By Ben S.
Bernanke*
After several days of market upset, a few reflections on last week’s
momentous vote in Great Britain.
Even more obvious now than before the vote is that the biggest losers,
economically speaking, will be the British themselves. The vote ushers in what
will be several years of tremendous uncertainty—about the rules that will
govern the U.K.’s trade with its continental neighbors, about the fates of
foreign workers in Britain and British workers abroad, and about the country’s
political direction, including perhaps where its borders will ultimately lie.
Such fundamental uncertainty will depress business formation, capital
investment, and hiring; indeed, it had begun to do so even before the vote. The
U.K. economic slowdown to come will be exacerbated by falling asset values
(houses, commercial real estate, stocks) and damaged confidence on the part of
households and businesses. Ironically, the sharp decline in the value of the
pound may be a bit of a buffer here as, all else equal, it will make British
exports more competitive.
In the longer run, the uncertainty will dissipate, but the economic
costs to the U.K. still will exceed the benefits. Financial services and other
globally oriented industries, which depend on unfettered access to European
markets and exchanges, will come under pressure. At the same time, the
purported gains from freeing the U.K. from the heavy regulatory hand of
Brussels will be limited, because Britain will likely have to accept most of
those rules (without ability to influence them) as part of restructured trade
agreements. Immigration is unpopular in the U.K., and slowing it was a motivation
for some “leave” voters, but a more slowly growing labor force likely would
also reduce overall economic growth.
The rest of Europe will also be adversely affected, even though
Frankfurt and a few other cities may gain finance jobs at the expense of
London. The biggest risks here are political, as has been widely noted: In
particular, markets are already beginning to price in the risk that other
countries or regions will press for greater autonomy from Brussels. Even those
sympathetic to such demands should worry that attempts to unwind existing trade
and regulatory arrangements could be highly disruptive, as they will likely be
for Great Britain. A move toward exit by a member of the euro zone would be
particularly destabilizing, as even the possibility that a country might leave
the common currency could provoke bank runs and speculative attacks on the
country’s sovereign debt and on other countries that might be thought to be
next in line. The challenge for European leaders will be to keep the overall
integration process on track, while finding ways to meet the concerns of
potential leavers. One issue that could be revisited is the EU’s commitment to
the absolutely free movement of people across borders, which seems more a
political than an economic principle; the perception that the U.K. had lost
control of its borders was one of the most effective arguments for “leave,” and
secessionist movements elsewhere have also seized on the issue. [1]
Globally, the Brexit shock is being transmitted mostly through financial
markets, as investors sell off risky assets like stocks and flock to supposed
safe havens like the dollar and the sovereign debt of the U.S., Germany, and
Japan. Investors are perhaps more risk-averse than they otherwise would be
because they know that advanced-economy central bankers have less space than in
the past to ease monetary policy. Among the hardest hit countries is Japan,
whose battle against deflation could be set back by the strengthening of the
yen and the decline in Japanese equity prices. In the United States, the
economic recovery is unlikely to be derailed by the market turmoil, so long as
conditions in financial markets don’t get significantly worse: The
strengthening of the dollar and the declines in U.S. equities are relatively
moderate so far. Moreover, the decline in longer-term U.S. interest rates
(including mortgage rates) partially offsets the tightening effects of the dollar
and stocks on financial conditions. However, clearly the Fed and other U.S.
policymakers will remain cautious until the effects of the British vote are
better sorted out.
Although bank stock prices are taking hits, especially in the U.K. and
Europe, a financial crisis seems quite unlikely at this point. Central banks
are monitoring the funding and financial conditions of banks, and so far
serious problems have not emerged. (It helps that the date of the referendum
has been known for months, giving authorities time to prepare. Also helpful is
the substantial buildup in bank capital in recent years.) Through its currency
swap lines, established during the global financial crisis, the Fed is
making sure that other major central banks have access to dollars.
As I’ve already suggested, the biggest risks to financial stability at this
point appear to be political—specifically, the risk of further defections or
breakdown in the European Union—rather than economic. The story may not be over
yet.
[1] Britain has substantial immigration from both EU and non-EU
countries. The debate over Brexit sometimes seemed to confound the two, even
though only the former is protected by the EU treaties.
·
Ben S. Bernanke is a Distinguished Fellow in Residence with the
Economic Studies Program at the Brookings Institution and also serves as a
Senior Advisor to PIMCO and Citadel. From February 2006 through January 2014,
he was Chairman of the Board of Governors of the Federal Reserve System.
·
This article was published first on the Brooking Institute Web on 28
June 2018
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