EXCHANGE RATE PASS-THROUGH UNDER THE EFFECT OF BREXIT: AN EMPIRICAL ANALYSIS ON THE UNITED KINGDOM

Abstract

Purpose - This study aimed to examine the effects of the environment of uncertainty caused by the United Kingdom (UK) people's decision to leave the European Union (EU) as a result of the referendum held on June 23, 2016, on the UK's economy. In this context, the effects of fluctuations in exchange rates on prices (consumer and producers) and profitability rates were analyzed. Methodology - The data set was divided into the Brexit period (2016:06 - 2020:02) and the pre-Brexit period (2010:01 - 2016:05) for a comparative analysis of the effect of Brexit on ERPT. Structural Vector Autoregressions (SVAR) models were used to get rid of the non-theoretical structure of standard VAR models, and the McCarthy (1999) model was taken as the reference for the theoretical framework of the model. The analysis of variance decomposition was performed to examine the relationship between the variables using the dynamic structure of VAR models. Findings- The unexpected result of the referendum and the environment of uncertainty caused by this result in the UK's economy had negative effects, especially on producer prices. It was observed that the increase in costs, which was due to fluctuations in the exchange rate caused by the environment of uncertainty after the referendum, could not be fully reflected on consumer prices by firms. According to the results of the analysis of variance decomposition, while 5.55 percent of changes in producer prices and 4.44 percent of changes in consumer prices in the Pre-Brexit period were explained by changes in the exchange rate, these rates were found to be 16.45 percent and 6.41 percent, respectively, during the Brexit period. Conclusion- During the Brexit period, it was observed that firms could not reflect the increases in costs to prices and this situation caused a decrease in the profitability rates of the firms. Some of these decreases in the profitability ratios of firms are expected to be permanent. However, it will be possible to make a distinction between structural effects and periodic effects after the terms of the agreement are determined. Considering the overlap of two important global events, such as the COVID-19 pandemic and the Brexit process, it is observed that the UK's economy is going through an extremely sensitive period. Accordingly, the monetary authorities in the UK should take into account many more variables while taking decisions during this period, unlike previous periods.

Keywords

• Exchange rate pass-through
• inflation
• Brexit
• variance decomposition
• SVAR analysis

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