The Brexit Vote—Not Likely to Be Another Lehman Moment

June 24, 2016 5:00 PM

Despite the market turmoil on the first day after the Brexit vote, it seems unlikely that the Leave victory will trigger a rerun of the 2008–09 Great Recession.  Instead, the present volatility seems more likely to resemble the temporary downswings prompted by the Chinese renminbi in August 2015 and by low oil prices in early 2016.

The vote has indeed roiled financial markets, causing equities to fall 6 to 8 percent in Europe and Japan and 3½ percent in the United States (and 3 percent in the United Kingdom itself).  There has been an adverse spillover to the euro (down about 3 percent against the dollar), a strong safe-haven boost in the yen, and moderate safe-haven rise in the dollar (about 1 to 2 percent against the Canadian dollar, Chinese renminbi, Australian dollar, and Korean won, and 4 percent against the Mexican peso).  Oil prices have fallen 5 percent. The most extreme impact has been on banking sector stocks, which have fallen 20 to 25 percent for several UK and European banks—but, it turns out, not to levels below their low points already reached in early 2016.

International banks are much better capitalized than they were in 2008, and the housing market is advancing rather than in a rare historical decline.  The principal recessionary impact seems likely to be in the United Kingdom itself, where what had been an outlook for 2 percent growth in 2017 could turn into recession.  Even there, the nearly 10 percent decline in the pound sterling should spur net exports by as much as 2 percent of GDP by 2018.  The direct effect of UK recession would be modest for the United States, as the United Kingdom represents less than 3 percent of US trade, and total US exports are only about 13 percent of GDP.  The key question is how far the spillover effects would amplify the impact.  Euro area growth for 2017 might be cut from a 2017 baseline of 1.7 percent to say 1.2 to 1.4 percent. US growth might ease from its baseline 2.3 percent to 2.1 to 2.2 percent.  Over the medium term, the main downside risk would be an induced unraveling of the euro area if other countries sought exit.  Overall, although the Brexit vote has adverse economic implications for the United Kingdom and to a lesser extent the euro area, it is unlikely to mark the beginning of Great Recession II.