Brexit associated sharp depreciation and implications for UK’s inflation and balance of payments

Abstract

Purpose The purpose of this paper is to analyse the implications of exchange rate depreciation for inflation targeting and trade balance of UK in the context of the Brexit epoch. Design/methodology/approach The study employed a time-varying structural vector auto-regression (TVSVAR) model framework in which the sources of time variation were both the coefficients and variance-covariance matrix of the innovations on the data from January 1989 to September 2016. Findings The findings suggest that the depreciation of the Stirling has significant effects on inflation and trade balance in UK in context of Brexit epoch. It also showed that such a depreciation can be helpful in the improvement of external balance as well as steering the inflation to its statutory target. Despite, the inflation targeting, there is strong evidence of a pass-through. Research limitations/implications Research has profound implications in terms of the sharp depreciation of GBP associated with the Brexit outcome. The study is very topical and could be very interesting to the readership of JES as well as wider audience. The study has limitations in a context that the significance of the results and association of the under analysis entities is contingent on the future trade relationships and Channel between UK and EU. Therefore, although there is a lot of uncertainty about the future of Britain trade relationships, this study provides guidance on the importance of exchange rate channel if the similar trade arrangements prevails in the post-Brexit era. Practical implications The research has profound practical implications, using a TVSVAR model in which the relationship among the entities varies over time; it has shown the importance of exchange rate in terms of external balance and inflation targeting. Hence, it has appeal for the practitioners as well as academics. Social implications The research has great social implications. The Brexit is the biggest political and economic event of this era for UK and EU. There are big questions about the relationship between UK and EU in the post-Brexit epoch as well as questions about the future of the European integration. In this context, this study has shown that how the exchange rate could play an important role for the UK economy when its contemporary trade channels prevail. Concomitantly, it has social implications particularly for the European society. Originality/value The research is an original piece of work. It has contributed to the debate on the exchange rate deprecation, external balance and inflation targeting in context of the Brexit associated sharp depreciation of Stirling. It has used a framework, i.e. TVSVAR, which also have unique features in terms of testing the associations among under analysis entities against time.

Brexit referendum and European stock markets: a sector analysis

“…Other researchers concluded that Brexit-induced policy uncertainty will continue to cause instability in key financial markets and has the potential to damage the real economy in both the UK and other European countries (Burdekin et al, 2017;Tielmann and Schiereck, 2017;Belke, 2017;Belke and Gros, 2017; Brexit and European stock markets Belke and Ptok, 2018;Padilla and Garrido, 2018). Other studies provided evidence on the effects on market volatility (Adesina, 2017;Sita, 2017;Cox and Griffith, 2018;Nishimura and Sun, 2018), exchange rate correlation (Alvarez-Diez, 2019) and the sharp depreciation of GBP (Ali Nasir and Simpson, 2018;Ali Nasir and Morgan, 2018), whereas Schiereck et al (2016) investigated the impact of Brexit on credit default swaps spread and EU banks' share prices and confirmed a negative impact on share prices and increased political uncertainty.…”

US trade deficit, a reality check: New evidence incorporating asymmetric and non‐linear effects of exchange rate dynamics

“…For the adjustment of trade balance through appreciation and depreciation, one can go as far back as Hume's (1742) price–specie flow mechanism argument. The empirical studies since then often support a significant relationship between exchange rate and trade balance (Baharumshah, 2001; Bahmani‐Oskooee et al., 2019; Bahmani‐Oskooee & Ratha, 2004; Bahmani‐Oskooee & Saha, 2017; Nasir & Simpson, 2018; Stucka, 2004). However, the net benefit of depreciation (appreciation) can only be positive (negative) if the elasticities of export and import sum up to a value greater than unity, i.e., Marshall–Lerner condition (see Bahmani‐Oskooee et al, 2019; Bahmani‐Oskooee Ratha, 2004; Bahmani‐Oskooee & Saha, 2017; Devereux, 2000).…”

The Effect of International Currency Crises on the Balance of Payments: Evidence From Jordan

“…A separate study by Nasir and Simpson (2018) examined the consequences associated with the depreciation of the ER considering factors such as inflation on the trade balance of the UK between January 1989 and 2016 by employing a "time-varying" structural vector auto-regression model. The findings revealed that depreciation had a major impact on inflation along with the balance of trade in the UK.…”