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September 05, 2019

Would Keynes be in favour of Brexit?

We have always argued that the economic consequences of Brexit are an issue beyond economic forecasting or even economic analysis. The reason is that some of the most important parameters are variable. Good policies designed to exploit the regulatory opportunities or a permanent change in the real exchange rate could have profound effects on economic performance in the long run, and overwhelm all the other stuff that backward-looking trade models tell us will happen.

So far most of the discussions has been about Brexit itself, not about the policies, except in one area: fiscal policy. We agree with Ángel Ubide’s remark that the UK yesterday took a lead in fiscal stimulus, with its much under-reported annual spending round. It produced the fastest real growth in day-to-day government departmental spending in 15 years - a projected increase of 4.1% in real terms.

The eurozone will find it much harder to transition away from austerity than the UK. The eurozone remains stuck with its multiple fiscal rules that produce suboptimal fiscal policy for many member states. We have argued before that there exists one rational reason for a member state to leave the eurozone: not to be bound by such a set of rules that keep you in a state of semi-depression. This may not be a sufficient reason, but the mere existence of a rational reason is not to be taken lightly.

The EU did not directly influence the macroeconomic policy stance of the UK. The Maastricht Treaty’s 3% deficit rule applies to non-eurozone members as well, but without any enforcement procedures. Brexit is not about macroeconomics in the sense that the Brexit will not allow the UK to conduct policies it could not conduct as an EU member. But Brexit necessitates macroeconomic policy changes. And herein lies an opportunity.

The FT called Sajid Javin’s spending round a typical pre-election move. There is more money for local government in addition to funds previously announced for schools, police and hospitals. The budget would increase the state sector in the economy from 38% to 38.6% of GDP. The spending measures end up busting the UK’s own fiscal rule to keep annual borrowing at below 2% of GDP.

One of the biggest beneficiaries of the spending review is the Home Office, which also oversees the police. Previous British governments have done virtually nothing to combat an alarming rise of knife crime in London. The new plans foresee the recruitment of 6000 police officers next year as part of a plan to increase the force by 20,000. We expect this to be one of the most popular measures of government spending, and relevant for the upcoming election.

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