The UK economy has experienced significant macroeconomic adjustments following the 2016 referendum on its withdrawal from the European Union (EU). New research by Ben Broadbent, Federico Di Pace, Thomas Drechsel, Richard Harrison and Silvana Tenreyro documents these macroeconomic adjustments systematically and demonstrates that the effects of the referendum result on the UK economy can be thought of as news about a future slowdown in tradable productivity growth.
In the momentous referendum on 23 June 2016, voters decided that the UK should leave the EU. While many of the details regarding the UK’s ultimate withdrawal are still to be determined, the aftermath of the referendum has been characterised by significant macroeconomic adjustments in the UK economy.
UK economic activity has slowed relative to its long-run trend. Growth in the tradable sector has remained resilient in comparison to the non-tradable sector. The British pound sterling has been subject to a pronounced depreciation (and with it the relative price of non-tradable output has fallen). Exports have been growing robustly.
At the same time, UK interest rates have declined relative to their world counterpart and investment has slowed down materially, while employment has remained strong. The new study documents these empirical patterns using newly constructed UK macroeconomic data and demonstrates that they are consistent with what economic theory predicts for the effects of an anticipated productivity growth slowdown in the UK tradable sector.
The authors build a formal macroeconomic model with which they elicit the following economic mechanism. The Brexit news – conceptualised as a persistent drop in the growth rate of future productivity in the UK tradable sector – generates a temporary boom in tradable production.
This is driven by the response of the relative price of non-tradable output (an ‘internal’ real exchange rate), which jumps down when the news is revealed. Consequently, there is an opportunity to sell tradable output at a temporarily higher relative price before productivity in the sector actually falls, a temporary ‘sweet spot’ for producers of tradable output.
This generates the reallocation of capital and labour towards the tradable sector, a rise in tradable output growth and an increase in net exports, all of which reverse after the productivity growth decline in the tradable sector actually occurs.
The Brexit news also moves interest rates. In response to the shock, the return on bonds denominated in non-tradable output (the ‘domestic’ interest rate) drops sharply in the short run. Once productivity growth in the tradable sector actually falls, it prompts a reversal of the inter-sectoral resource flows towards the non-tradable sector.
This generates a persistent and hump-shaped rise in the real return on non-tradable denominated bonds over the longer term. In addition, the news triggers a material reduction in investment growth, while employment remains resilient. These patterns of the formal model are in line with the empirical facts that the authors document for the post-referendum period.
The study also explains how increased trade barriers, reduced capital flows and impediments to labour mobility can all be linked to a looming slowdown in the productivity of tradable goods and services. This discussion of the underlying drivers of productivity growth in the tradable sector lends further support to the authors’ choice of interpreting and modelling the referendum news.
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