Abstract
This paper analyzes the international monetary and financial implications of the UK's potential exit from the European Union, focusing on the impact on cross-border capital flows, on London's status as an international financial center, on the roles of sterling and the euro as international and reserve currencies, and on the roles of the UK and EU in the institutions of global governance (the International Monetary Fund, World Bank, Group of Seven, Group of Twenty, and Financial Stability Board. All such conclusions are necessarily speculative at this stage, but the implications are potentially farreaching.
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And as negotiated by those partners with one another. One can argue that the preference of the Trump Administration for bilateral negotiations and agreements points strongly in this direction; witness recent U.S. bilaterals with South Korea and Japan.
That uncertainty is presumably why no one has been reckless enough to undertake this exercise before, with the partial exception of Sampson (2017).
If this same history runs in reverse, then Brexit will reduce inward FDI from other OECD countries by up to 22% (28/(100 + 28)).
Their study has the advantage of encompassing years both before and after the advent of the Single Market, enabling them to pursue a quasi-difference-in-differences approach. Coeurdacier et al. (2009) focus on mergers and acquisitions, a specific forms of FDI (as distinct from greenfield investment) and similarly find a large and significant effect of EU membership.
Welfens and Baier (2018) offer a dissenting view. Considering both EU and European Economic Area effects, they argue that the observed FDI differential is in fact an EEA and not an EU effect.
The authors also find an impact of bilateral trade on the volume of bilateral bank flows, but the effect is small.
And expressed in millions of U.S. dollars Since 2013 the survey has been conducted twice a year, in June and December, but for consistency only the December surveys are utilized in what follows.
Following previous literature, the common language dummy equals one when a language is spoken by at least 9% of the population in both countries. The common currency variable equals one when 2 countries that are not EU members share a currency.
In contrast, a euro-area destination will receive 53 to 71% more inward portfolio investment than an otherwise comparable country. The coefficients on the control variables enter with their expected signs and are well defined (colonial heritage, common language, common religion, common currency, origin-country GDP and destination-country GDP all affect portfolio investment stocks positively, while origin country population affects it negatively, due to its association with lower per capita GDP; the only anomaly is the inconsistent sign of destination-country population.
Note, for comparison, that the estimated impact on outward portfolio investment stocks is larger, on the order of 29%, almost exactly the same number found in earlier studies of FDI.
They could also be cleared in a third-country clearinghouse recognized by ESMA. In some cases, such as swaps involving the Hungarian forint and the Czech koruna, this creates the interesting possibility that transactions will be cleared not in the EU, where the relevant facilities are lacking, but in the U.S. by CME Clearing, which is recognized by ESMA.
RepoClear, the Paris-based branch of the London Clearinghouse, already clears bond sales, purchases and repurchases inside the Euro Area, and it is also clearing a growing volume of bond and repo-related transactions. LCH’s Paris unit already has access to the Target2 Securities Settlement Platform, enabling it to net securities transactions between traders with accounts at different national central securities depositories and cash accounts at different euro area central banks, a convenience not available to the LCH’s UK unit.
According to Brummer (2015), p.307), EU clearinghouses receive no explicit or guaranteed ECB backstop, whereas Dodd-Frank authorizes US clearinghouses to receive liquidity support from the Fed in “unusual or exigent circumstances.” But this doesn’t rule out the possibility, or importance, of implicit guarantees.
These problems could also be surmounted were the ECB to make an unlimited currency-swap arrangement with the Bank of England. In which case the issue of governing law and legal jurisdiction could be circumvented. But such an agreement would expose the ECB to the exchange risk that comes with a major clearinghouse crisis, which makes an unlimited swap arrangement unlikely.
This tendency was made abundantly clear by the run-up to the global financial crisis (see e.g. Tett 2009).
Griliches’ method is used to instrument the lagged dependent variable, reducing the risk that it is picking up serially correlated omitted influences. In robustness checks the model is extended to include a list of additional explanatory variables, without noticeably affecting the coefficient on the lagged dependent variable.
This is according to the IMF. Shares are calculated at market exchange rates, these being what are appropriate for international financial comparisons.
This assumes reversion to WTO trading rules. More precisely, Treasury estimates that UK GDP will be 7.5% lower than otherwise after 14 years. Others have criticized this estimate of the growth slowdown as exaggerated.
The data are for the period before 1914, when the currency composition of foreign exchange reserves is known. An advantage is that this was a period of proliferating military alliances, introducing variation to the data. A disadvantage is that this period in the relatively distant past may not be informative for the twenty-first century.
The current presumption, however, is that such a breakdown remains unlikely. On the other hand, both Donald Trump and Jeremy Corbyn are NATO skeptics, and a weaker NATO might impel the EU toward tighter security cooperation on its own, leaving the UK on the outside (see Bush 2017).
Given that the euro area has a single currency and in that sense a single exchange rate, whereas the EU does not, and that IMF deals with currency and exchange rate issues, it can be argued that the second option makes more sense. That said, other IMF-relevant issues such as regulation of capital flows are EU rather than euro area competencies. Banking union, which is relevant insofar as the IMF is concerned with financial stability, is a hybrid: participation is obligatory for euro-area members, but other EU member states can and have opted in.
An additional difficult, which will remain, is that the presidency of the EURIMF rotates only every two years, unlike the presidency of the European Union which rotates every six months.
The euro area currently lacks observer status in the IMF Executive Board, which European Commission (2015) proposes to correct.
This would involve Germany increasing its aid budget to Africa by 20%. This is known within German finance ministry as the “Compact for Africa.”
Nonetheless, this change remains unlikely, since other member states resist the proposal as well. The proposal to move to QMV, advocated by Commission President Jean-Claude Juncker, is opposed by Ireland in particular.
This could be a good thing or a bad thing, depending on one’s priors.
Currently three-quarters of euro interest-rate swaps cleared through LCH are between counterparties neither of which is a resident of the euro area and one of which is generally a resident of the UK.
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I thank Jon Cunliffe for inspiring me to write on this topic, the Bank of England for hosting me, the editor (Paul Welfens) for useful comments, and William Jungerman and Chris Liu for research assistance.
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Eichengreen, B. The international financial implications of Brexit. Int Econ Econ Policy 16, 37–50 (2019). https://doi.org/10.1007/s10368-018-0422-x
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DOI: https://doi.org/10.1007/s10368-018-0422-x