Adam Smith, the economist credited with the theory of the invisible hand in economics, once said about mankind’s economic decision-making process that “By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” This quote, from his most famous work The Wealth of Nations, serves as a reminder even today that when individuals make decisions on what to do with their disposable income, there are far-reaching unintended consequences, some positive and others negative. Smith’s theory is seen as the principle which underlies the arguments in favor of laissez-faire economics, under which governments do not intervene in the marketplace. Smith and his supporters would argue that the “invisible hand” will over time correct market inefficiencies as economic agents continue to make decisions purely out of self-interest, because their decisions, even if they are not made out of altruistic or malicious motives, will effect society as a whole.
Unfortunately, in June of 2016 when a referendum vote in the United Kingdom showed that the majority opinion was that the U.K. ought to break from the European Union, many people seemingly forgot about the invisible hand theory. In the months following the so-called “Brexit” referendum, the exchange rate for the British Pound plummeted to its’ lowest levels in over 30 years, reflecting a lack of investor confidence in British industry performance without the backing of the EU. Of course, this caused widespread panic not only in the U.K., where many areas like Scotland had overwhelming support in favor of staying in the European Union, but also with foreign investors with interests in the U.K. Thankfully, it now appears that most of this concern was unwarranted, as GDP growth in the U.K beat expectations, growing at 0.6 percent in the final quarter of 2016. Further, the Bank of England, Britain’s central bank is setting growth expectations for 2017 at 1.4 percent, which would place the U.K in the mid-range of the G7, a group of seven highly industrialized economies across the world.
So, how did Britain go from a state of economic panic in July to where they are now? The answer, in short, is that the central bank engaged in quantitative easing and cut interest rates. This is a surprisingly small amount of central bank intervention when compared to the multiple rounds of quantitative easing, a repossession period where the Fed bought back mortgage-backed securities, and repeated interest rate cuts in the aftermath of the 2007-2009 financial crisis in the United States, just to scratch the surface. Of course, Britain’s response to the panic which ensued after Brexit was not purely laissez-fare in nature, but it was decidedly less interventionist than the American approach in 2007, which is still heavily criticized as being too interventionist and ultimately rather ineffective.
Since Brexit, Britain has shown a higher level of restraint when making monetary policy decisions, and it has benefitted them greatly when compared to the aftermath of the Financial Crisis of the late 2000’s in the United States. GDP growth in America has still not been able to return to pre-recession levels, and many believe that GDP will likely never again grow at the three percent rate which we previously enjoyed. Britain’s monetary policy decision makers clearly do not support the American system for easing downturns, where the focus is on making the downturn as small as possible, because as Smith would point out there are unintended consequences to any economic decision. Britain has been wise to stay away from overuse of monetary policy instruments since Brexit, instead taking smaller measures to prop up their economy and relying on other events like the upturn in their manufacturing sector in the aftermath of Brexit.