With the EU referendum concluded, attention has already turned to defining what type of exit the government will pursue. Whatever view you hold on the merits of an exit from the EU, the exact economic impact is uncertain. This is mainly because “it” is not predetermined – there exist a range of views among Brexiteers.
As the Conservatives embark on electing a new leader, each candidate’s vision for a post-EU Britain needs articulating, and implementation will ultimately require a popular mandate. In this respect, a General Election over the next 12 months looks almost inevitable.
Ahead of these political manoeuvres, the economy will require skilled stewardship. Effective policy intervention and clear communications will secure a markedly better outcome than inertia and silence.
We learnt on Friday morning that the warnings of the Treasury and the Bank of England had fallen upon many deaf ears. Public opinion across large parts of the UK was impervious to the views of senior public officials. Most observers of the referendum, myself included, had assumed a late swing back to the status quo with the weight of economic uncertainty driving this move. It was a swing factor that never materialised. For George Osborne and Mark Carney in particular, this will have proved a chastening experience. The good news for them – at least while they both remain in office – is that their control over fiscal, monetary and financial stability policy is still largely intact.
So what should this economic leadership team do to secure near-term stability for the UK economy? Well, first, they should avoid a knee-jerk reaction. Although it may frustrate businesses and investors when such important actors are data dependent, this is infinitely preferable to having ideologues occupying Threadneedle Street or Horse Guards Road. Capital market volatility in the days following large geopolitical events is rarely a good basis for designing a policy response.
As we get a clearer picture of the fallout from the referendum, however, a coordinated fiscal and monetary response may well be necessary for the first time since the Financial Crisis. Since 2010, the Bank of England has been asked to do too much of the heavy-lifting of domestic demand. Any signs of a contraction in UK economic output should provide the basis for a shift to stimulative fiscal policy and a temporary suspension of deficit reduction plans. The Treasury’s own fiscal rules have a growth “knockout” for such an eventuality. It is this rather than the ludicrous “punishment Budget” mooted during the referendum campaign that represents the appropriate response to a slowing UK economy.
The Bank of England should also consider additional quantitative easing or interest rate cuts depending on the scale of the slowdown, but it faces a delicate balancing act with stable prices, current account financing and the pound all vulnerable to looser monetary policy. This preference for fiscal intervention also reflects the fact that monetary policy has a long and variable lag time.
In designing any stimulus package, the Treasury will be cognisant of the deep resentment within non-metropolitan communities that underpinned the vote to leave the EU. Spending increases should look to put billions of pounds into communities that voted for what amounted to a rejection of global capitalism. The Northern Powerhouse programme and city deals require acceleration and financing. This decentralisation of spending control from Westminster as identified by Lord Heseltine in the last Parliament will be key to maintaining the unity of the United Kingdom.
Over the shortest time horizon there is an acute need for engagement and signalling from government to fill a vacuum which will otherwise be filled by speculation. Business secretary Sajid Javid’s promise to meet with UK business leaders represents a good start. However small and mid-sized companies have been at the heart of the UK economic recovery in recent years and are unlikely to command an audience with a Cabinet minister. For them clarity on what type of Brexit is being pursued is key. It will be this that will unlock investment capital and put a floor under business and consumer confidence. It cannot come soon enough.