Brexit associated sharp depreciation and implications for UK’s inflation and balance of payments

Abstract

Purpose The purpose of this paper is to analyse the implications of exchange rate depreciation for inflation targeting and trade balance of UK in the context of the Brexit epoch. Design/methodology/approach The study employed a time-varying structural vector auto-regression (TVSVAR) model framework in which the sources of time variation were both the coefficients and variance-covariance matrix of the innovations on the data from January 1989 to September 2016. Findings The findings suggest that the depreciation of the Stirling has significant effects on inflation and trade balance in UK in context of Brexit epoch. It also showed that such a depreciation can be helpful in the improvement of external balance as well as steering the inflation to its statutory target. Despite, the inflation targeting, there is strong evidence of a pass-through. Research limitations/implications Research has profound implications in terms of the sharp depreciation of GBP associated with the Brexit outcome. The study is very topical and could be very interesting to the readership of JES as well as wider audience. The study has limitations in a context that the significance of the results and association of the under analysis entities is contingent on the future trade relationships and Channel between UK and EU. Therefore, although there is a lot of uncertainty about the future of Britain trade relationships, this study provides guidance on the importance of exchange rate channel if the similar trade arrangements prevails in the post-Brexit era. Practical implications The research has profound practical implications, using a TVSVAR model in which the relationship among the entities varies over time; it has shown the importance of exchange rate in terms of external balance and inflation targeting. Hence, it has appeal for the practitioners as well as academics. Social implications The research has great social implications. The Brexit is the biggest political and economic event of this era for UK and EU. There are big questions about the relationship between UK and EU in the post-Brexit epoch as well as questions about the future of the European integration. In this context, this study has shown that how the exchange rate could play an important role for the UK economy when its contemporary trade channels prevail. Concomitantly, it has social implications particularly for the European society. Originality/value The research is an original piece of work. It has contributed to the debate on the exchange rate deprecation, external balance and inflation targeting in context of the Brexit associated sharp depreciation of Stirling. It has used a framework, i.e. TVSVAR, which also have unique features in terms of testing the associations among under analysis entities against time.