Working Paper: CEPR ID: DP13993
Authors: Ben Broadbent; Federico Dipace; Thomas Drechsel; Richard Harrison; Silvana Tenreyro
Abstract: The UK economy has experienced significant macroeconomic adjustments following the 2016 referendum on its withdrawal from the European Union. This paper develops and estimates a small open economy model with tradable and non-tradable sectors to characterize these adjustments. We demonstrate that many of the effects of the referendum result can be conceptualized as news about a future slowdown in productivity growth in the tradable sector. Simulations show that the responses of the model economy to such news are consistent with key patterns in UK data. While overall economic growth slows, an immediate permanent fall in the relative price of non-tradable output (the real exchange rate) induces a temporary “sweet spot” for tradable producers before the slowdown in the tradable sector productivity associated with Brexit occurs. Resources are reallocated towards the tradable sector, tradable output growth rises and net exports increase. These developments reverse after the productivity decline in the tradable sector materializes. The negative news about tradable sector productivity also lead to a decline in domestic interest rates relative to world interest rates and to a reduction in investment growth, while employment remains relatively stable. As a by-product of our Brexit simulations, we provide a quantitative analysis of the UK business cycle.
Keywords: Brexit; Productivity; Trade; Growth; Exchange Rate Adjustment; UK Economy; Tradable Sector
JEL Codes: E13; E32; F17; F47; O16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Brexit vote (F69) | expectations of future productivity decline (O49) |
| expectations of future productivity decline (O49) | increased tradable output (F16) |
| expectations of future productivity decline (O49) | increased net exports (F69) |
| increased tradable output (F16) | resource reallocation to tradable sector (F16) |
| expectations of future productivity decline (O49) | decline in tradable output (F14) |
| decline in tradable output (F14) | increase in production in nontradable sector (O49) |
| expectations of future productivity decline (O49) | decline in domestic interest rates (E43) |
| expectations of future productivity decline (O49) | reduced investment growth (E20) |