This working paper uses the new CBR macro-economic model of the UK economy to investigate possible futures following the referendum decision to leave the EU. The paper briefly explains why we felt the necessity to build a new model and describes some of its key features. Since Brexit is a unique event with no precedent it is not possible to do a normal forecast in which a few assumptions are made about a limited range of exogenous variables. The best that can be done is to construct scenarios and two are presented here. The difficult part is to decide what scale of adjustment is needed to reflect the likely realities of Brexit. Analysis by HM Treasury of the potential impact of various outcomes for trade outside the EU is examined and found wanting. Instead the actual experience of UK export performance is examined for a long period including both pre- and post- accession years. This suggests a more limited impact of EU membership. While we include a scenario based on Treasury assumptions, a more realistic, although in our view still pessimistic, scenario assumes half of the trade loss of the Treasury. The results are presented through comparing these scenarios with a pre-referendum forecast. In the milder Brexit scenario there is a 2% loss of GDP by 2025 but little loss of per capita GDP, less unemployment but more inflation. In the more severe, Treasury-based scenario the loss of GDP is nearer 5% (2% for per capita GDP), inflation is higher and the advantage in unemployment less.

A model based largely on equations reflecting past relationships between macroeconomic variables has little to go on in attempting to project a long-term future outside the EU. Nor is there much on which to base a judgement about how much of investment and consumption might be delayed or cancelled due to inevitable uncertainty about the future. Our two scenarios about possible futures leading up to and following Brexit are based on a series of assumptions not only about what form trade arrangements might take, but importantly, what impact these changes will have on the wider economy. We have rejected the gravity model approach as an inappropriate and blunt instrument for assessing potential trade losses. A timeseries approach is better but still leaves a wide range of possibilities.

The first of our two scenarios examines the Treasury’s assumptions even though we feel that these have little basis in reality. More probable but still pessimistic is our baseline Brexit scenario. In the latter the loss of GDP peaks at less than 3% early in the next decade before beginning to recover. Postponed investment, loss of EU trade and lower migration all play a role, but an accommodating monetary policy and a depreciated currency help to manage the shock, as they should. In per capita terms the loss is never much more than 1% and soon recovers. Even under these somewhat pessimistic assumptions about (temporary) uncertainty and trade losses, the path of GDP is projected to be only a little lower than it might have been in the absence of a Leave vote. Inflation is higher but unemployment lower as migration is restrained.

The economic outlook is grey rather than black, but this would, in our view, have been the case with or without Brexit. The deeper reality is the continuation of slow growth in output and productivity that have marked the UK and other western economies since the banking crisis. Slow growth of bank credit in a context of already high debt levels, and exacerbated by public sector austerity prevent aggregate demand growing at much more than a snail’s pace.