Productivity

Monetary policy

Fiscal policy

Nominal wages as a macroeconomic instrument?

Conclusion

Notes

Introduction

IF YOU ask a macroeconomist how macroeconomic policy should change as a result of Brexit, the chances are they will reply by saying it is a daft question. Leaving the Single Market and Customs Union of the EU will have a negative effect on UK productivity and, therefore, inevitably living standards, that the conventional tools of monetary and fiscal policy can do nothing to prevent or reverse. In this chapter I want to suggest this is rather oldfashioned thinking. What the global financial crisis (GFC), austerity and now Brexit have shown us is that sharp negative shocks to the economy can have additional permanent effects if they are not offset quickly and strongly by macroeconomic policy. One reason the UK has had a poor productivity performance since the GFC is that macroeconomic policy tools have failed to do this. To the extent that Brexit itself will reduce growth in living standards, it is imperative that we do not compound this by repeating the macroeconomic policy mistakes of the last decade. This chapter looks at where we have gone wrong and how we can do better after Brexit.

Productivity

Unless we stay in both the Customs Union and Single Market, Brexit will make trade with the EU substantially more difficult. Brexiters talk about making new trade agreements with countries outside the EU, but in reality, we are likely to lose more agreements with those countries by leaving the EU than we are likely to gain. Even if trade with third countries did increase, gravity equations—empirical relationships that look at the extent of bilateral trade—tell us that trade with third countries will never compensate for the trade lost to the EU simply because the EU is on our doorstep. That is what the government’s own analysis tells us, and it reflects every serious academic study. Less trade with the EU means that the UK economy becomes less open. That reduces productivity (how much output you get from a given labour force) because you lose some of the gains of specialisation. There is also good evidence that less open economies (in terms of goods and migration) have slower productivity growth than more open economies. Productivity growth is the main determinant, in the medium and long run, of growth in living standards.