Last July, Arnold Kling made the following observations:

Tyler Cowen on Brexit, Steven Pinker, and Joseph McCarthy

Posted on July 22, 2016 by Arnold Kling

And also other topics. The link goes to a Twitter post with a video.

Judge for yourself, but to me it sounds like he is telling a PSST story. He says that, for better or worse, the UK spent the last twenty years working with a set of rules on trade in services with other European countries, and now that those rules have been cast into doubt by the Brexit vote, the British economy is in trouble. It is a very different take from that of those who think in GDP-factory terms.

Here are my thoughts on these issues:

1. Real and nominal shocks have very different effects on an economy. Real shocks tend to cause re-allocation from one sector to another, without significantly impacting the unemployment rate.

2. Real shocks may impact the long run level of real GDP, without a big impact on the business cycle. Nominal shocks strongly impact the business cycle, without significantly affecting the long run level of real GDP.

3. Brexit is a real shock that will not create a UK recession, but may well impact the long run level of real GDP.

4. The “GDP factory” model is not useful when thinking about real shocks (such as 2006-07), but is useful when thinking about nominal shocks (such as 2008-09)—which tend to influence the overall economy, not just a few sectors.

During 2006-07 there was a lot of re-allocation out of housing, without a US recession. During 2008-09 there was a significant drop in America’s nominal GDP, which had the effect of reducing real output in the “GDP factory”.

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