Must-Read: Paul Krugman: Notes on Brexit and the Pound
Must-Read: The argument for a Brexit recession always seemed to me to be that:
- The pound would need to drop a lot to generate enough exports to offset the fall in investment in the City that the prospect of downsizing London finance would generate.
- Perhaps the Bank of England would be unwilling to let the pound drop that far for fear of what it would do to inflation.
- Perhaps the drop in the pound would destabilize the pound’s role as a safe store of value and thus further erode the City’s comparative advantage, already under threat by the uncertain institutional consequences of Brexit.
Whether the pound and the domestic interest rate drop far enough to avoid a short-term Brexit recession thus always seemed to me to be a matter of policy choice and animal spirits…
Paul Krugman: Notes on Brexit and the Pound: “The much-hyped severe Brexit recession does not, so far, seem to be materializing…
…But we are seeing a large drop in the pound, which has steepened as it becomes likely that this will indeed be a very hard Brexit. How should we think about this?… I’m coming at it from the trade side–especially trade in financial services…. Financial services… are subject to both internal and external economies of scale, which tends to concentrate them in a handful of huge financial centers… one of which is, of course, the City of London. But now… those services [will move] away from the smaller economy (Britain) and into the larger (Europe). Britain therefore needs a weaker currency to offset this adverse impact. Does this make Britain poorer? Yes… the efficiency effect of barriers to trade… [and] a terms-of-trade effect…. A weaker pound shouldn’t be viewed as an additional cost from Brexit, it’s just part of the adjustment. And it would be a big mistake to prop up the pound: old notions of an equilibrium exchange rate no longer apply.