On the Brexit "divorce bill"

Robert Halfon says voters will “go bananas” if the government pays the EU a £40bn “divorce bill”. There might be a simple solution here.

Mr Halfon is right to think it unacceptable to fund the (say) £40bn payment by raising taxes or cutting spending. It is vanishingly unlikely that a fiscal tightening of 2% of GDP will be justified in the next couple of years.

Nor is it right that the bill be paid by borrowing, even though the government can borrow at negative real interest rates. Borrowing is deferred taxation. Even if we set aside considerations of Ricardian equivalence, as perhaps we should, it’s unacceptable that young people today will face higher taxes in future to pay for a decision taken by their elders. And it would be astoundingly hypocritical of a government that has justified austerity on the grounds that public debt imposes a burden on future generations to demand that they do so.

But there is, of course, a trivially simple alternative here. Quite simply, the bill could be paid by printing money. The Bank of England can print £40bn and hand it over to the government; in effect, we’d have another £40bn of quantitative easing.

This would not be inflationary, except to the extent that converting £40bn into euros would tend to weaken sterling: this would be a neat test of just how liquid the FX market is. This is because the £40bn is not being spent on domestic goods and services, and so will not raise aggregate demand. If you want to see this in MV=PT terms, the increase in M will be offset by a fall in V – so there’s no inflation.

There’s no reason therefore to get het up about handing over £40bn. Because we can print our own money, giving £40bn to the EU does not mean we have to sacrifice real resources. The analogy with a divorce bill is misleading. When a man pays to divorce his wife, he suffers a loss of real wealth – some of record collection and DVDs and so on. This need not be the case with leaving the EU.

Of course, I believe Brexit will make us genuinely poorer. But this is because we’ll have less favourable trading terms with the EU and tougher immigration restrictions. The “divorce bill” is (barring the impact on sterling) neither here nor there.

Which poses the question: why are the Tories making such a big issue of it?

Simple. It’s because creating £40bn in this way would raise the question: if the government can easily find £40bn for the EU, why couldn’t it find £40bn for the NHS?

In principle, there is a good reason. Spending an extra £40bn in the domestic economy could be inflationary, whereas giving it to the EU is not. The constraint upon government spending is inflation.

The Tories, however, cannot use this argument. For years, they have claimed that austerity was necessary because the constraint upon spending was the state of public finances. That was false. If they were to pay off the EU in a rational way, they therefore have to admit that austerity was largely unnecessary.

In this sense, the Tories’ past stupidity compels them into making even more mistakes.

Comments

[Acarraro]

I dont think this is correct. The UK government cannot print euros. After the FX transaction someone will own the extra sterling, they don't disappear. So there would still cause extra demand in the UK. I mean even normal monetary policy has effects on the demand in other countries through the FX channel.

[d]

what acarro said

[Dave Timoney]

@Acarraro,

You are correct that someone will have to buy the pounds so that we can pay the EU in euros, and logically those extra pounds will find their way back into the UK economy unless foreigners wish to hold Sterling as cash (let's assume they don't), but that means foreigners buying export goods and services in the main.

This will have an indirect impact on domestic demand, but one that is more than offset by other benefits - e.g. an export boom might lead to increased overtime and thus more domestic spending, but it would also increase GDP, wages and perhaps productivity (because of sector averages).

The risk to inflation would largely arise from a fall in the value of Sterling. In theory, that should also help boost exports, though recent experience suggests it is now a weak effect (essentially because the export sector is smaller and its composition less price-sensitive).

The political point is that Brexiteers who object to paying the EU anything are the same people who reckon we're all set to become a thriving trading nation once again. Self-interest should suggest that they be generous. The more we pay the EU, the greater the potential demand for exports.

That's the logic of QE: put more money into the hands of people who can spend in a beneficial way.

[Jacques René Giguère]

I concur with the above. The only way the "bill" can be paid is by the EU buying british goods. Either Britain is at full employment and pay through reduced consumption. Or it is not at FE and yes you have costless QE and why didn't the Tories didn't do it already?

[chris]

@ Acarro. I take your point. However, the extra (say) £40bn is a tiny proportion of existing £; M4 is £2076bn and foreigners' sterling deposits with UK banks are £343.9bn. (Plus there are £ deposits with foreign banks, where I can't immediately find the data) £40bn is only 1.7% of this. I suspect a small fall in sterling (and hence small rise in inflation) would be sufficient to induce people to hold that extra 1.7%. We're talking small effects here - certainly, surely, far more innocuous than £40bn of tax rises or spending cuts.

[Andrew Carey]

"Of course, I believe Brexit will make us genuinely poorer. "
Blimey , not a single report said that before the referendum. There were reports saying the leave outcome would mean being better off but not by as much as if we stayed in, one gave a difference of around £4k per household.
Still not the same as a considered post-ref result that we would be 'genuinely poorer'.

[Dipper]

The obvious point is that this is money that we already owe, so how come no government had budgeted for this? I'm not sure what the point of all those budgets was pre 2016 if in fact hidden in all the accounts was a line that we were shovelling an open-ended amount of money to the EU without any parliamentary approval. Clearly all the data concerning government spending and deficits we have been given over the last 40 years or so has been missing a quite large and undetermined term.

[Dipper]

"Of course, I believe Brexit will make us genuinely poorer. "

will it makes us as poorer as not being in the Euro has made us?

[D]

So how would it be different from printing for the NHS?

All things equal, there'd be more inflation and that would reduce the value of sterling... which is sort of the same as reduce value sterling causing inflation?

Are we basically saying a one off printing of 40billion would be fine?

If so, I'm all for it but... A. How would we respond to slippery slecounter arguments? B. We should mention the opportunity cost - ie that printed 40 billion could be spent on something else.

Someone please correct me f I've got this all wrong. :-)

[Blissex]

«Are we basically saying a one off printing of 40billion would be fine?»

My interpretation of our blogger's argument is that somehow adding £40 billion of spending to the £1,900 billion per year flow of GDP over four years is less inflationary than adding £40 billion to £2,076 billion of M4 because «this would be a neat test of just how liquid the FX market is. This is because the £40bn is not being spent on domestic goods and services, and so will not raise aggregate demand.»

The assumption seems to be that the EU27 will not spend the £40 billion buying stuff from the UK, but in the EU27 itself.

But the UK government will pay in euros, and the BoE cannot print euros, which is of course a grave limitation of UK sovereignty :-).

The UK government can buy euros by selling pounds, and the buyers will be those who want to buy stuff from UK suppliers, or who want to buy UK assets.

If they buy stuff from UK supplies that won't be any different than handing out £40 billion to UK businesses and people, and there will be inflationary pressure if there is no "general glut".

So probably our blogger is assuming that the buyers of £40 billion of extra pounds will spend them all to buy UK assets, like flats in central London, or UK government securities, or UK company shares, driving up asset prices, which does not count as "inflation".

[Sam]

An interesting post.

But - in the end, I think Eurosceptic Tories oppose giving £40bn to the EU purely because they hate the EU and don't want to give it things.

They won't have thought through this business of logical inconsistencies with austerity, anyway.