I am British, I am American, and I am continental European. I was born and raised in Britain and I am a British citizen by birth. I have lived in the United States for thirty years and I am an American citizen through naturalization. I am a continental European through my two year stint of teaching economics in Italy where centuries of European culture seeped into my pores by osmosis and took up residence in my bones.
The British people have voted to leave the European Union. You may, or may not, have strong views about the outcome of that vote. All of us, wherever we are located in this existential adventure that we call the planet earth, will be affected by it. Now is the time for those of us most directly affected, whether British or Continental European, to come together and help to forge a future in which all of us can prosper. That may not look much like the vision of Jean Monnet for a European Federation, but I am confident that it will not lead to a return to the Europe of fractured nationalisms that ended in two world wars.
I did not join the chorus of economic experts who threatened Armageddon if the vote were to turn out in favour of leave. There were persuasive arguments to be made for significant economic costs of leaving the EU. Some suggested that these costs would be long-term. That is a hard case to make. Economists cannot accurately predict what will happen six months from now. If you want a long-term prediction I hear that reading entrails was effective for the Emperor Augustus.
That is not to say we can avoid short-run economic costs. But those costs will be a great deal worse for all involved if we allow an atmosphere of panic to take hold in the financial markets. Mark Carney, Governor of the Bank of England, has promised to support UK financial institutions. That was a good start and it will, I believe, prevent a further slide in the exchange value of the pound.
I am not overly concerned by the decline in the value of the pound that has occurred to date. I am more concerned by its cause. The pound fell because international investors pulled money from UK asset markets and fled to gold and to US treasuries. So far, with the possible exception of the French stock market, international asset markets have been volatile but they have not gone into free fall. A persistent free fall in the financial markets will, if allowed to occur, cause a major recession.
The Bank of England should make clear that a catastrophic drop in the financial markets will not be permitted. I recommend a statement that the Bank will, if necessary, buy shares in an exchange traded fund to support the value of the FTSE and that it will pay for those shares by selling short-term treasury securities. As I argued here, if necessary, the Treasury should support that action by providing the Bank with the authority to borrow on its behalf.
My recommendation is based on empirical research that shows a stable persistent connection between the value of financial assets and the unemployment rate. My own research was conducted on US data. Studies conducted at the Bank of England and at Hamburg University have replicated my findings on UK data and on German data.
Some economists have called for lower interest rates, perhaps even moving into negative territory. I do not think that is the right answer. Interest rate control was effective for more than twenty years as a tool to control inflation. We need a new approach to deal with financial crises. That approach should, in my view, take the form of a direct intervention in the asset markets by the Bank of England, to prevent the excess volatility that is caused by fear of the unknown. It is the job of policy makers to contain that fear. It is the responsibility of journalists and opinion makers to refrain from exacerbating it.
We should refrain from pouring petrol onto the fire of volatile financial markets by speculating that the sky is falling. It isn’t: Yet. Words are powerful and may become self-fulfilling prophecies. Let us choose them carefully.
I discuss these ideas, and many more, in my forthcoming book, Prosperity for All.