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IW-Kurzberichte 72. 2016
Galina Kolev / Jürgen Matthes / Berthold Busch
Brexit impacts on Germany?
How does the depreciation of the British pound
and the foreseeable slowdown in economic activity in the United Kingdom affect the German
economy? So far, the pending Brexit’s short-term
impacts on the UK have been less severe than
feared. This raises the next question as to what
effects can be expected for Germany in 2017 (see
Grömling/Hüther, 2016).
In the aftermath of the referendum, the British pound
lost more than 10 per cent of its value against the
euro. But following a short-term slump in key business indicators, the economic situation in the United Kingdom stabilised once again. This applies both
to the recovery of stock prices (Diermeier, 2016) and
especially to the relevant economic sentiment indicators. One explanation for this surprising resilience
is this: While there remains a high level of insecurity
regarding how things will continue to develop, nothing is changing in the trade relations between the
UK and the EU for the time being. Furthermore, the
depreciation and interest rate reduction are having
a stabilising effect. However, aggregated prognoses
by Consensus Forecasts for the UK for the year 2017
have decreased since the Brexit referendum, from
over 2 per cent to a solid 0.5 per cent with an upward
tendency. This basis allows for the calculation of the
impact of the growth slowdown by about 1.5 percentage points and the depreciation of the pound by
some 10 per cent on German trade with the UK and
on Germany’s economic output. An econometric
study (cointegration analysis; see Johansen, 1995)
was conducted for this purpose, allowing for the
calculation of relevant long-term effects based on
historical data (see appendix).
The study reveals the following results for the year
2017:
■■ A coefficient of –0.62 was calculated for the ex­
change rate responsiveness of German exports of
goods and services to the UK. On this basis, a depreciation of the pound by 10 per cent against the
euro is accompanied by a reduction in German
exports to the UK by some 6 per cent (all other
things being equal).
■■ The effect of the depreciation of the pound on
Germany’s imports from the UK is smaller, but still
negative. The coefficient lies at –0.35, implying
that a 10 per cent depreciation of the British pound
is accompanied by a decline in Germany’s imports
Abb. 1
Brexit
by 3.5 per cent. This negative effect contradicts the
prevalent textbook hypothesis that a currency
appreciation tends to have a positive impact on
an economy’s imports. In Germany’s case, this can
be explained by the strong link to the UK in terms
of intermediate input and the high share of imported intermediate inputs used in German exports.
■■ For the responsiveness of German exports to the
UK in relation to the British GDP, the coefficient
lies at 1.78. Thus, with all other things being equal,
a decline in the UK’s GDP by 1.5 percentage points
is associated with a decline in German exports to
the UK by around 2.7 per cent.
The estimated decline of German exports imported
into the UK in 2017, resulting from the supposed
impact of the Brexit debate on the UK, should cause
Germany’s economic output in the coming year to
decrease by approximately one-fourth of a percentage point.
Besides this main scenario, two alternative scenarios
were examined, showing the differing expectations
connected with either a “soft” or a “hard” Brexit (see
chart). While the UK’s departure from the EU will not
take place until well after 2017, the British government and the EU circles could either take a soft line
(willing to compromise) or a hard line (highly conflictual) in their negotiations – in contrast to the
current assessment in the main scenario depicted
above. Thus, the assumptions were adjusted to account for variations in the decline of the GDP in the
UK and the depreciation of the pound. Under these
conditions, Germany’s economic output would
decrease by around one-seventh of a per cent of GDP
in the event of a soft Brexit, and by one-half of a per
cent in the case of a hard Brexit (as defined in the
table).
Since the model only covers the bilateral trade relationships between Germany and the UK – thus leaving out the indirect effects of the Brexit on other
countries as well as the impact of uncertainty on
investments and consumption in Germany – these
estimates are more likely to reflect the minimum
potential impact on the German economy.
Abb. 1
Brexit
Appendix
Within the framework of a time series analysis, an
examination was conducted into how trade between
Germany and the UK reacts to changes in the real
exchange rate (RER) and to economic activity, measured by GDP. As the explanatory variable, the bilateral trade flows for goods and services were taken
from the Deutsche Bundesbank’s balance of payments statistics and then converted into real values
with the help of the overall price deflator for exports
and imports. In doing so, the assumption was made
that the price development in German trade with the
UK roughly corresponds to the price development in
Germany’s overall trade of goods and services. The
annual price changes are relatively insignificant,
making it seem reasonable to apply the calculated
coefficients – at least for a limited time period – to
the development of nominal exports from the balance of payments statistics. Seasonally adjusted real
GDP data for the UK and in Germany, and the real
exchange rate between the pound and the euro (on
a consumer price basis), were used as explanatory
variables for the bilateral trade flows. All data used
came from Eurostat.
In an initial step, the stationarity of the time series
was examined. The augmented Dickey-Fuller test
(ADF, see Dickey/Fuller, 1975) showed that both the
trade flows and the time series for the GDP and the
RER are integrated of order one. The Johansen test
was used to check for the presence of a long-term
relationship in terms of a cointegration of time series.
The lag structure was determined by applying the
Akaike information criterion (AIC) and the Hannan-Quinn information criterion (HQC). Corresponding
to these criteria, a lag length of two was used for the
further analysis. The trace statistic confirmed the
presence of a cointegration relationship among the
applied variables. The econometric estimate shows
that all five variables used have some influence on
this cointegration relationship, with coefficients that
are significantly different from zero. The exact estimated results will be provided upon request.
The analysis of impulse response functions shows
that a shock coming from the exchange rate or from
GDP of the UK would have a lasting impact on Germany’s exports and that this long-term effect would
already set in after two or three quarters. These results can thus be used for an estimate of the Brexit
effects on German trade with the UK and on the
German GDP for the year 2017. An OLS estimate based on (stationary) rates of change of nominal exports, imports and real GDP reaches similar results
with regard to the estimated coefficients and to the
impact on Germany’s economic output.
References
Consensus Forecasts, various editions
Dickey, David A. / Fuller, Wayne A., 1979, Distribution
of the estimators for autoregressive time series with
a unit root, in: Journal of the American Statistical
Association 74, pp. 427–431
Diermeier, Matthias, 2016, Brexit – Hohe Unsicherheit, panische Stimmung und zuversichtliche Märkte,
IW-Kurzbericht, No. 64, Cologne
Grömling, Michael / Hüther, Michael, Brexit bringt
kurzfristig keinen Schaden für deutsche Konjunktur,
IW-Kurzbericht, No. 35, Cologne
Johansen, Søren, 1988, Likelihood-Based Inference
in Cointegrated Vector Autoregressive Models, Oxford