Academic journal article National Institute Economic Review

Will Brexit Raise the Cost of Living?

Academic journal article National Institute Economic Review

Will Brexit Raise the Cost of Living?

Article excerpt

This paper considers two aspects of this question. First, Brexit has already induced a devaluation of sterling of around 14 per cent since June 2016, which has started to work through to consumer prices: between June 2016 and July 2017 consumer prices increased by around 2.5 per cent. Second, while it is not government policy, nor the desire of the UK public, that the outcome of negotiations is a 'MFN Brexit', this remains a distinct possibility. Thus we ask how the imposition of tariffs on imports from the EU will work through into consumer prices. Making very conservative assumptions, we conclude that 'MFN Brexit' will increase the average cost of living by around I per cent and increase it for 8 per cent of households by 2 per cent or more. We present results for different groups of households according to their employment and structural characteristics and show that the impact will generally be largest on unemployed, single parent and pensioner households.

Keywords: Brexit; consumption; international trade; tariffs; partial equilibrium model.

I. Introduction

The point of economic policy is to increase citizens' welfare, and while individuals' real incomes are not the only criterion on which we might judge this, they are certainly the dominant one. Most of the analysis of Brexit has concerned its effects on exports, production and earned incomes, and this is undoubtedly the main way in which it will ultimately impinge on UK residents. However, it will also have direct effects on the cost of living which are of interest both per se and particularly to people whose incomes are sticky, such as those on benefits or pensions. Our question, therefore, is to what extent Brexit will increase the UK cost of living.

We analyse two forces that influence the cost of living, and consider their effects on households with different family and employment profiles. First, Brexit has already had a significant effect on the exchange rate, with a devaluation of sterling of around 14 per cent since June 2016. This has started to work through to consumer prices and so we analyse the incidence of actual price changes since June 2016. There will, of course, have been other influences on prices, but there is little doubt that the Brexit-induced devaluation has been the major one over this period.

Second, we consider future trade policy. Although UK government policy is to seek a deep and special relationship with the EU, which would preserve many of the features that render current UK-EU trade costs so low, this is, at present, very far from being assured. Negotiations have to finish by about October 2018 in order to allow any agreement to be signed and ratified. The UK has only started to spell out its negotiating objectives in August 2017, but these often lacked concreteness and were poorly aligned with the negotiating objectives in the rest of the EU. (1) UK politics remain as fractured as ever over Brexit, with divisions at every level from the Cabinet downwards and in the opposition Labour Party; the government lacks a majority and there are several veto points that could delay (and hence prevent) an agreement. Thus while it is not policy, nor the desire of the public, a Brexit with little cooperation on trade between the UK and EU remains a distinct possibility.

Under such a Brexit, the UK and the EU will be obliged by WTO rules to impose the same tariffs on their mutual trade as they impose on imports from the countries with which they currently have no free trade agreements.

Given the UK government's intention not to change tariffs from current levels, we model this as levying the current EU most favoured nation tariffs on UK imports from the EU, for which reason we term it a 'MFN Brexit'. By limiting ourselves to just one dimension of Brexit we cannot comment on the overall costs or benefits of the policy. Moreover, for several technical reasons, which we outline below, our estimates of the cost of living effects are certainly too conservative. …

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