29 November 2018

The Bank of England’s Brexit forecasts aren’t just wrong. They’re absurd


Yesterday the Bank of England published its latest Brexit analysis. The scenarios the Bank paints include some that are lurid, wild and absurd, and, of course, it is those scenarios that have attracted all the headlines.

In particular, the Bank’s scenario for a disorderly no deal Brexit has GDP contracting 8 per cent in a year. That’s right, contracting, and that’s right, in one year. To put that into context, the highest annual contraction in GDP since modern records began was in 2009, when the financial crisis led to about half the UK’s banking system being nationalised and the worst recession since the 1920s. The Bank is claiming that in a no deal Brexit scenario the contraction in one year could be twice as much as that.

An 8 per cent contraction in GDP is not the kind of thing that happens as the result of an economic shock or a financial crisis. It is what happens if there is a civil war, or the economy experiences hyperinflation, or the sort of one-year contractions experienced in Communist countries when the Soviet Empire collapsed and there was no-one left to plan the economy.

Or to put the point another way, 8 per cent of GDP would be a reasonable estimate for the total value to the UK economy of trading with EU countries — not the value of an EU trade deal, but the contribution to GDP of the trade itself. So to say that leaving the EU with no deal would cost 8 per cent of GDP in one year is to say that by leaving with no deal the UK would lose the entire value of trading with the EU as it has built up since pre-Roman times, all lost in one year. I would call that “not even wrong”, but I don’t feel that would nearly capture how absurd a claim that is.

Paul Krugman, no fan of Brexit, has said he worries that forecasts of this sort reflect “motivated reasoning” (politically correct speak for “bias”).

In fact, the Bank’s projection is even worse and even more implausible than I have made it sound, because not only does it have GDP contracting 8 per cent in one year, but there is no recovery phase. GDP just collapses by 8 per cent and then stays at a new lower level, growing no faster than if we had embraced May’s deal.

Some have tried to defend the Bank publishing this absolutely ludicrous projection on the grounds that it was not what the Bank was forecasting what would happen, just a scenario. Well, obviously it’s not the Bank’s forecast, because it’s not the government’s policy to have no deal and it’s not the Bank’s job to say that the government’s policy will fail.

But it is what the Bank says might potentially happen in a disorderly no deal Brexit scenario in a document that states that its task is to analyse “the consequences of leaving the EU without a Withdrawal Agreement.” If the Bank’s defence is “When we put out a report saying that in a disorderly Brexit GDP might fall 8 per cent within a year we didn’t mean anyone to infer that if there were a disorderly Brexit GDP might fall 8 per cent in a year” then that’s even more ridiculous than its “forecast”.

I suspect that most of the hyperventilating about the dangers of a no deal Brexit would prove in the event to be hot air. But it would not have been unreasonable for the Bank to include some extreme scenario forecasts for how bad things could get in a really bad case.

The nearest analogues from recent decades for a disastrously bad short-term impact from a disorderly no deal would, I suggest, be Heath’s “three day week” from January to March 1974 when electricity supplies ran low because of the miners’ strike, the Winter of Discontent of 1978/9, and the strikes, inflation and disorder of 1980. In 1974 GDP contracted by 2.5 per cent. In 1980 GDP contracted by 2 per cent.

In my view it would have been credible for the Bank of England to consider a range of scenarios for the first year of a no deal Brexit that included an extreme case of a 2.5 per cent contraction up to a case in which a no deal Brexit proved to have few effects and the world economy grew faster than expected, boosting UK GDP growth to 2.5 per cent – so a range from -2.5 to 2.5 per cent growth.

But an 8 per cent contraction in one year is not that. Some people have called the latest round of forecasts a “re-run of Project Fear”, referring to the Treasury’s forecast of a “year-long recession” following a vote to leave the EU — a recession that did not happen at all, even for one quarter, let alone last a year. But those Treasury forecasts, though exaggerated, over-hyped and in the event wrong, were at least within the realms of the kinds of things that happen when there is a recession in the UK. They were not for an 8 per cent contraction in GDP — the kind of thing that would require us to have a widespread famine or be invaded and occupied by a hostile power.

One final remark on this Bank of England “analysis”. Near the start, it declares that the fundamental guiding assumption of the work is that Brexit will lead to the UK economy becoming less open over time in every scenario. That is despite the fact that advocates of Brexit and the UK government state that their intention is for the UK economy to become more open over the long term as a consequence of Brexit. This seems to me to be a wholly improper assumption to make in what purports to be an objective analysis.

Suppose, for example, that the Green Party had a stated policy of liberalising banking but someone at the Bank of England believed that, in practice, if it came to power the Green Party would probably seek to jail bankers. Then suppose the Bank produced what it claimed was an objective analysis of the impact of a Green Party government. Would it be proper for the Bank to make the central guiding principle of its analytical framework be the quantification of the impacts of jailing bankers? And if the Bank did do that, should we regard its analysis as an attempt at neutral technical analysis or, instead, a transparently political analysis dependent on controversial and disputed policy assumptions that ran flat against the stated policy of those it was analysing? I think we know the answer, and it’s the same when it comes to Brexit.

The UK economy is not going to contract 8 per cent in one year, regardless of how disorderly Brexit gets. For the Bank to say that might happen is not some speaking truth to power objectivity. It is absurd, nonsensical and incredible.

Andrew Lilico is an economist and political writer.