Friday’s figures confirming that real GDP grew by 0.7 per cent in Q3 seem to have confirmed Brexiters’ claim that “Project Fear” was wrong to have predicted an immediate adverse impact of the vote to leave the EU. There is, though, a point here which both sides are underplaying.
It’s that if we look only at the macroeconomic data, events since June look very similar to what would have happened if the inflation target had been raised last year, or if we’d shifted from an inflation target to a generous money GDP target.
What would have happened if we’d made that shift? The Bank of England would have cut rates, real bond yields would have fallen in anticipation of looser future monetary policy, and sterling would have fallen as a result. We’d also have seen a rise in inflation and inflation expectations. We’d have seen export orders and prices pick up in response to the weaker pound. And we’d have seen consumer spending rise, perhaps temporarily as people pulled spending forward in anticipation of rising prices in 2017, or perhaps permanently because of lower real interest rates.
We’ve seen all of this. So far, therefore, the observed macroeconomic consequences of Brexit look very much like a relaxation of the inflation target.
To a macroeconomist, however, such a relaxation would have been superior to Brexit as it would not have increased uncertainty about future trading rules and so would not have dampened capital spending: the volume of business investment in Q4 was 3.3% down from its peak in 2015Q3.
All of this suggests to me that everybody who thinks that Brexit has been a success so far should have been calling for a relaxation of the inflation target for years. Such a move would have achieved much of what we’ve seen since June, without the downside.
But I'm not sure they did this. Yes, many economists were arguing for such a relaxation. But I get the impression that these were more likely to be Remainers than Leavers. Brexiters were not, generally speaking, among the strongest advocates of changing the inflation target. Perhaps the opposite. To take one example, Ryan Bourne – who recently criticized Project Fear – has also accused the Bank for being too soft on inflation.
Of course, there is reason not to have wanted such a relaxation, especially recently. For example, if you believe the OBR’s claim that output is more or less at its potential level, you’ll think that such a move would generate inflation more than real growth*.
This, though, is also a reason to doubt the benefits of Brexit because if firms are at full capacity, we’ll not see much increase in export volumes or domestic output in response to higher consumer spending.
This leaves me puzzled. Brexiters who are cheering the economy’s recent strength should also have been longtime advocates of a higher inflation target. Everything the Brexiters are celebrating now could have been achieved with much less palaver by changing the inflation target. But they were much less vocal in that advocacy than they were about Brexit – to say the least. This strengthens my view that calls for Brexit weren’t really based upon economics at all.
* Personally, I think the idea of an output gap is silly, but let that pass.