Does the Bank’s latest forecast mean Brexit has had no effect?

The focus of many (not all) journalists on GDP growth was in evidence again in the reporting of the Bank of England’s latest UK forecast.

Bank of England Inflation Report February 2017 and (in italics) my estimates

Growth rates of	2016	2017	2018	2019	Ave 98-07
GDP	2.0	2.0	1.6	1.7	2.9
Household Income	2	0.75	0.25	0.75	3.0
Savings ratio [1]	5.75	4.5	3.75	3.25	8.0
GDP per head	1.25	1.25	1.0	1.0	2.25 [2]
Household Income p.h.	1.25	0	-0.5	0	na

[1] Level [2] Average 1955-2007

The headline news was Brexit didn’t seem to be having much effect on GDP growth, despite earlier pessimism from the Bank. Leavers have never forgiven the Bank for giving their pessimistic views on the immediate impact of Brexit during the campaign. There is also an attempt to suggest that because many macro forecasters have been surprised by the resilience of the economy since the vote that must mean that the near universal view of economists that Brexit will be bad in the medium term is also now very suspect. Anyone who knows about these things knows that an unconditional macro forecast is very different from a conditional forecast based largely on international trade evidence, but as most people do not know these things (including most political journalists) it is an effective bit of propaganda.

A major reason for the more optimistic forecast now is that consumers so far have decided to reduce their saving, which the Bank had not expected. One possible reason for this is that a lot of consumers have decided to undertake major purchases like buying a car to beat the coming price rises expected as a result of the depreciation. That alone would imply that the decline in the ratio is temporary, but as we shall see, the Bank is now expecting it to continue.

It is hard to forget a remark made to a fellow economist during the referendum campaign by the member of the audience in a public meeting in the North West. After this economist had talked about the beneficial effects of joining the Euro on GDP growth, they said something like ‘it may have helped your GDP but it hasn’t helped mine’. In that spirit I want to make two points that were generally ignored by the media in their reporting of this forecast.

First (as regular readers will know), GDP is the output of the country, not the output of an average member of that country. Although the ONS now releases estimates of GDP per head (or per capita as it is often known) with its GDP estimates, most journalists seem to have not noticed. One reason for the focus on aggregate GDP is that forecasters like the Bank continue to publish only aggregate figures.

The table above is an attempt to adjust the Bank of England’s forecast for expected growth in the population. I’ve basically just taken the average population growth rate for the last few years and projected it forward. That could be on the high side if immigration from the EU falls off substantially over the next few years, but this would probably only increase the numbers by another 0.25%. Growth of 1% in GDP per head does not sound so good, particularly when you note it is less than half the historic average.

Second, over the following few years even GDP per head is likely to not feel like ‘my GDP’. We can see this from the Bank’s forecast for real household income. These fail to get above 1% growth. The reason is something Leavers do not like to talk about, and which therefore many journalists ignore: the impact of the Brexit depreciation in sterling. As this depreciation gradually leads to inflation not matched by higher nominal wages, real income growth will suffer.

Why is forecast GDP growth so much higher than income growth? The Bank now expects consumers to reduce their savings to unprecedentedly low levels. Why would they do that? The Bank operates a model where consumers base their current consumption on anticipated future income, and where expectations are rational. If, as economists universally expect, Brexit leads to slower income growth in the future, consumers should have reacted to that by cutting current consumption because their future income will grow more slowly relative to pre-Brexit vote expectations. This they clearly have not done, in part because many of them do not believe future income growth will be reduced by Brexit. That is at the heart of the recent forecast revisions. But this leaves the Bank without any guide to how the savings ratio will evolve. If consumers continue to believe everything is OK, despite the short term fall in their income growth, then further falls in the savings ratio are possible.

Of course even these numbers for household income are also inflated by likely household growth. (They measure all income going to households, not the income of an average household.) The final row adjusts for the expected growth in households. The average household size has remained constant over the last decade, and I have assumed that continues. As you can see, the income of the average household is at best going to be flat, and may fall slightly. So to say, as some Leavers have, that this forecast suggests Brexit will have no effect before we leave is completely wrong.

So how is the score in the match going between Leavers and economists, where goals are actual events rather than clever soundbites. The last time we looked the Leavers had let in two goals: the depreciation in sterling immediately after the vote, and then the Bank having to bring rates down to their lower bound again and start another round of QE. Nothing since then suggests those goals were invalid. If I’m feeling generous I’d say having to revise up a forecast could count as a shot on goal, but as it reflects a mixture of policy and consumers saving less I think it is also a miss.

But there has been a new goal scored by the Leavers, but unfortunately in their own goal. It is now clear to those not dependent on Brexit propaganda that as a result of Brexit we are going to be a supplicant to probably the most dangerous and right wing US president ever. Truly awful. Should never have been president. Got 5 million less votes, and that’s not counting those stopped from voting. Complete fluke. Only got the votes he did because of a biased media and fake news. FBI is an absolute disgrace. Everyone agrees. He’s got to go. Some people are saying he is unstable. Others that he is a stooge of the far right. Impeach the guy. Truly awful. (Sorry, couldn’t resist)

Which all means, the score is now

Economists 3 Leavers 0

and we haven’t even reached half-time yet. But there may be a lot more goals to come when the negotiations conclude. If the economists keep scoring, we can avoid extra time, which is desirable because that only ends in 2030!