 1.8
Mining and Utilities 1.5 67.9 0.3 0.4
Agriculture 0.1 73.7 0.0 0.0
Services 13.6 44.7 1.9 2.6
Business sector services 12.3 43.5 1.7 2.2
FIRE and business services 7.9 42.8 1.0 1.4
Community services 1.2 56.6 0.2 0.3
Construction 0.1 50.1 0.0 0.0
Total 24.6 46.8 3.6 4.8
NIGEM GDP impact 1.9 2.3
(Ebell and Warren 2016)
National Institute of Economic and Social Research
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
As per cent of total gorss exports, 2011
Specialization in four services
National Institute of Economic and Social Research
Macroeconomic framework
Trade policy is no longer just about tariffs (WTO avg. is 3%)
o Common standards and regulatory requirements
o Property rights and investment protection
o Access to domestic service sector markets
Encroaches on domain of domestic policy makers
This raises spectre of the inconsistency between internationalism and the policy domain of nation states.
National boundary: triple co-incidence (Shin, 2014) Government, decision making and currency.
National Institute of Economic and Social Research
Probabilities of recession
National Institute Economic Review
Issue 237, August 2016
Dr. Rebecca Piggott
National Institute of Economic and Social Research
Our modal forecast
National Institute of Economic and Social Research
Summary of short-term shocks introduced from 2016Q3
Calibrated from Size of shock Duration
Exchange rate premium Data- first two weeks of July 40% of magnitude observed in
2008
2016Q3
Uncertainty Historical data Reamains at June 2016 level
(180% of average in 2016Q2)
Flat until 2017Q1 and then
shock decays to zero over
the following 8 quarters
Term premium Estimates on post-referendum
data from Lloyd and Meaning
(2016)
-20 basis points Shock decays to zero over
period to forecast horizon
Household and
corporate credit
premium
Cantor and Packer (1996),
Alfonso et al. (2012), Kiff et al.
(2012), historical data and
author’s calculations
50 basis points Shock persists for 6 quarters
and then decays to zero over
the following 5 quarters.
Note first quarter of shock is
a 30 bp increase
Equity premium Available data post-
referendum and author’s
calculations
30 basis points Shock persists for 3 quarters
and then decays to zero over
the following 10 quarters
National Institute of Economic and Social Research
GDP growth (per cent per annum)
-6
-4
-2
0
2
4
6
19
98
20
00
20
02
20
04
20
06
20
08
20
10
20
12
20
14
20
16
20
18
20
20
Forecast
Source: NiGEM simulations
National Institute of Economic and Social Research
Monetary policy stimulus
0.0
0.5
1.0
1.5
2.0
2.5
3.0
t t+2 t+4 t+6 t+8 t+10t+12t+14t+16t+18
Diffe
rence fro
m b
aselin
e (
per
cent)
Interest rate cut IR + £200bn QE
IR + £300bn QE
GDP impact of monetary policy options
Source: NiGEM simulations
National Institute of Economic and Social Research
CPI inflation (per cent per annum)
Source: NiGEM simulations
National Institute of Economic and Social Research
Unemployment rate (per cent of labour force)
1
2
3
4
5
6
7
8
9
2005 2007 2009 2011 2013 2015 2017 2019
Forecast
Source: NiGEM simulations
National Institute of Economic and Social Research
Summary
• 50 per cent chance of a technical recession between 2016 Q3 and 2017 Q4
• Key risks to our forecast
– Uncertainty affects firms’ hiring decisions
– More/less wage rigidity
– Reduced net migration
National Institute of Economic and Social Research
Brexit: the short term implications for the rest of the EU National Institute Economic Review
Issue 237, August 2016
Dr. James Warren
National Institute of Economic and Social Research
Changes to our forecast for Europe
Euro Area European
Union France Germany Ireland Italy Netherlands Spain United
Kingdom
2016 1.4 (-0.1) 1.5 (-0.1) 1.2 (-0.1) 1.7 (0) 1.5 (-3) 0.7 (0) 1.2 (-0.4) 2.7 (0) 1.7 (-0.3)
2017 1.3 (-0.4) 1.3 (-0.6) 1.1 (-0.4) 1.5 (-0.2) 2.5 (-0.7) 0.5 (-0.5) 1.7 (-0.4) 2.2 (-0.4) 1.0 (-1.7)
2018 1.6 (-0.2) 1.7 (-0.3) 1.4 (-0.1) 1.4 (0) 3.3 (-1.2) 1.4 (-0.3) 1.8 (0) 2.4 (-0.4) 1.9 (-0.6)
Note: The numbers reported are annual averages for GDP growth, those in brackets highlight the difference from our May forecast
National Institute of Economic and Social Research
Economic Scenario • The scenario encompasses only the effects of the short run
• We apply shocks to a variety of risk premia in NiGEM
– Exchange rate risk premia to match observed since the referendum
– Equity risk premia
– Term premia
– Household lending premia
– Uncertainty
• These shocks are calibrated so that the movements in the corresponding variables in NiGEM match what we have observed to date.
National Institute of Economic and Social Research
EU spillovers
-1.6
-1.4
-1.2
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
Eu
ro A
rea
Euro
pean U
nio
n
Fra
nce
Ge
rma
ny
Ire
lan
d
Ita
ly
Ne
ths
Spain
UK
2016 2017 2018 Per
cent
diffe
rence f
rom
baselin
e
National Institute of Economic and Social Research
EU – UK feedback
-1.6
-1.1
-0.6
-0.1
0.4
0.9
20
16
2
01
7
20
18
20
16
2
01
7
20
18
20
16
2
01
7
20
18
20
16
2
01
7
20
18
20
16
2
01
7
20
18
20
16
2
01
7
20
18
20
16
2
01
7
20
18
20
16
2
01
7
20
18
20
16
2
01
7
20
18
EA EU FR GE IR IT NL SP UK
EU only UK
Note: EU represents only the domestic shocks to the EU economies and the UK include the shocks to the UK only
Per
cent
diffe
rence f
rom
baselin
e
National Institute of Economic and Social Research
Summary • Significant downward pull on Euro Area GDP over the next
three years
• Due to feedbacks through trade a large proportion of the downward pressure is due to weakness in the UK economy
• Risks not captured
– Further financial contagion from stress within European banking system
– The economic impact if constitutional issues arise in the European Union
• What is the probability that constitutional issues will arise, and which indicators should we be looking at?
National Institute of Economic and Social Research
Questions
• Given the long wait until the ONS publish preliminary estimates of GDP for 2016Q3, to which indicators should we be paying most attention?
• Are we underestimating the spillovers to Europe and the rest of the world from the UK’s Referendum Result?
• Should policy respond now and if so with what instruments and in what magnitude?
• Should the macroeconomic framework for stabilisation policy be more carefully examined?
National Institute of Economic and Social Research
Additional slides
National Institute of Economic and Social Research
Summary of short-term shocks introduced from 2016Q3 (Baker et al, May 2016 Review)
Calibrated
from
Size of
shock
Duration
Exchange rate premium 3-month options-
implied sterling
volatility
2/3 of the
magnitude
observed in
2008
Shock decays to zero
over the following 7
quarters
Uncertainty Betting markets
and historical
data
Three times
the level in
2016Q2
Shock decays to zero
over the following 13
quarters
Term premium Joyce et al
(2011), Breedon
et al
(2012),Meaning
and Warren
(2015)
100 basis
points
Shock persists for 4
quarters and then
decays to zero over the
following 4 quarters
Household and
corporate credit
premium
Cantor and
Packer (1996),
Alfonso et al.
(2012), Kiff et al.
(2012),
historical data
and author’s
calculations
50 basis
points
Shock persists for 6
quarters and then
decays to zero over the
following two quarters
Equity premium Historical data
and author’s
calculations
50 basis
points
Shock persists for 6
quarters and then
decays to zero over the
following two quarters
National Institute of Economic and Social Research
Prospects for the UK Economy: slowdown and policy response
National Institute Economic Review
Issue 237, August 2016
Simon Kirby, with Oriol Carreras, Jack Meaning, Rebecca Piggott and James Warren
National Institute of Economic and Social Research
Marked slowdown 2016H2-2018
-6
-4
-2
0
2
4
6
19
98
20
00
20
02
20
04
20
06
20
08
20
10
20
12
20
14
20
16
20
18
20
20
Forecast
Source: NiGEM simulations
GDP growth fan chart (per cent per annum)
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2008 2010 2012 2014 2016 2018
August 2016 Review May 2016 Review
Forecast
Source: NiGEM database; NIESR forecasts
Real GDP growth (per cent per quarter)
National Institute of Economic and Social Research
Post-referendum developments
-0.45
-0.40
-0.35
-0.30
-0.25
-0.20
-0.15
-0.10
-0.05
0.00
1 day change 2 day change 3 day change
Chan
ge s
ince 2
3 J
une
20
16
(pe
rcenta
ge p
oin
ts)
10 year yield
10 year interest rate expectations
10 year term premium
NIESR uncertainty index
Source: NIESR calculations Note: The series is an index with mean zero and standard deviation equal to one.
Changes in UK sovereign bond yields
Source: NIESR calculations
-2
-1
0
1
2
3
4
5
1997 2000 2003 2006 2009 2012 2015
National Institute of Economic and Social Research
Domestic spending to decline in 2017
1
2
3
4
5
6
7
8
9
2005 2007 2009 2011 2013 2015 2017 2019
Forecast
Unemployment rate fan chart (per cent of labour force)
Source: NiGEM simulations
80
85
90
95
100
105
2002 2005 2008 2011 2014 2017 2020
Forecast
Source: NIGEM database; NIESR forecast
Per capita consumer spending (2007Q4=100)
National Institute of Economic and Social Research
Monetary policy stimulus expected GDP impact of monetary policy options CPI inflation rate (per cent per annum)
Source: NiGEM simulations
0.0
0.5
1.0
1.5
2.0
2.5
3.0
t t+2 t+4 t+6 t+8 t+10t+12t+14t+16t+18
Diffe
rence fro
m b
aselin
e (
per
cent)
Interest rate cut IR + £200bn QE
IR + £300bn QE
Source: NiGEM simulations
National Institute of Economic and Social Research
Fiscal Charter has been over-ridden •Cumulative £47bn more borrowing expected 2016-17 to 2020-21 •Gross debt rises above 90% of GDP by the end of 2017 •New Fiscal Charter in the Autumn Statement?
National Institute of Economic and Social Research
Forecast summary
National Institute of Economic and Social Research
Forecast summary • Assume Article 50 of triggered at the start of 2017
– UK leaves EU in early 2019 and new relationship is EFTA
• Marked slowdown expected – GDP growth of 1.7% in 2016, 1% in 2017 and 1.9% in 2018
– GDP to decline by 0.2% 2016Q3
– ‘Technical’ recession not modal forecast
– Evens chance of such an event in period 2016Q3-2017Q4
• Unemployment rate to rise from 4.8% to a peak of 5.8% – Increase of 320,000 by 2017Q3
– Temporary; unemployment returns to 5% by end 2018
– Real consumer wages regain previous peak (2009Q4) end 2024
• Inflation rate temporarily above target – More than 1 pp above target by end 2017; first time since March 2012
National Institute of Economic and Social Research
Forecast summary • Monetary stimulus expected
– Interest rate reductions in August and November – Despite inflation rising above 3 per cent; first time since March 2012 – MPC to look through temporary rise in inflation
• Interest rate cuts plus QE could boost level of GDP of 1½% – £300bn lowers gilts yields by 1pp – Implies APF holding well over 50% of existing nominal gilt stock
• APF does not purchase at the short end (less than 3 years). Implies holding of 60+% of some issues?
– Negative implications for corporate DB pension funds
• Public sector net borrowing increases by cumulative £47bn over the period 2016-17 to 2020-21
– Assumes automatic stabilisers allowed to operate – Annual average of £9.5 billion (0.5% of GDP) – Absolute surplus not achieved in 2019-20 – Fiscal Charter has effectively been over-ridden
• Gross government debt rises above 90 per cent by the end of 2017
National Institute of Economic and Social Research
Prospects for the World Economy
National Institute Economic Review
Issue 237, August 2016
Graham Hacche with Oriol Carreras, Simon Kirby, Iana Liadze, Jack Meaning, Rebecca Piggott and James Warren
National Institute of Economic and Social Research
Developments in financial markets
40
60
80
100
120
140
160
2006 2008 2010 2012 2014 2016
20
06
= 1
00
Germany Japan US UK
60
80
100
120
140
160
2006 2008 2010 2012 2014 2016 2
00
6Q
1=
10
0
US Japan Euro Area UK
National Institute of Economic and Social Research
Impact on sovereign bond yields
• Largest fall in the UK
• Declines in the US, Germany and Japan occurred mainly before the UK referendum
National Institute of Economic and Social Research
Impact of UK withdrawal on EU economies
National Institute of Economic and Social Research
Simulating the impact of UK withdrawal
• Movements in financial data used to calibrate shocks to a variety of risk premia in the UK and EU
• Global econometric model, NiGEM, is used to access the overall impact
• GDP in Europe in aggregate 0.4 per cent below the ‘remain’ counterfactual in 2017
National Institute of Economic and Social Research
Limited room for response
• Euro Area economies already suffer from a number of weaknesses/fragilities: – Insufficient growth
– Limited progress on reducing financial imbalances
– High levels of public and private debt aggravated by low inflation
– Weak banking sector
National Institute of Economic and Social Research
Risks to the outlook
• As usual forecast is subject to number of risks
• Focus on risks related to the UK’s decision to leave the EU
― concerning prospective economic effects - on balance seem to be on the downside
― possible threat to globalisation
― leading to important policy implications
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