Shock and severe shock

You might remember that the Treasury produced an assessment of the immediate economic impact of a vote for Brexit. You can find it here. Below is the summary table from the report.

Looks pretty bad, doesn't it? Well, it turns out that the severe shock was suffered by the Treasury, not the economy.

The Guardian has a series tracking how the Brexit vote has affected the economy. The January 2019 edition is here. Below are the graphs showing what in fact happened during the two year period covered by the table above.

On the one hand, inflation has indeed gone up ...

... which is not surprising as sterling has indeed gone down.

On the other hand, every other Treasury prediction was completely wrong, not just in magnitude but in direction.

Let's start with the biggies. 

The Guardian puts it like this: "The average wages of British workers rose at the fastest annual rate since the financial crisis in the three months to November as unemployment fell to the lowest rate since the mid-1970s. Average weekly earnings, excluding bonuses, increased by 3.3% in the biggest rise since 2008. Meanwhile, the number of people in work also rose after an increase of 141,000 people entering employment to a record high of 32.54 million in the three months to November." That is pure unadulterated good news. See graphs below:

(Note that the unemployment graph shows a percentage of the population, while the wage growth graph shows growth rates, i.e. the graph on the left shows quantities and the graph on the right shows a first derivative. So wages have increased - wage growth has been positive - for every three-month period since the Brexit vote but there was a reduction in wage growth - the second derivative went down while the first derivative went up - in early 2017. Second derivatives are not so evident in the first graph. I don't find the juxtaposition of these two different types of graph terribly helpful.)

Also, Government borrowing is down:

(I think this is in £bn. This graph is quite helpful once you understand it. As a self-employed person I am pleased to see that my bi-annual income tax payments make a material difference to Government borrowing.)

I had to go to the ONS for GDP figures, but they are also up, not down:

(Graph taken from here, discussing the UK's long recovery from the 2008 recession. The period we are interested in is from 2016.)

I also went to the Government for house price data. As at November 2018, house prices had been rising every year since well before the Brexit vote and were continuing to do so, although the rate of increase has been declining in England (not in other UK countries) - click through to the link to look at those second derivatives, guys!.

I've said before that talking about Brexit means not talking about worse things. But it also means not talking about the wonderfully good run the economy has had over the last few years. I'm sure the Treasury is ringing with shouts of joy that its considered, entirely neutral, predictions for the results of a Brexit vote have been so utterly confounded by glorious reality.

Sarcasm aside, what do we learn from this failure of forecasting? It's tough to make predictions, especially about the future? Sure. Motivated reasoning doesn't help? Sure. But the Treasury (whose forecasts were not hugely out of line with other people) got it right about inflation and the exchange rate. Why so?

Getting both of those right is not that surprising, as I mentioned above. If the value of the pound in other currencies goes down then the price of imports to the UK goes up. The UK imports a lot of stuff, and the amount of importing was not going to change much in the short term, so predicting that the exchange rate would go down would give you a good steer that inflation would go up.

I think the key is that the financial markets' reaction to news is reasonably easy to predict, at least in the short term: the currency graph is the only one where the Brexit vote is noticeable in the data. If the Anti-Brexit Fairy arrived today and announced that Brexit would not take place then it's a decent bet that the pound would jump and there would be a big uptick in the FTSE 100 too. It's not too hard to spot what people who work in financial services think about Brexit. Equally, I can be pretty confident that a visit from the Anti-Brexit Fairy would be welcomed by a leading article in the Economist discerning the beginning of a turn against populism and favour of openness, perhaps coupling it with the Democrat successes in the US mid-terms. When we are talking about these subjects we are really talking about small numbers of people with clearly expressed views, and it is reasonably easy to know what they think. But when it comes to the country as a whole - or the trading world as a whole - working out what people think is necessarily much harder, and it is numbers on this scale that determine GDP, jobs and so on.

There's another point to consider here. What the Treasury was describing in 2016 as a shock or a severe shock is broadly the same magnitude of event as reversing the economic gains that the country has made since 2016. For example, the number of people in work around the time of the Brexit vote was about 31,757,000 and is now about 32,535,000, an increase roughly equivalent in magnitude to the number of people who were predicted to lose their jobs in the 'severe shock' scenario. So that's what the Remain campaign would threaten if there were a second referendum: vote Remain or be cast back into the dark days of 2016! It's not the feariest Project Fear, is it?