The Implication Of The European Union Brexit?

The European Union represents an “economic and political partnership between 28 European countries” (European Union, 2015). The EU is characterised as a single market where the movements of goods, services and labour are free between countries. However, the issue of the PIIGs (Portugal, Ireland, Italy and Greece) destabilised and challenged this union. As it created financial contagion within the economies, and lead to Britain and other members contributing to bailout funds for these debt ridden economies. This has consequently lead to the creation of the term ‘Brexit’, which is associated with the notion of Britain potentially withdrawing from the European Union (EU) (Oliver, 2015). Since the 2015 general election this term has been very prevalent in the media, due to the rising support from the British public to withdraw Britain’s membership from the EU. This was largely reflected in the 2015 general election vote, in which UKIP votes represented 12.5% (BBC News, 2015) of the UKs vote share. This has since prompted David Cameron to commit to an in-out referendum in 2017 on Britain’s membership. Therefore, this essay will evaluate the implications of a ‘Brexit’. Specifically, analysing how these consequences may alter the response of the Monetary Policy Committee (MPC) in maintaining monetary stability. Immigration Immigration is key aspect of the EU, as unlike other trade agreements it also allows for labour mobility between member countries. If Britain was to leave the union the level of immigration would fall significantly. The implications of this is that immigration “keeps prices and inflation low” (Arnold, 2011:p356), as it increases the supply of labour. This in turn reduces the real wage rate and exerts downward pressure on inflation. This can be illustrated by the Classical model (Figure 1). Moreover, as a consequence of the low inflation, interest’s rates will also be at low levels. Therefore, if we were to reduce immigration by leaving the union higher inflation would be anticipated, due to upward wage pressures. Effectively, the Monetary Policy Committee would have to intervene and raise interest’s rates to relive wage pressures and keep inflation at the 2% target. Moreover, there is also empirical evidence to support this. For example, Bentolilia et al (2008) looked at the effect of an influx of immigrants on the Spanish economy from 1995-2006. They found that the immigration accounted for 2.2% of an offsetting of the inflation rate per year (Bentolilia et al, 2008). This shows how European Union immigration specifically, is placing downward pressure on the inflation rate of member economies. Therefore, theoretically and empirically with respect to immigration a ‘Brexit’ indicates increases in inflation. Trade The most significant implication of a ‘Brexit’ on the UK economy would be with respect to the country’s balance of payments. As the EU is regarded as Britain’s “most important trading partner” (Dhingra et al, 2015:p20). This is depicted in figure 2, which illustrates how until the recent financial crisis a large proportion of UK exports went to the EU. Therefore, by leaving the union the UK economy would see a vast fall in exports as a result. The fall in the exports would create a trade deficit in the economy as the level investment will exceed the level of saving. Consequently, the exchange rate will appreciate. This is shown in figure 3. Due to this appreciation exports will become more expensive and imports will become cheaper. This will then cause aggregate demand to fall, as shown in figure 4. In conjunction to this the price and output level will also fall. This fall in prices will …show more content…
Predominately looking at what theory implies will occur in the economy, as well as, combining that with empirical and statistical evidence. What this essay has not considered until this point is that these are not normal times. The UK economy is currently experience “weak growth and low inflation” (),in the last quarter of 2015 inflation was actually negative. Furthermore, interest rates in the economy are at historical lows of 0.5%. The UK economy is currently considered as being in a liquidity trap, in which interest rates have become an inefficient tool in influencing inflation. Since, we have seen the Bank of England engaging in quantitative easing. This paints a picture of an economy in need of