Commenter Matthew Moore asked the following question:

Any chance of a post on the likely consequences of GBP devaluation? Ejection from the ERM caused a boom. I realise the UK wasn’t deliberately overvalued this time, but are there parallels?

In my view the key difference is not the question of “overvaluation” but rather the source of the shock. In 1992, the devaluation was a policy decision, which was (correctly) seen as enabling a more expansionary monetary policy. Hence it had an expansionary impact on NGDP.

This time around the shock was Brexit, which was seen as reducing the real growth prospects for the British economy. One way we know this is that British stocks fell on the news. By the way, in several earlier posts I underestimated the impact of the shock to British equities, by looking at the FTSE100. Commenter Vaidas Urba pointed out that this index includes lots of multinationals with a great deal of foreign earnings. An index of domestic British firms declined much more sharply, comparable to many mainland stock markets. So the expected hit to the UK economy was presumably larger than I originally thought. Mea culpa.

Nonetheless, I continue to believe that the most important effects are global, and that at the global level this was primarily a monetary shock. For instance, the Japanese yen soared in value and the Japanese stock market crashed. Obviously this has nothing to do with the likely long and boring negotiations over tariff rates between the UK and the continent. This is about risk averse investors looking for a safe haven currency, and pushing that currency up so much that deflation may return to Japan.

One of the most complicated issues here is the extent to which the depreciation of the pound reflects the direct impact of the Brexit shock, and the extent to which it reflects actions the Bank of England might take to soften the blow. In my view the bottom line is that NGDP growth in the UK is likely to slow despite the fall in the pound, based on the reaction of their stock and bond markets. However, the BOE is probably expected to do much better than the BOJ, and hence the hit to UK stocks should probably be thought of as mostly a real shock, whereas the severe hit to Japanese stocks, and indeed most foreign stocks, would reflect a monetary shock, that is, the failure of central banks to keep Brexit from depressing expected NGDP growth.


Arnold Kling objects to me calling declines in expected NGDP growth “monetary shocks.” Ben Bernanke and I think the term is appropriate, as they are shocks to the value of money. But even if Arnold were 100% correct, it would not have any practical implications for my policy views. If someone insists that I call then uncertainty shocks, or banana shocks, then I’ll simply insist that it’s the central bank’s job to prevent uncertainty shocks, or banana shocks. The bottom line is that unstable NGDP causes economics dislocation, regardless of the ultimate cause of the change in NGDP. Central bank errors of omission and commission are equally bad, equally inexcusable. And central banks have near infinite ability to adjust the quantity of fiat base money, and hence have the tools required to stabilize its value, in terms of the share of NGDP that can be purchased with each dollar, or pound, or yen.