What does robust UK gdp growth show?

Scott Sumner has a very good post on that question, noting that UK gdp growth has been robust and suggesting this refutes uncertainty-based theories of the business cycle.  I see the matter somewhat differently, however.  In standard real business cycle theory, a’la Long and Plosser, a business cycle is defined in terms of comovement and persistence.  The real business cycle “victim” can either take a direct hit to wealth, or by various processes of smoothing and substitution, spread the hit out across various sectors and over time, thereby generating comovement and persistence and thus what we call a cycle.  Taking the direct, concentrated hit isn’t a “cycle” but it still is very painful, in most simple versions of the model it is more painful than doing the smoothing.

Now fast forward to Brexit.  There is no representative agent, and the shock “attacked” the UK economy in the form of an immediate exchange rate depreciation.  That is a hit to wealth, concentrated on import purchases, though with a good deal of smoothing over time, because import purchases are themselves spread out.  Presumably British consumers would prefer the price increases to be more evenly distributed, and not just over imports, but it is easy enough to cite reasons why, in heterogeneous agent models, that won’t happen so easily.  Of course over time, some of this smoothing will occur, as the Brits reallocate domestic production to substitute for the now more-expensive foreign goods, pulling resources away from a broader variety of sectors.

None of this refutes real business cycle theory once you see that the non-cyclical immediate “hit” to wealth is an ever-present option.  The results don’t look like a “cycle,” but they very much fit the overall framework.  But the result is a mix of a super-rapid wealth adjustment, and a super-slow motion series of taxes on imports; I think Scott is a little too distracted by not seeing cyclical action at the usual intermediate frequency.

A while ago I estimated the costs of this “hit” at 5,625 pounds per capita, though since then the British pound has fallen even further, thereby raising those costs.

As for the uncertainty theories, I’m not sure the Brexit story is a good case study for them.  At first I was uncertain as to whether it really would happen, but not very much any more.  It doesn’t seem the market was ever that uncertain about the final results.  A known but surprise event came, and the market knocked down British wealth, mostly bypassing the cycle.

The key point here is that the cycle is an artifact, not something that absolutely has to happen.  The negative wealth effect is a more fundamental category, and we absolutely have seen one of those in Great Britain.

The puzzle here — and it is a very real one — is why economies sometimes get immediate hits to wealth, and no cycle, and other times they have to go through the wringer with an ongoing process of temporal decay.  The answer lies in part with Britain’s nature as an open economy, and the total lack of stickiness in the exchange rate price, but I think there is also more to it than that…

Comments

People discount the risk of real shocks because that's what people do, while people exaggerate the effects of NGDP shocks because that's what people do. Like most animals, people travel in herds. I read the front pages of the NYT and the WP the past two weeks and expect a real shock, while others merrily go about their daily lives as if nothing out of the ordinary is happening. As for the Brits, I dunno. If the financial sector in Britain really does move to the continent, would that be a real shock in Sumner's dichotomy?

Shorter TC, shorter Sumner: the economy is largely random, a stochastic process with a slight upward bias, and macroeconomics, be in real business cycle theory or monetarism or Keynesianism, is largely bogus.

You are not certain whether Brexit produced uncertainty? Is the concept of uncertainty so vague that it can't confidently be applied? Then it has no place in a theory of business cycles. Or is it just very hard to discern in real time (and even after some passage of time)? Then the uncertainty theory, while it may be correct, is practically useless.

Yes, if the "confidence fairy" (used as a fudge factor in macroeconomics of all stripes) is a wildcard, and can be any delta, then macroeconomics theory can explain everything, and therefore nothing. Also the data for GDP is unreliable; this is well known, and evidenced by the large fluctuations in GDP quarter by quarter, even when seasonally adjusted. TC should blog on this more. Next quarter we might see negative UK GDP, does this prove BrExit is bad, with a lag factor?

On lag: most business people in UK were worried about Brexit and got currency hedges before the vote. Those hedging is ending little by little and now they have to pay more for imports = inflation. That nominal GDP growth may just be running in a treadmill.

"A while ago I estimated the costs of this “hit” at 5,625 pounds per capita, though since then the British pound has fallen even further, thereby raising those costs."

Shouldn't any attempt to attribute a "hit" to Brexit also count any extra GDP growth created as a result (and any subsequent appreciation in the pound that that growth causes) as an offset to the hit?

And how are you able to attribute further depreciation in the time since to Brexit? Short-term stock market event studies have lots of problems. You're looking at an over six month event study and still attributing the change to one cause.

So, Tyler is saying higher prices, higher labor costs, higher taxes from VAT on higher prices plus the higher taxes on profits and property in the UK from inshore production have been good for the economy.

Obviously this is totally bogus because everyone knows the key to higher gdp is lower prices for everything so consumers eat much more food, wear far more clothes, commute twice as far to work, drive two cars instead of one, get colonoscopies twice a year, Lasix corrective eye surgery twice a year, ....

This doesn't make sense. And there was no "hit to wealth."

The UK imports 55% of gas. As the GBP goes down, gas gets more expensive. Look at the nice figure: https://www.britishgas.co.uk/the-source/our-world-of-energy/energys-grand-journey/where-does-uk-gas-come-from

Also a significant fraction of food is imported into the UK. I'm lazy to look for more recent data (if available), but: "For households in the lowest 20% by equivalised income
16.4% of spend went on household food, 0.2 percentage points above 2007." As GBP goes down, that imported food goes......? https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/526395/foodpocketbook-2015update-26may16.pdf

Tyler wrote in Bloomberg, "This [just looking at currency change] isn’t any kind of formal international trade model, with a full set of measurements and moving variables. It's just a simple way of showing that the costs of Brexit can be high without a recession."

It isn't just a simple way of showing costs but misleading since so incomplete. Macroeconomists would almost never discuss "costs" this way. You sometimes see this type of thing by journalists or business economists who don't have macro training and so makes it a surprising column.

"the shock “attacked” the UK economy in the form of an immediate exchange rate depreciation. That is a hit to wealth, ..."

Much of the population has housing as its great store of wealth. If your house loses a little value so too does the next house you will buy, so the effect isn't too harsh. In fact, insofar as it reduces the size of the next mortgage loan you'll need, it might even be welcome. The second largest store of wealth is probably pensions savings: they seem so far to have increased in value.

Quite soon these effects will be lost in the noise and turmoil of various events around the world. They'll effectively vanish as the EU breaks up, or Wall St collapses, or Trump is assassinated, or whatever else the future holds.

P.S. I hope Mr Trump is spared assassination, but then he'll have to live with the blame for the next Wall St collapse even though it will be none of his doing.

If your house has a lower assessed price, you can no longer refi to get cash to pay for a vacation or pay credit card bills.

You are poorer according to voodoo economics.

Wealth is based on prices rising on old stuff, not on paying workers with cash to build you more useful assets.

Such flawed economics was erased when Reagan took office in 1981.

Wealth is created now by eliminating labor costs, not building assets but instead burning assets, which makes assets increasingly scarce so the prices of decaying assets increase in price, creating wealth.

If the UK is forced to pay workers to build factories to produce what was formerly imported, that destroys wealth.

I know this to be true because Milton Friedman wrote how everyone was worse off from tax policies in the 60s that caused too many productive assets being built producing too much stuff like too much oil, too much electricity that was too reliable, too many new expensive consumer goods. And in the 80s, he wrote about how great cheap Chinese imports were because American consumers were being given gifts of cheap stuff from China were didn't need to pay for by working like slaves to produce stuff to export to China.

The globalised UK semi-resident upper class takes an immediate hit due to loss of wealth on cash and property assets. It’s also possible that stubborn determination to reverse Brexit which is rife among the mainly London-based liberal-progressive middle class is due to the dramatically higher cost of their overseas holidays, a relatively silent cause of simmering resentment. If pension savings are rising as you claim then that’s nice, but it must be due to deferred gratification and the robustness of stock market because the Bank of England is determined to continue hitting savers with zero interest rates in the (again, stubborn) misguided belief that their ‘stimulus’ is somehow ‘causing’ UK’s perplexing post-referendum dynamism (as reported in Financial Times) and globally outstanding speed of economic growth.

Brexit is too politicised to be a typical economic shock. Experts claimed that Brexit would have catastrophic consequences, and continued these claims after the referendum strongly enough to earn the name "remoaners". The fact that Brexit won the referendum suggests that a large number of consumers didn't believe them, and in fact still don't believe them, which should cushion even justified losses of consumer confidence. Furthermore, supermarkets have been very reluctant to pass on price increases, even refusing to stock goods (https://www.theguardian.com/business/2016/oct/13/tesco-unilever-resolve-marmite-dispute-price-supermarket). Supermarkets may believe that customers will regard price increases as profiteering, especially as the product which got all the attention (Marmite) is reportedly produced in the UK, and so not affected directly by exchange rate changes. Just to confuse things, extreme weather conditions in Spain have ruined crops of fresh vegetables, especially iceberg lettuces. Again supermarkets are simply allowing themselves to run out, or even rationing sales, instead of offering a market-clearing price. However they may now have a more palatable excuse for increasing prices.

The open economy mentioned by Cowen is probably an important factor. When I lived in UK I was surprised how much fruit and vegetable was imported from Africa and Latin America. Lettuces and cucumbers grown in Spain can be substituted more easily by reverting to great British hobby of garden and allotment produce.

How about "We, the self-appointed Experts, were wrong about Brexit."

https://www.amazon.com/When-Prophecy-Fails-Psychological-Destruction/dp/0061311324

I don't think economics is akin to a UFO cult. The latter is much more plausible.

Ha ha! Sick burn, bro.

Why do you let stuff like this get you so upset. I mean sure it's been a tough few months for you, but those library computer screens can only take so much spittle.

Hard to say. In between raging and destroying all the furniture in the library (which gets me ejected so I have to go to another branch) combined with week-long crying jags, I'm really going overboard here. I think I need to go abort a couple of babies to calm down. Maybe I'll even ask the mothers' permission this time.

Every time Tyler blogs about Brexit, he loses more credibility with his busted or unfalsifiable predictions. Especially as the ranks of broken doomsayers swell, from the BoE downwards through Treasury to the appointed chatterati and globalists experts. Today, though, it is business cycle fairies which explain the continued refusal of reality to play ball. He'd do well to imitate Caplan, and give a precise time period and metric by which he will allow his prognostications to be judged. And maybe, just maybe, change his mind.

Incidentally, he thinks the hit is £5600 per capita. Well, this may be a little hard for types like Prof Cowen to understand, but many Brexit voters don't have that much wealth to lose in the first instance. But I'm sure it will put a larger dent in the portfolios of the London-based internationally mobile professional classes. To paraphrase a voter oft-quoted here in the UK; "This is a hit to your economy, not ours."

It means some (some straussian bolloxs) or that economics is itself straussian bolloxs?

If this logic works--like Todd Kreider, I'm not sure it does--then hasn't the United States gotten perceptibly richer since the election of Donald Trump? Shouldn't American voters be congratulated on their wise, wealth-maximizing, rationally self-interested decision? (Including their wisdom in designing a system that is not purely majoritarian.) I'll wait, but I won't hold my breath.

"The puzzle here — and it is a very real one — is why economies sometimes get immediate hits to wealth, and no cycle, and other times they have to go through the wringer with an ongoing process of temporal decay.  The answer lies in part with Britain’s nature as an open economy, and the total lack of stickiness in the exchange rate price, but I think there is also more to it than that…"

Personally I find the business cycle literature too complicated, but I have read Schumpeter and assorted political economy, of which two main types — the overarching glacial technological cycle in the advanced economies and the recurring short-run base level activist-neoliberal cycle which all economies experience at all times. BREXIT adds a non-cyclical geo-political dimension due to sort of structural imperative to escape the EU straightjacket, wherein ‘temporal decay’ was the failure of EU from institutional standpoint.

Correct … going through the wringer can be fast or slow depending on the degree of economic flexibility of which currency plus trade and investment openness have vital role. However there is also something less tangible which some lazily label ‘culture’ but which is really to do with a mix of institutional flexibility, ideology, short run stoicism combined historical legacies of individual responsibility, and the willingness of political leadership to unleash a shock for rapid correction. Sum it up as political or institutional innovation cycle equivalent to the techno-economic innovation cycle.

The basic reason for the rise of Trump or Trumpian is the delay of a ‘truthful’ adjustment to the 2007-9 financial crisis, and the consequent slow-motion societal and political decay. But it’s a rough ride when society finally faces up to the task of change, the leadership can take blunt forms, some of the policies can be atavistic, and it’s all quite shocking for the hitherto artificially sheltered elite, middle, and intellectual groups. So a task for economics in the future I guess is to learn again from Schumpeter and deliberately avoid the slow wringer cycle, making more use instead of the fast rinse cycle.

Do the Quebec independence referendums not provide a counterpoint to the thesis that the shocks will be fast? Quebec was not plunged into a recession right around either referendum, but the long term negative effect on growth of the uncertainty is blatantly obvious to anyone who has been to both Montreal and Toronto before and after. Once they were economically comparable. Now there is no comparison. The magic of compounding of small differences in growth rates in action is very real.

Due to the magic of left-wing thinking, Quebec separatism is a left-wing cause (although ethnocentrism is evil if white Anglophones do it). Therefore Tyler will never say anything bad about it. All his writings have to be read through a political prism.

Academics are so superficial and transparent. I presume (never having been an academic) that it stems from never being judged by real world standards, but only by equally superficial and transparent peers.

LOL those academics are all sad now that you put them in their place.

A brief tour of the academic blogosphere will demonstrate that most of them are consumed with envy of their former classmates, who had better grades back then and who make much more money now in the private sector. (Admittedly, we work harder and don't have Guaranteed Lifetime Employment, but they're still jealous.)

'We'? LOL. On the internet no one knows you're a dog.

Gross value added per capita is in Quebec about 20% lower than the Canadian mean. The place has been less affluent than Anglophone Canada since statistics have been kept, so I wouldn't attribute that to the most recent sovereignty referendum.

Currently, it’s hard to say where the growth rate is going, but just need to watch out things. I believe things have been really slow due to Brexit, so just now need to be watchful. I enjoy it a lot with OctaFX due to their low spreads from 0.1 pips while there is also huge rebate program where there is 50% given back on all trades even if it’s with losing one. I truly enjoy it and give me the freedom that we all wish and want.

The negative wealth effect is a more fundamental category, and we absolutely have seen one of those in Great Britain.

Not sure a weaker pound in the short term should be taken as evidence of a permanent reduction in wealth for the median Briton -- there are winners and losers, but does anyone still think Greece functions best under a stronger currency? For instance:

A while ago I estimated the costs of this “hit” at 5,625 pounds per capita, though since then the British pound has fallen even further, thereby raising those costs.

That would imply the market only gradually (i.e. inefficiently) accumulated knowledge about Brexit. If you can't tie a news item to an immediate move in a price, it very likely didn't cause it -- never reason from a price change!

Comments for this post are closed