niesr economists’ briefing – niesr august 2016 review ... brief aug... · national institute of...

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


Brexit and the world economy

National Institute Economic Review

Issue 237, August 2016

Dr Angus Armstrong


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


Four sets of trade negotiations

Share of UK total trade

EU

WTO/ uncovered

EU FTAs

EU FTAs pending

CU and EEA (ex EU)


• 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


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


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)


0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

As per cent of total gorss exports, 2011

Specialization in four services


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.


Probabilities of recession



Dr. Rebecca Piggott


Our modal forecast


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


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


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



CPI inflation (per cent per annum)



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



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


Brexit: the short term implications for the rest of the EU National Institute Economic Review


Dr. James Warren


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


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.


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


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


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?


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?


Additional slides


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


quarters and then


following two quarters

Equity premium Historical data

and author’s

calculations

50 basis

points


quarters and then


following two quarters


Prospects for the UK Economy: slowdown and policy response



Simon Kirby, with Oriol Carreras, Jack Meaning, Rebecca Piggott and James Warren


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


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)


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


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)


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)


Monetary policy stimulus expected GDP impact of monetary policy options CPI inflation rate (per cent per annum)


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



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?


Forecast summary


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


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


Prospects for the World Economy



Graham Hacche with Oriol Carreras, Simon Kirby, Iana Liadze, Jack Meaning, Rebecca Piggott and James Warren


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


Impact on sovereign bond yields

• Largest fall in the UK

• Declines in the US, Germany and Japan occurred mainly before the UK referendum


Impact of UK withdrawal on EU economies


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


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


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

niesr economists’ briefing – niesr august 2016 review ... brief aug... · national institute of...

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