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Brexit | Extended Uncertainty | Divided Europe

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Issue 36 | August 2016

Global Economics Monthly

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Brexit at Two Months: A Slow Burn in European Integration

Robert Kahn, Steven A. Tananbaum Senior Fellow for International Economics

Bottom Line: Markets have absorbed the initial economic shock from Brexit, but navigating the new landscape will remain a challenge. Two months after the vote, the politics of Brexit is producing a lengthy and uncertain renegotiation of Britain’s place in Europe and the world. Such extended uncertainty is likely to produce a long-lasting drag on both UK and European economies, which could ultimately threaten the viability of the European Union (EU). 

Brexit at Two Months

The June 23 Brexit vote was not a “Lehman moment,” as some analysts had feared. That it did not cause a financial market freeze similar to what followed the fall of Lehman Brothers in August 2008 is a result of the strong central bank action to calm markets and subsequent monetary easing from the Bank of England. Markets have stabilized and the recent economic data has been solid, leading many market analysts to declare the crisis over. 

Such optimism is premature. For the United Kingdom, which before the vote was expected to grow at 2 percent annually, the damage to growth still could be severe, perhaps on the order of 2 to 3 percent of gross domestic product over the next eighteen months. This contraction reflects the substantial political and economic uncertainty created by Brexit and its likely effect on investment and consumer demand. The exchange rate depreciation and easy monetary policy will provide a powerful offsetting boost, but it will take time to be felt. The United Kingdom remains on the front line of this event.

The more difficult question is the extent of contagion to the rest of the world and in particular Europe, given the EU’s weak economy and its population’s increasing frustration with its economic prospects. As in the United Kingdom, uncertainty about post-Brexit relations is likely to weigh powerfully on investment throughout Europe. Financial stability is also an issue: European bank stocks continue to underperform and the continental banking system is struggling with the legacy of the crisis and weak profitability. Lower interest rates will not help on that latter score. The European Central Bank can ensure adequate liquidity to troubled banks, but it cannot make them lend. If Europe wants above-trend growth in this environment, fiscal policy will need to do more.

Looking ahead, I see two systemic market risks coming out of Brexit. The first is the potential for lengthy negotiations to extend the exit process at a significant economic cost for markets that crave certainty. This tension is the result of a disconnect between economic and political timelines. The second risk is that it will distort decision-making by European policymakers on critical economic questions. Although many of Europe’s challenges would have presented thorny problems absent Brexit, the UK vote creates a low-growth, populist environment in which decision-making will be even more difficult. Consider each of these drivers in turn.

A Disconnect Between Political and Economic Timelines

Immediately after forming her government, UK Prime Minister Theresa May announced her intention to trigger Article 50 at the end of 2016, beginning the formal process of Britain exiting the EU. Now, there are reports that invoking Article 50 may be delayed until the end of 2017 and a formal exit delayed until the end of 2019. Read more »

 

Looking Ahead: Kahn's take on the news on the horizon

Japan

Prime Minister Abe announced a 28.1 trillion yen ($276 billion) stimulus package, but much of the package consists of loans, and fresh government spending is 7.5 trillion yen. Is it the start of a shift in major economies’ industrial country fiscal policy? 

Group of Twenty (G20) and China

G20 leaders’ summit will be held in Hangzhou September 4 through 5. In their July meeting, G20 finance ministers and central bank governors expressed their concerns about heightened global risks due to Brexit. The upcoming leaders’ summit will test China’s leadership role in ensuring that G20 takes a more coordinated approach to fiscal policy and other critical issues including infrastructure investment.

Venezuela

Venezuela’s economic crisis is deepening, and default seems a question of when rather than if. The government has debt repayments of $1.8 billion due in October and $2.9 billion in November, and is looking to a debt swap operation between the state oil company PDVSA and creditors to get through the year without default.

 

FROM THE MACRO AND MARKETS BLOG

Turkey’s Shaky Economy: a Local or Global Concern?
 

Robert Kahn 

Emerging markets have held up impressively in the aftermath of the Brexit vote last month. Turkey’s importance in global markets on the surface appears small relative to factors like Brexit, so it's reasonable to expect that Turkish markets eventually will find their footing and the risks will remain local. But any sense of a significant economic problem in Turkey, an important and liquid emerging market, could pull an important prop out of the benign emerging market story. That could be the economic legacy of this weekend’s events. Read more »

 
Brexit’s Threat to Global Growth
 

Robert Kahn 

Thursday’s Brexit vote wasn’t a “Lehman moment”, as some have feared. Instead, it was a growth moment. And that may be the greater threat. If policymakers respond effectively, the benefits could be substantial: a stronger global economy, and an ebbing of the political and economic forces now pressuring UK and European policymakers. Conversely, failure to address the growth risks could cause broader and deeper global economic contagion. Read more »

 
Britain’s Bold Leap into the Unknown
 

Robert Kahn 

Britain’s vote to leave the European Union was fueled by a broad range of social and political concerns, including a fear of immigration, resurgent nationalism, and a populist rejection of UK and European policies, institutions and policymakers. But it is also an extraordinary economic experiment. Read more »

 

ABOUT CGS

The Maurice R. Greenberg Center for Geoeconomic Studies (CGS) works to promote a better understanding among policymakers, scholars, journalists, and the public about how economic and political forces interact to influence world affairs.

 
Michael A. Levi
@levi_m
Director of the Maurice R. Greenberg Center for Geoeconomic Studies

Edward Alden
@edwardalden
Bernard L. Schwartz Senior Fellow

Thomas J. Bollyky
@TomBollyky
Senior Fellow for Global Health, Economics, and Development

Willem H. Buiter
Adjunct Senior Fellow

Blake Clayton
@bcclayton
Adjunct Fellow for Energy

Heidi Crebo-Rediker
@heidirediker
Senior Fellow

James P. Dougherty
Adjunct Senior Fellow for Business and Foreign Policy

Jennifer Harris
@jennifermharris
Senior Fellow

Miles Kahler
@MilesKahler
Senior Fellow for Global Governance
Robert Kahn
Steven A. Tananbaum Senior Fellow for International Economics

Sebastian Mallaby
Paul A. Volcker Senior Fellow for International Economics

Meghan L. O'Sullivan
Adjunct Senior Fellow

Peter R. Orszag
@porzsag
Adjunct Senior Fellow

Kenneth S. Rogoff
Senior Fellow for Economics

Varun Sivaram
@vsiv
Douglas Dillon Fellow

Matthew J. Slaughter
@MattJSlaughter
Adjunct Senior Fellow for Business and Globalization

A. Michael Spence
@amspence98
Distinguished Visiting Fellow

Benn Steil
@BennSteil
Senior Fellow and Director of International Economics
 
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