Making Astrology Look Respectable: On the Extraordinary Abuse of Economic Models in the EU Referendum Debate

In June 2016, I released an article entitled: “Measurement without Theory: On the extraordinary abuse of economic models in the EU Referendum debate” in advance of the referendum on 23 June 2016 on whether the UK should leave the European Union. That article heavily criticised two reports that had been released by the UK Treasury on the consequences of Brexit, calling them “dodgy dossiers” for “grossly exaggerating the impact of the economic consequences of Brexit and providing no analysis of the risks from remaining in the EU”. This article reproduces the 2016 article and also provides an update on the state of the UK economy five years after the publication of the reports. It confirms that the only purpose the two Treasury reports was to make astrology look respectable.

as planets orbiting the Sun. The model assumes that countries closest to the centre of the EU have the greatest economic benefits-in terms of bilateral trade and foreign direct investment and their subsequent effects on productivity and economic growth-from membership of the EU. This, of course, means the countries in the Euro Area.
The Treasury estimates the consequences of the UK leaving the EU and moving further away: first into the European Economic Area, then into the European Free Trade Area and then into the Rest of the Word (ROW) where World Trade Organisation (WTO) rules operate.
The model's predictions are unambiguously clear: the UK will be worse off outside the EU by 2030.
There are no circumstances in which the UK could be better off outside the EU.
The Treasury's gravity model has some very powerful implications: • Not only would the UK be better off by staying in the EU, it would be even better off joining the Euro Area-which is closest to the Sun.
• All countries in the world would be better off joining the EU and the Euro Area. And this result holds even if the EU collapses into a black hole-which is not an unlikely possibility, certainly in the case of the Euro Area.

What the Treasury's long-term economic model cannot do
The Treasury's gravity model cannot be used to determine with any degree of reliability what the economic consequences of Brexit are, for a very simple reason-there are no data points to calibrate the EU gravity model properly. In the absence of this, the model assumes that leaving the EU is the opposite of joining the EU.
But this is not at all valid and the economic consequences cannot be determined as though they are.
The relationships already established within the EU will mean that the UK should be able to negotiate a much better mutually beneficial trade deal than a country that never joined the EU, such as Norway or Switzerland.
The gravity model seriously overestimates the costs of Brexit. There are a number of pointers to this in the report: • The government used a gravity model to assess the economic consequences of Scotland leaving the UK and predicted that cross-border trade between Scotland and the rest of the UK would fall by 80%. Can anyone possibly believe that this figure is plausible, given the previous 300 years of political and economic union, the geographical proximity, the common language and currency, and similarity of the legal systems?
• The UK's recent trading experience with the EU is completely inconsistent with the predictions of the gravity model: the share of UK exports to the other EU countries which has fallen from 54.2% in 2006 to 43.7% in 2015 or by 19%.
All this is pointing to the real possibility that the UK could be much better off if it "jumped" solar make a very poor predictor of what would actually happen during the first two years after Brexit.
The report also states on that "no member state has ever left the EU". But this is not true. Greenland left the European Communities in 1985 without triggering the kind of recession outlined in this report. Indeed, the economy boomed after leaving the EU: the average annual real growth rate was 5.7% in the five years after leaving the EU, compared with 0.7% p.a. in the preceding five years.
The report also ignores the fact the when Ireland left the currency union with the UK in 1979 and adopted the Irish punt and later the euro in 1999, there was a negligible effect on trade between the two countries.
So the Treasury is using a short-term model that cannot tell what size shock there should be, has no policy responses, and produces results completely at odds with Greenland's experience of leaving the EU or with Ireland's experience of leaving the currency union with the UK. But worse than this, neither the short-term nor the long-term model accounts for the non-economic risks of remaining in the EU.

It's more than the economy stupid!
The EU is a potentially highly unstable gravitational system. There are a number of reasons for this.
The first has to do with the euro. It was quite obvious from the start of European Economic and Monetary Union (between 1999 and 2002) that most of these conditions for the euro to survive would fail to be satisfied in the Euro Area.
But it is not just the economics. A fundamental problem is the democratic deficit in the EU. This is because the EU is a political project and the EU political elite are prepared to ride roughshod over the wishes of its citizens. But this attitude will inevitably bring into question the political and social stability of the EU itself. All these issues are ignored by the Treasury.

Embarrassing for the economics profession
The reports do not consider the alternative economic models that predict that the UK will do well out the EU. All serious economic studies should report the results of alternative studies. Most of these models predict that there will be very little difference to GDP by 2030 whether the UK stays in the EU or not.
Finally, the reports do not even consider the economic risks of remaining in the EU, never mind the full range of non-economic risks. These failures are embarrassing for the economics profession.

The political abuse of the Treasury models
There is doom-mongering on every page of the two reports. It's no different from the way children are frightened into doing what their parents want. We are all being treated like children.
Both the Chancellor of the Exchequer and the Prime Minister have used the reports to ramp up the scare-mongering.

Even more political abuse
The second report gives the strong impression that we really don't have a choice-the UK can never www.scholink.org/ojs/index.php/ape Advances in Politics and Economics Vol. 4, No. 4, 2021 22 Published by SCHOLINK INC. actually leave the EU, because it would be too difficult to unravel and too difficult to negotiate any new trade deal with other countries.
However, international law recognises a "presumption of continuity" and all the parties need to do is sign a documentation of continuation in force. Further, the WTO does not allow tariffs to be raised once they have been lowered between countries.

Conclusion
There was a time when the global plutocracy relied on the mysticism of religion to keep the populace in its place. Now the modern global plutocracy is using the mysticism of economic models.
If we fall for this, we will enter a new Dark Age where fear over the size of the EU trade dummy in a gravity model is intended to keep us all under control.
The British Treasury has in effect become a propaganda machine for a political institution led by Jean-Claude Juncker-a man who has declared his hostility to "democratic choice" when it comes to the wishes of the European people. This whole exercise is utterly dangerous for democracy.
The Treasury's application of gravity and VAR models to assess whether the UK would be better in or out of the EU confirms John Kenneth Galbraith's dictum that: "The only function of economic forecasting is to make astrology look respectable".
What is happening is no different from Tony Blair's "dodgy dossier" on Saddam Hussein's weapons of mass destruction. These two reports will rightly gain the same status of "dodgy dossiers".

Introduction
No economic model by itself can be used to determine whether a decision by the UK electorate to leave the European Union will make people better off or worse off. This is because a whole range of factors in addition to economic ones-political, legal, financial, trading, diplomatic, security, military, social, environmental, demographic-will determine whether our individual welfare improves or reduces after leaving. This is because the EU is an institution that embraces all these factors. In addition, when looking across all the people living in the UK, there will be both gainers and losers. This is an inevitable consequence of any change.
Further, it is equally important to take into account the consequences of the status quo, i.e., remaining in the EU. This is because the EU has serious long-term political and economic problems that arise because of a democratic deficit and because of the adoption of the euro by certain member states, problems that are now recognised even by supporters of the EU as well as its detractors.
The Treasury has published two reports on the economic consequences of a vote by the UK to leave the European Union in the Referendum on 23 June. The first is a long-term economic model whose results were described in "HM Treasury Analysis: The Long-term Economic Impact of EU Membership and the Alternatives", published on 18 April 2016. (Note 1) The second is a short-term model whose results were considered in "HM Treasury Analysis: The Immediate Economic Impact of Leaving the EU", published www.scholink.org/ojs/index.php/ape Advances in Politics and Economics Vol. 4, No. 4, 2021 23 Published by SCHOLINK INC.
on 23 May 2016. (Note 2) Together, the reports predict that each household in the UK will be worse off (in terms of a lower, gross domestic product or GDP) by an average of £4,300 by 2030.
This prediction is grossly exaggerated for two main reasons. First, the Treasury assumes that the government will not respond to what it calls the "extreme shock" of leaving the EU-a shock that is assumed to last for two years, which is longer than that caused by the Global Financial Crisis-and so will stand by while the economy dives into a recession with GDP falling by up to 6% over the next two years (relative to where the economy would be if the UK remained in the EU)-equivalent to losing 50% of our trade with the EU, even though we will still be in the Single Market during this period. This is simply not credible-had the government responded in the same way during the GFC, the consequences for the economy would have been catastrophic. Second, it assumes that the UK, the fifth largest economy in the world will be unable to negotiate more favourable trading arrangements than currently exist with either the EU or the rest of the world-which has three times the GDP of the EU and nine times its population and is growing much faster than the stagnant EU economy. As a result of this assumption, GDP is predicted to be lower by up to 7.5% p.a. by 2030.
This prediction comes from combining the outcome from a short-term model (called a vector autoregressive (VAR) model) which is used for the first two years after leaving with a long-term model (called a gravity model) which is used to project GDP between 2018 and 2030. The reason that the models are switched in 2018 is because this is the maximum time allowed to negotiate an exit from the EU under Article 50 of the Treaty on European Union.
The specific gravity model used by the Treasury is centred on the EU: this model predicts that the UK would actually be better off not only staying in the EU but actually joining the euro-although the Treasury does not acknowledge this. Had the Treasury used a different gravity model centred on the rest of the world-which it certainly should have considered-it might well have found that the UK would be better off leaving the EU.
Most of the other economic models that have examined the economic consequences of Brexit-and which have been entirely ignored by the Treasury-find that it will make little difference to the UK's economy whether the UK stays in or leaves the EU. This is consistent with both Greenland's experience of leaving the EU in 1985 and Ireland's experience of ending currency union with the UK in 1979-neither of which is considered in the Treasury reports.
I have examined both models and will review the reports in the order they were published.

The Treasury's long-term economic model-the gravity model
The Treasury's long-term economic model is actually made up of a number of different models. The principal one used is a "gravity model". This "allows the analysis to isolate the influence of the different trade relationships from all the other influences that affect bilateral trade and Foreign Direct Investment is a place you would not want to be, since it is so far away from the Sun. It is very cold out there and you will be completely isolated from warm inner core that is the Euro Area. See Figure 1 and Figure   1.B on p. 29 of the Treasury's report, reproduced below.

Problems with the Treasury's long-term economic model
There are two sets of problems with the Treasury's long-term economic model. The first set relate to the assumptions made concerning key variables in the model, while the second set relate to the incomplete nature of the Treasury's analysis.
One key variable in the model is productivity-which measures output per worker. This is because trade and net inward investment influence of the level of productivity and hence economic growth. If the true number of workers is higher than official estimates, but output is accurately measured, then true productivity is lower than official estimates. A key problem is accurately measuring the number of workers in an economy when there is worker migration. would have a consequential effect on economic growth.
Another problem is that the model ignores the effect of future worker migration. But this is not at all clear from the report. On p.136, the report predicts that net immigration will fall from 329,000 p.a. in 2014 to 185,000 p.a. from 2021. This means that the report accepts that there will be a total of 3 million new workers by 2030, the year for which it projects the above reductions in GDP per household.
However, the report then goes on to state: "no additional effect from net migration has been assumed in the modelling". It took a letter from Sir Andrew Dilnot, Chair of the UK Statistics Authority, to Jack should be treated with considerable caution. More on this later.
As an academic economist, I have spent 40 years working with various types of economic model and after this time you get to know many tricks of the trade-such as the small changes in assumptions that lead to very big effects when compounded over long periods-the flapping of the butterfly's wings in Australia that leads to storms over Europe. One such butterfly is the assumption that any temporary uncertainty over Brexit leads to a loss of output that has permanent effects. This is stated without further explanation (p.153 and p.185): "the persistence effect is estimated to be 1% of GDP…and is included as a shock to productivity in long-term scenarios". This is approximately equivalent of a permanent reduction in GDP growth of 1% p.a. or around £700 per family by 2030, more than a quarter of the loss of £2,600 if the UK left the EU and joined the EEA.
So if you take into account the possibilities that the current size of the working population is underestimated by up to 5%, that the number of households by 2030 could be miscalculated by between 5 and 14% and that a persistence effect equal to 1% of GDP is exaggerated, then it would be hard to tell whether the model's predicted reductions in GDP of 3.8%, 6.2% or 7.5% p.a. by 2030 are actually the result of the UK leaving the EU or whether they could be explained by measurement error or by other noise in the system.
Turning to the incomplete nature of the analysis, the report focuses entirely on the potential negative effects of leaving the EU and promotes only the positive effects of remaining. For example, the report argues on p. But this is not at all valid. Leaving the EU is not the opposite of joining the EU and the economic consequences cannot be determined as though they are. To use an aircraft analogy-landing a plane is not the opposite of a plane taking off. A plane takes off with its front wheels leaving the ground first. A model which assumed that a plane lands with its front wheels touching the ground first would predict that the plane would crash. However, we know a plane can land safely if its rear wheels touch the ground first. And the correct model would have predicted this.
The relationships already established within the EU will mean that the UK should be able to negotiate a much better mutually beneficial trade deal than a country that never joined the EU, such as Norway or Switzerland. (Note 12) Any sensible model would reflect this.
This means that the economic consequences of leaving the EU will be much less severe than the model predicts. In other words, the gravity model seriously overestimates the costs of Brexit. There are a number of pointers to this in the report: • This first is given on p. 156 which discusses the economic consequences of Scotland leaving the UK. The government also used a gravity model to assess this and predicted that cross-border trade between Scotland and the rest of the UK would fall by 80%. Can anyone possibly believe that this figure is remotely plausible, given the previous 300 years of political and economic union, the geographical proximity, the common language and currency, and similarity of the legal systems? The same point has recently been made by Patrick Minford. (Note 13) But why has this figure never been questioned before by anyone else? Is it because we are so bamboozled by the mysteries of econometric modelling that no one dares to question the output of these models-even when it is clearly not plausible?
• the UK left a relatively small customs union with external trade barriers and began trading freely with the rest of the world?
All this is pointing to the real possibility that the UK could be much better off if it "jumped" solar systems and joined one centred on the ROW. As mentioned above, the Treasury's gravity model could This means that when the IMF's Managing Director, Christine Lagarde, stated on 13 May 2016 that the UK leaving the EU would have "pretty bad to very, very bad consequences"-that could result in a "sudden stop" in money flowing into the finance sector which would drive down the value of the pound and lead to a sharp rise in interest rates, falling house and commercial property prices and the erosion of London's status as a global financial centre, all of which would lead to a technical recession (Note 16)-these predictions come from the same model that the Treasury is using. The IMF predicts that UK GDP could fall by between 1.5% and 9.5%.
We should not forget that the IMF's record of predicting the results of UK economic policy is not especially good. In 2013, the IMF's chief economist, Olivier Blanchard, predicted that the UK was "playing with fire" with its austerity programme for reducing the government deficit faster than he would have liked. He predicted that this would reduce economic growth, but this did not happen. The UK shortly became one of the fastest growing economies in the EU. The IMF's predictions were even worse when it came to predicting the outcome of the Greek bail-out in 2010. It said GDP would contract by 2.6% and then recover rapidly. It was out by a factor of 10-Greek GDP declined by 26%.
On May 12, the Governor of the Bank of England, Mark Carney, also said that Brexit could lead to a technical recession. (Note 17) Once again these predictions come from a gravity model similar to the Treasury's. So the predictions of the Bank and the IMF are not independent of the Treasury's.
However, the main job of the Bank of England is not to estimate the cost of Brexit, but to set interest rates to control inflation. In 2013, shortly after becoming Governor, Mark Carney introduced "forward guidance", a policy announcement that interest rates would rise once unemployment fell below 7%.
Just six months later, the policy was abandoned because unemployment did fall below 7%, but the Bank judged that economic conditions did not justify raising interest rates. Nevertheless, since then, Mr Carney has confidently predicted that an interest rate rise was just around the corner. Unemployment is currently 5%, but interest rates have still not risen three years after the Bank Governor predicted they would. However, there is absolutely no economic content in the Treasury's short-term economic model. The model used is a vector autoregressive (VAR) model. This is a model that (1) merely projects forward the existing trends amongst a series of variables that might or might not be causally related, and (2) is incapable of identifying and predicting the consequences of a structural change that has not been previously observed in the historical data used to calibrate the model.
What the model does do is make the assumption or judgement that a vote to leave the EU on 23 June 2016 would constitute a "severe shock" to the UK and global economies that is equivalent to 50% of the size of the shock of the Great Recession in 2008-09. (Note 20) The shock manifests itself in a 50% increase in a "comprehensive UK uncertainty indicator" on 24 June. (Note 21) The report calls this the "uncertainty effect" of a vote to leave, since we will not know on this date the terms of withdrawal from the EU, the new trading relationship with the EU, the new trading relationships with the ROW or the consequential changes to the UK's domestic regulatory and legislative framework. The heightened uncertainty lasts for the full two years that the UK has to negotiate an exit under Article 50 of the Treaty on European Union (TEU). The UK's relative GDP falls by up to 6% during this period.
As a result of this increase in uncertainty about the UK's future trading arrangements with the EU and the ROW, there would, according to the model, be a "damaging effect on both the demand side and supply side of the economy" (p. 7). In particular, the "uncertainty effect would also lower overall demand in the economy in the immediate aftermath of a vote to leave" (p. 6).
The report calls this the "transition effect": the "emerging impact of the UK becoming less open to trade and investment under any alternative to EU membership" and therefore a "less productive and permanently poorer" country in the long term following a vote to leave the EU, resulting in GDP being (using the central estimate) £4,300 lower for each household by 2030 and every year thereafter (Note 22)-as predicted by the Treasury's long-term model.
All businesses will reduce their investment spending and cut jobs until the nature of new arrangements Apparently, "none of these uncertainties could be resolved easily". The lower investment spending reduces productivity which, combined with the jobs cuts, reduces real wages.
Similarly, all households will reduce their consumption expenditure. The Financial Times explained how this will happen: "people will begin to learn that they have made a decision that will make the UK worse off in the long term, taking the Treasury's initial long-term calculation that the economy would ultimately be 6% smaller than it otherwise would be. Not only does this shock affect the long term, but if people anticipate this drop in their lifetime incomes, they will understand that they need to tighten their belts straight away so that they do not hit a crisis in their finances by spending as if they were going to be as rich as they previously thought". (Note 23) This belief will help to cause a recession with relative GDP reduced by 6% and unemployment increased by 800,000 by 24 June 2018. (Note 24) Does this really sound like the "trusty British shopaholic"? (Note 25) There will also be a "financial conditions effect": the uncertainty effect and the transition effect will lead to a fall in asset prices. "Financial markets would start to reassess the UK's economic prospects.
The UK would be viewed as a bigger risk to overseas investors, which would immediately lead to an increase in the premium for lending to UK businesses and households" (p. 7). The value of UK personal investments would fall-house prices will fall by 18% and equities by 29%-and the value of sterling would fall by 15%, raising inflation by 2.7 percentage points.
Turning to the international sector, "after a period, exports would then begin to fall, reflecting the weaker outlook for productivity, driven by the transition effect, which would more than offset the impact of the fall in sterling" (p. 47). A 15% fall in sterling would normally be expected to boost exports significantly, but not in this model apparently. The fall in sterling leads to an increase in the price of imports that would immediately be passed on in terms of higher consumer prices. The fall in sterling happens to be a "modelling assumption" that "reflects the views of Citi, Commerzbank, Credit Suisse, Deutsche Bank, Nomura, Oxford Economics, HSBC, JP Morgan, NIESR and the OECD" (p. 42). (Note 26) Turning to the government accounts, "net borrowing in 2017-18 would be around £39 billion higher and debt would be around £54 billion higher than under a vote to remain [due to] the fiscal deterioration and the lower level of nominal GDP. This fiscal deterioration would put at risk the government's fiscal deficit reduction plan and the aim for debt as a share of GDP to be falling in each year until 2019-2020" (p. 52).
The Treasury does not, however, believe it will be possible for the UK to agree the terms of withdrawal from the EU, a new trading relationship with the EU, new trading relationships with the ROW, and change the UK's domestic regulatory and legislative framework all within this two-year period. As a result of this, the uncertainty would be larger and could last up to a decade or more: "A period of persistent uncertainty about the UK's economic policy, regulatory and legislative regime in the event of a decision to leave the EU would therefore be unavoidable" (p. 7).
So it could get worse (p. 9 and p. 43): • The report concludes that "a vote to leave the EU would result in a marked deterioration in economic prosperity and security….. In contrast, a vote to remain in the EU would see uncertainty fall back rapidly with little lasting impact on the economy".
How does all this happen? The report models the economic impact of uncertainty shocks using a vector autoregression (VAR) model (p. 39). The model uses 25 years of data from 1989 to 2016 to estimate the relationship between the uncertainty indicator, overall economic activity and financial market conditions. The uncertainty indicator is then elevated to isolate the impact of an uncertainty shock on key economic and financial variables.
The VAR model is given on p. 66: where uncertainty is the level of the uncertainty indicator; C, I and P are consumption, business investment and the GDP deflator, all in log differences; R is Bank Rate, hhprem is the household borrowing spread, corpprem is the corporate borrowing spread and equityprem is the equity risk premium, all in differences. A0 is a vector of constants and ɛt is a vector of residuals. ( Crisis (GFC). As mentioned earlier, the Treasury assumes that voting to leave the EU will be equivalent to an increase in the uncertainty indicator that is 50% of the size of that in the Great Recession. (Note 28) This elevated value for the uncertainty indicator is then put into the VAR model above and the model is allowed to run-the dynamics of the VAR model are driven by the size and persistence of the uncertainty shock. The output from the VAR model is then put through NiGEM to find out what the implications for the rest of the economy would be, and, in particular, future GDP. The results discussed above are the output from NiGEM. (Note 29)

Problems with the Treasury's short-term economic model
There are a number of problems with the VAR model and also with how it is implemented. These relate to how the Treasury assumes businesses and households respond to the "shock" of leaving the EU, how long that "shock" is assumed to persist, and, finally, to the assumption made by the Treasury about how government policy will react to the way that businesses and households are predicted to behave. The self-fulfilling prophecy in the Treasury's short-term model is that Brexit will lead to such uncertainty that it will set off a chain reaction that leads to a recession which makes the uncertainty worse and which, in turn, leads to the recession getting deeper. This results in a never-ending downward spiral in GDP-through a positive feedback loop (Note 33)-as shown in Figure 2. C of the report on p.57 and reproduced above. The lines on the chart stop two years after Brexit, but there is nothing to stop those lines falling to -100%. In other words, UK GDP will eventually become zero-see the box below headed "Create your own sunspot equilibrium".

Create your own sunspot equilibrium
It is easy to create a sunspot equilibrium and generate a recession. Suppose we have the following simple VAR model linking GDP and an Uncertainty Indicator (UI): (Note 34) UIt= -UIt-1 with GDP0 = 10 and UI0 = 1. This shows that GDP in quarter t is equal the previous quarter's GDP less 50% of the previous quarter's value of the uncertainty indicator. In addition, the value of the uncertainty indicator in quarter t is the negative of its value in the previous quarter. In other words, the economy exhibits, over the relevant data period, a regular two-quarter bi-polar cycle of "bear" (depression) and "bull" (elation) animal spirits. Figure 2 shows this bi-polar pattern of the uncertainty indicator and the response of GDP. GDP responds with a one-quarter lag. The uncertainty indicator has a value of 1 in quarter 1 and this leads to a mini recession in quarter 2, with GDP falling from 10 in year 1 to 9.5 in quarter 2. However, the uncertainty is reversed in quarter 2 and the uncertainty indicator takes a value of -1 in that quarter. This generates a mini boom the following quarter and GDP rises to 10.5 in quarter 3. This pattern repeats itself over the next 8 quarters. Suppose that during the previous 25 years, the same pattern in the data was observed and this data had been used to estimate the parameters of the VAR model.

Figure 2-VAR model of GDP and the uncertainty indicator: recent history
While this is a simplified and stylised version of the VAR model used by the Treasury, it is perfectly acceptable to use it to show how the Treasury demonstrates that Brexit would be a disaster for the UK.
Suppose the Treasury assumes that the uncertainty indicator following Brexit rises to 2 and stays there.

Figure 3-VAR model of GDP and the uncertainty indicator: the effect of Brexit
Another problem is that the shock to uncertainty remains constant throughout the two-year period after Brexit (p. 40). However, Chart A.2 in the report shows that not even in the Great Recession did the shock stay constant for two years: the heightened uncertainty when the Great Recession started only lasted for one year before falling back to one quarter of its peak level for the next four years. The persistence of uncertainty in the model helps to explain why the relative fall in GDP after two years (with the extreme shock) is 6%, one percentage point more than in the Great Recession, despite the initial shock being only 50% of the size generated by the GFC. Holding the level of uncertainty constant for two years certainly speeds up the self-fulfilling prophecy in a VAR model.
A VAR model simply projects forward existing trends. If a variable has been increasing in the past, the model will project that it continues to increase. If a variable has been declining in the past, the model will project that it continues to decline. Similarly, if, over a particular historical sample, the model has estimated a negative relationship between two variables-such that when one rises, the other falls-then, if during a projection simulation, one variable is arbitrarily increased, the model will project that the other variable will fall. Depending on the sizes and signs of the parameter estimates, the second variable can continue to fall without limit, even if the increase in the first variable is reversed.
In other words, the increase in the first variable sets off a chain reaction that moves the system from a state of rest onto a perpetual downward trajectory. The system will only stop when a boundary condition is reached-such as when the second variable hits the floor with a zero value. If the first variable happens to be an extraneous random variable like the degree of "uncertainty", the chain reaction that is set off becomes a self-fulfilling prophecy that ends in a "sunspot equilibrium".  However, there is no causality in any of this. It is simply the mechanical structure of the model that drives the outcome. Any increase in the uncertainty indicator for any reason drives the result. Further, the same increase in the uncertainty indicator will give the same result whatever the cause. Take a look again at Chart A.2 and the relationship between the uncertainty indicator and GDP changes. Start by looking around the time of the two recessions. The downward co-movement between the two variables at the start of each recession is almost instantaneous-with the uncertainty indicator taking a short lead.
Yet GDP is a slowly moving juggernaut compared with the uncertainty indicator which can change on a daily or hourly basis. The uncertainty indicator might well be elevated at the same time that GDP is falling, but it takes a leap of faith to then say that the heighted level of uncertainty "causes" GDP to fall almost instantaneously. (Note 35) A key fault with Newton's theory of the gravity was that signals could cross instantaneously from one end of the universe to the other. It took another two centuries for Einstein to tell us that no signal can travel faster than the speed of light. The VAR model used by the Treasury has a similar defect. Further, if you ignore the periods around the two recessions, can you see much of a relationship between the two variables? Take the period following the Great Recession-GDP recovers more rapidly than the uncertainty indicator is reduced. The relationship between GDP and the uncertainty indicator could be almost entirely spurious-but that, of course, is entirely consistent with a "sunspot equilibrium".
One of the most serious deficiencies of the model is that there is no policy response by the government to the developing recession generated by the model. Compare that with the £375 billion that the Treasury poured into the banking system to end the GFC.
This lack of policy response also helps to explain why the relative fall in GDP after two years (with the extreme shock) is 6%, one percentage point more than in the Great Recession, despite the initial shock being only 50% of the size generated by the GFC. Holding policy constant for two years also speeds up the self-fulfilling prophecy in a VAR model.

Linking the Treasury's short-term and long-term economic models
It is clearly absurd that a Brexit will eventually lead to the UK's GDP vanishing-as in Figure 2.C and Figure 3. This is why the Treasury abandons the short-term VAR model after two years and switches to the long-term gravity model which moves the economy to a long-term equilibrium by 2030. The economic rationale used by the Treasury for switching models after two years is that the UK's trading position with the EU will have by then become clear, since two years is the maximum period to negotiate an exit under Article 50 of the TEU. Apparently, UK businesses and consumers will suddenly realise what a bad deal has been negotiated and so will switch to the gravity model and move to one of the three "permanently poorer" equilibria (EEA, EFTA or ROW/WTO) by 2030 where GDP is reduced by 3.8%, 6% or 7.5% p.a., respectively. This is shown in a modified version of Figure 2.C below.
However, the two models used by the Treasury-the VAR model and the gravity model-are completely different and indeed completely inconsistent with each other. Yet they need to be linked together to produce a coherent explanation of the trajectory of the economy between 2016 and 2018 and between 2018 and 2030. This is achieved by setting the initial shock in the VAR model at a level that generates just the right fall in GDP after two years (as shown in Figure 2.C) that is consistent with the additional fall in GDP predicted by the gravity model after 14 years, i.e., by 2030. In other words, the short-term model has been calibrated to be compatible with the long-term model, conditional on switching models after two years. This implies that the Treasury backed out the required size of the initial shock in the short-term model-50% of that in the Great Recession-once it knew what results the long-term model generated.
This is confirmed on p. 11 of the short-term report in the following way: "The first effect of a vote to leave the EU would be that businesses and households would start to make decisions consistent with the transition to becoming permanently poorer in the long term" in line with the predictions of the Treasury's long-term economic model. For the two models to be consistent with each other, the size of the initial shock-the elevation of the uncertainty indicator-is determined by the long-term model, rather than how economic agents would actually respond on the day after a vote to leave the EU. We consider this point in more detail in the next section.

VAR Model
Gravity Model Switch models in 2018

What the Treasury's short-term economic model cannot do
The main problem with the short-term model is that it cannot be used to estimate the GDP loss from Brexit. There are two reasons for this. The Treasury therefore has to make a judgement-that Brexit will be 50% as bad as the Recession.
There is no evidence for this-it is a pure judgement. The report also states on p. 24 that "no member state has ever left the EU". But this is not true. The report also ignores the fact the when Ireland left the currency union with the UK and adopted the Irish punt in 1979 and later the euro in 1999, there was a negligible effect on trade between the two countries. (Note 46) So the Treasury is using a short-term model that cannot reliably tell what the initial size of the shock should be, has no policy responses to manage expectations, and produces results completely at odds with Greenland's experience of leaving the EU or with Ireland's experience of leaving the currency union with the UK. But worse than this, neither the short-term nor the long-term model accounts for the non-economic risks of remaining in the EU.

It's more than the economics stupid!
The EU is a potentially highly unstable gravitational system. There are a number of reasons for this.
The first is economic and has to do with the euro. four quotes-the first from a former British politician, the second from the Founding Father of the EU, the third from the current President of the European Commission, and the fourth from the current German Chancellor: • "No government dependent upon a democratic vote could possibly agree in advance to the sacrifice which any adequate plan must involve. The people must be led slowly and unconsciously into the abandonment of their traditional economic defences, not asked, in advance of having received any of the benefits which will accrue to them from the plan, to make changes of which they may not at first recognise the advantage to themselves as well as to the rest of the world" (Peter Thornycroft, Design for Europe, 1947).
• "Europe's nations should be guided towards the super-state without their people understanding what is happening. This can be accomplished by successive steps, each disguised as having an economic purpose, but which will eventually and irreversibly lead to federation" (Jean Monnet, letter to a friend, 30 April 1952). These quotes quite clearly demonstrate that the EU is a political project and the EU political elite are prepared to ride roughshod over the wishes of its citizens. Those who genuinely believe in "ever closer union", because it will stop future European wars, will only ever be able to see problems, such as the Greek debt crisis, as an opportunity for "more Europe" and faster. This means that the EU is incapable of being reformed to make it more democratic and accountable, because this might slow down the progress to "ever closer union". Immediately after the UK Referendum, the European Commission will release plans for a joint EU budget which is the first step to a fiscal union to match the monetary and banking union in the Euro Area. (Note 50) Similarly, Federica Mogherini, High Representative of the Union for Foreign Affairs and Security Policy, will announce plans to establish an EU Army immediately after the Referendum; apparently, the EU "can manipulate the Lisbon Treaty in order to bypass the UK's traditional veto on defence matters". (Note 51) But this type of attitude and behaviour will inevitably bring into question the political and social stability of the EU itself. The democratic deficit is not just a concern for citizens of the UK. According to an Ipsos Mori poll reported on 10 May 2016, more than 50% of Italian and French citizens wanted a vote on EU membership, with 48% of the former and 41% of the latter saying that they would vote to leave. Clearly, Europe's people are no longer prepared to fall for the political con trick underlying the EU.
One key factor responsible for EU-wide discontent with the EU is the refugee crisis. The plight of refugees escaping war deserves not only our sympathy, but also our economic support.
Some go further and argue that the refugees provide a timely solution to Europe's joint demographic crises of an ageing population and declining fertility. On 18 May 2016, the Tent Foundation and Open Political Economy Network published a report entitled "Refugees Work: A Humanitarian Investment that Yields Economic Dividends". (Note 53) The report argues that the refugees will create more jobs, increase demand for goods and services, and fill gaps in European workforces-while their wages will help finance pensions and public services. While the report accepts that supporting the refugees will increase public debt by almost €69 billion (£54 billion) between 2015 and 2020, it argues that, during the same period, refugees will help GDP grow by €126.6 billion-a ratio of almost two to one, so "investing one euro in welcoming refugees can yield nearly two euros in economic benefits within five years".
For this to work, employability is crucial, according to the report (p. 9):

German lawyers and economics professors writing in The Sunday Times on 15 May 2016.(Note 56)
They argue that the UK government's renegotiation deal with the EU to prevent "ever closer union" is virtually worthless and will do nothing to protect the UK from further EU integration or immigration. This is because of the "future judicial activism" of the European Court of Justice. There is nothing in the EU-UK agreement that can offer the UK permanent legal safeguards against being dragged along the path of further integration. The agreement cannot do so, because it does little to reform the EU and does not exempt Britain from the jurisdiction of the ECJ. They also argue that the measures to deter immigration by cutting benefits will also fail. Once the million-plus asylum-seekers "are naturalised in Germany (and elsewhere), there is nothing to prevent them from exercising their right to free movement and cross the Channel legally. The UK may not be part of the EU's common asylum policy, but no country will be able to escape its consequences".
One way or another, the migrants will affect both labour supply and labour productivity in the EU. The same will be true when the five candidate countries for EU accession join: Albania I am sure that I do not need to remind everyone that economics is a social science-not only does it take into account economic factors, it also properly takes into account social, political and legal factors.
No economic model that is used to conduct a cost-benefit analysis of whether the UK is better off staying in or leaving the EU can ignore the above issues. They will affect the safety, security and quality of life of the citizens of the UK and other European countries for generations to come.
The Sun at the centre of the EU Solar System has the very real potential to blow up into a large red giant by expanding uncontrollably and then collapsing into a black hole and doing so very rapidly-in much the same way that the Royal Bank of Scotland expanded uncontrollably before collapsing a black hole in 2008 and requiring a bail out by the UK taxpayer of £37 billion. Just four years before, Fred Goodwin, the chief executive of RBS, was awarded a knighthood for "services to banking".

Embarrassing for the economics profession
The two Treasury reports continually repeat the point that other organisations, like the IMF and Bank of England, have models which lead to the same dire predictions. Well this is because they are using the same models-which the reports also acknowledge. So the Treasury is saying "we are using the same www.scholink.org/ojs/index.php/ape Advances in Politics and Economics Vol. 4, No. 4, 2021 50 Published by SCHOLINK INC.
widely accepted models as all major respectable organisations and all these organisations are predicting a calamity if the UK leaves the EU which confirms and reinforces our own findings". Well-to repeat-that is because they are using the same model-these predictions are not independent of each other. If ten organisations are using the same model to make the same predictions, this does not mean that the weight of evidence is ten times that of the case when only one organisation is using an alternative model.
The projections in both studies are also reported with a very high degree of confidence-almost with the status of facts. While there is some sensitivity analysis at the end of the documents, no serious economic study should be making predictions out to 2030 on the basis of models like the VAR and gravity models without admitting that there can be very little confidence about these predictions. I was going to suggest that we should all come back in 2030 and assess the accuracy of the models' predictions. But, of course, we can't do that, because the studies do not report the projected levels of GDP and GDP per household in 2030 under the two scenarios of stay or leave. All that is reported is the projected difference between the two. It will be impossible to tell in 2030 what the difference is because only one of the scenarios will have been realised-it could only be assessed if 50% of the UK population left the EU, while 50% remained. In addition, the Brexit outcome is reported as an annual loss of GDP per household of £4,300in 2015 terms. This is likely to confuse many people, since it gives the impression that household incomes will be reduced by £4,300 p.a. if the UK leaves the EU.
All this is deliberate obfuscation and the Treasury must be fully aware of this.
The reports do not consider the alternative economic models that predict that the UK will do well out the EU. All serious economic studies should report the results of alternative studies, such as: • Open Europe's model which predicts that "the more realistic range is between a 0.8% permanent loss to GDP in 2030-where the UK strikes a comprehensive trade deal with the EU but does nothing else; and a 0.6% permanent gain in GDP in 2030-where it pursues free trade with the rest of the world and deregulation, in addition to an EU Free Trade Agreement". (Note 60) Treasury has become so politicised that it is reduced to rationalising the views of George Osborne. The modelling methods it has used to do Osborne's bidding are the ones anyone would employ to rubbish Brexit. By leaving the EU, we go to global free trade and we rid ourselves of the intrusive EU regulation that bears down most heavily on our smaller firms who cannot afford huge HR and compliance departments. The gains to our economy from this are huge, as anyone would readily expect.
The trade gain amounts to 4 per cent of national income, directly enjoyed by our voters even after spending some of it helping out those affected producers, including our farmers. The gain from getting out of the heavy-handed regulation of our whole economy by the EU is more again, and a boost to our growth rate. The Treasury report gets it precisely the wrong way round". One economist is however named in the second report and that is Charlie Bean. He is thanked by the Chancellor, George Osborne, in the Forward to the short-term report: I am grateful to Professor Sir Charles Bean, one of our country's foremost economists and a former www.scholink.org/ojs/index.php/ape Advances in Politics and Economics Vol. 4, No. 4, 2021 53 Published by SCHOLINK INC.
Deputy Governor of the Bank of England, who has reviewed this analysis and says that: "While there are inevitably many uncertainties-including the prospective trading regime with the EU-this comprehensive analysis by HM Treasury, which employs best-practice techniques, provides reasonable estimates of the likely size of the short-term impact of a vote to leave on the UK economy".
I am a great admirer of Charlie Bean but he is in no better position to judge the likely size of the short-term impact of a vote to leave on the UK economy than I am. How can he possibly know this as there has been no previous exit of an economy of the size of the UK? Also he says nothing about the policy response to Brexit-and it is on policy matters-especially monetary policy matters-that he has spent most of his career. Further, he did not declare his view on Brexit.

The political abuse of the Treasury models
The two reports-especially the second one dealing with the immediate impact of Brexit-are two of the most ridiculous and excruciatingly awful official documents I have ever read. There is doom-mongering on every page. In fact, the more you read, the more hilarious it gets.
British consumers would be so shocked by the size of the shock they had created by a vote to leave the EU that they would not be able to get out of bed in the morning to consume. British investors, anticipating what was happening to British consumers, would be trapped like rabbits in a car's headlights and be incapable of investing. British workers, fully predicting the behaviour of consumers and investors, would be too scared to go to work. This would immediately have global spillover effects.
German workers, recognising that no one was going to buy their cars, would decide to go fishing instead. American investment bankers, realising that London was finished as a financial centre, would move their offices to the Cayman Islands, only to find themselves flooded out by a rising sea level  My first duty as Chancellor is to seek to deliver economic security and higher living standards for the people of Britain. We already know the long-term effects of a vote to leave: Britain would be permanently poorer. Now we know the short-term shock too: an economy in recession, major job losses and a self-inflicted blow to living standards and aspirations of the British people.
A vote to remain in the EU, however, would be the best way to ensure continued growth and safeguard jobs, providing security for working people now and opportunity for the next generation.
This document provides the facts that I hope the people of Britain will consider when they make this historic decision one month from today.
But there are no facts in these reports. As Roger Bootle, managing director of Capital Economics, said: "The fact of the matter is there aren't facts. There are assumptions, there are views, there are factoids you can push or bend in a certain direction, but this is not something where you are going to get the objective truth". Capital Economics' own analysis of different models revealed a 22% difference in projected GDP between the most extreme views. (Note 71) Speaking on BBC News on 16 May, Mr Osborne said the "the economic argument is beyond doubt: leaving the EU is a one-way ticket to a poorer Britain". (Note 72) This is an exceedingly unwise statement to make-no economic argument can be beyond doubt and the VAR and gravity models used by the Chancellor to make that statement provide a woefully incomplete analysis of the economic implications for the UK of either staying in or leaving the EU. We should not forget that Mr Osborne makes revisions at least every six months to his projections of GDP over the near term, never mind out to 2030.  insofar as the public just remember the Big Scary Figure. And here's a picture with Osborne at his press conference with his prized, concocted £4,300 figure.

So having established (1) a means of dressing up an increase as a decrease and (2) a bogus conflation of GDP with household income and (3) a way of covering up the immigration-driven surge in households,
The Prime Minister is also at it. In a letter written with the Chancellor, he writes: (Note 79) In exactly one month's time, Britain will vote in a referendum to decide whether to remain in the EU or leave it.
It will almost certainly be the biggest economic and political decision the British people will make in our lifetimes.
It is a question about the sort of country Britain wants to be in the world, and will affect families, jobs and the future of our country for decades to come. there will be a shock to the economy in the short term. It is difficult to say how big it will be. But the economy will probably shrink somewhat. And this will carry a short-term economic cost. In the longer term, we need to know much more information about what the trade relationships will be before we can assess whether there will be an economic cost and if so how much. …The balance of evidence we have taken as a committee is that there will be a cost, but it is difficult to assess how big it will be".

Even more political abuse
The second report gives the strong impression that we really don't have a choice-the UK can never actually leave the EU, because it would be too difficult to unravel.
For example, on p. 24: The  Figure 4 shows the alternative gravity model that the Treasury did not consider.

Conclusion
The Treasury has produced two reports which use two types of economic model to assess the consequences of Brexit. There is no balance is either report: the two models used-the VAR model and the gravity model-unambiguously predict that the consequences would be dire for households in the UK. The Chancellor has described anyone who disagrees with these reports as "economically illiterate".  The British Treasury has in effect become a propaganda machine for a political institution led by Jean-Claude Juncker-a man who has declared his hostility to "democratic choice" when it comes to the wishes of the European people. This whole exercise is utterly dangerous for democracy. Let us suppose the Treasury, the IMF and the Bank of England adopted the same approach and used models like these to evaluate the economic policies of British political parties at the time of a General Election and pronounced that the policies of a particular political party would have "pretty bad to very, very bad consequences"-that would result in a "sudden stop" in money flowing into the finance sector which would drive down the value of the pound and lead to a sharp rise in interest rates, falling house and Kepler in collecting empirical observations on the motion of planets that proved to be so useful to Isaac Newton when he developed his theory of gravity. But it was a correct theory in the end that was important in explaining the elliptical orbit of the planets around the Sun. By projecting these observations on the basis of a false theory-namely that the Earth was at the centre of the Universe-it was possible to predict that planets would suddenly and sharply change their direction of travel when viewed from Earth.
The Treasury's application of gravity and VAR models to assess whether the UK would be better in or out of the EU is also an exercise in "Measurement without Theory". The models confirm John Kenneth Galbraith's dictum that: "The only function of economic forecasting is to make astrology look respectable". But it is far more insidious. The two models have been deliberately engineered to produce the result that the government and the rest of the global plutocracy want. And the fact that fellow economists have drafted reports like these that are being used by politicians to frighten the British electorate into staying an institution as precarious as the EU is both intellectually dishonest and deeply shaming. Do you think economists like John Maynard Keynes and Milton Friedman would have allowed themselves to be used in this way?
The two Treasury reports are two of the most dishonest and deceptive public documents I have ever read.
The whole exercise should therefore be seen for what it is-an elaborate charade. What is happening is no different from Tony Blair's "dodgy dossier" on Saddam Hussein's weapons of mass destruction.
These two reports will rightly gain the same status of "dodgy dossiers".
However, the reports do serve one useful purpose-they tell you precisely how you would not handle a Brexit. First, the UK should not trigger Article 50 until all new trade arrangements have been agreed.
Begin discussions with Germany-they sell us £70 billion in goods and services p.a. and we sell them £45 billion, a deficit of £25 billion, the largest amongst member states. (Note 89) Everyone else will soon line up. (Note 90) Second, manage expectations. There is absolutely no rational economic reason why a UK decision to leave the EU should cause a recession of the depth outlined above or a permanent reduction in GDP. A sensible strategy for negotiating exit and timing-including not triggering Section 50 until an appropriate time-and an appropriate monetary policy could prevent all this. However, you wouldn't want any of the people involved with preparing these reports to be involved in these negotiations.

Appendix: Lord Mervyn King's interview with Martha Kearney
The scaremongering tone of the the campaign-and I quite carefully stayed out of that-that people would ask questions, and the one word they used more than any other was "scaremongering". They didn't want to be treated like fools.
They could have listened to a rational argument, and there's no doubt that leaving, creates uncertainties-that was a powerful argument. But it didn't help, to exaggerate that argument, by turning what were inevitably, very speculative forecast into facts, like £4,300 is the amount by which every household would be worse off, or that we would have an emergency budget, which will inevitably have to raise taxes and cut spending. The one thing that you do not need, if you believe that you are headed into a recession-and we don't know that, we may, we may not-but if it turns out that the economy is turning down, the last thing we would want is an emergency budget to raise taxes and to cut spending. And whether or not we would need to do so in the longer run, will depend upon the long run impact of the new situation with the UK outside the EU, and we have no idea what that would be.
Martha Kearny: So where does this leave the Chancellor?
Mervin King: Well I don't know, that's for him to decide. I think we desperately need someone who is going to put together a team of people now to do the preparations before the negotiations start in earnest, in the autumn. on Thursday night at midnight when people were speculating on the result and hope to rebalance the UK economy. Some fall in sterling at some point was inevitable.
Martha Kearny: But if there are problems as some suggest, with foreign direct investment, isn't that likely to make the trade deficit worse?
Mervin King: Well I think that foreign direct investment, undoubtedly, will probably fall, or be on hold for a period, and that was the largest, likely, short term economic pact of leaving the EU. But that reflects the uncertainty, and at some point that uncertainty will disappear, when the negotiations are completed, and then we will be in a different world again. So there are short term uncertainties, but I don't think that people should automatically translate that into deeply pessimistic views into the longer term.
Martha Kearny: Well it wasn't only the Chancellor who was as you say "deeply pessimistic", it was also the man who took over your job, Mark Carney. In May, he warned that the risks of leaving could possibly include a technical recession.

Mervin King:
That was a short term statement and the Bank had no choice but to make a judgment about the short term. We don't know whether that is true or not, but even if it were true, that tells you very little about the long-term impacts and the Bank was very careful not to get involved in the speculative judgements to which the government fell prey to make. I think very confident statements about the damage that would be done in the long term about which the honest answer is we simply don't know. My own guess, and it's no more than that, is that the long term effects maybe much smaller than either side claimed.
Martha Kearny: But again, the Governor of the Bank of England found himself in the centre of the political fray, he was criticised for having demonstrated a fundamental misunderstanding of central bank independence-was he wise to get involved in that way?
Mervin King: I don't think that he had any choice but to comment on the current state of the economy, where it might go in the next 6 to 9 months. Central bank governors are always criticised, I don't think that means to say they are wrong. The UK economy was, of course, badly damaged by the Coronavirus Pandemic. Gross Domestic Product (GDP) fell by around 10% in 2020, the largest fall in 300 years. However, the UK Office for Budget Responsibility in its "Economic and Fiscal Outlook-October 2021" argued that "The successful vaccine rollout has allowed the economy to reopen largely on schedule, despite continuing high numbers of coronavirus cases. The vaccines' high degree of effectiveness, combined with consumers' and businesses' surprising degree of adaptability to public health restrictions, has meant that output this year has recovered faster than we expected. …The economy is now expected to grow by 6.5% in 2021 …and unemployment to rise only modestly to 5.25%.…Over the medium term, we have revised up real GDP as we now expect post-pandemic scarring of potential output to be 2%". Figure 6 predicts that the economy will have fully recovered from the pandemic by the end of 2021 or the first quarter of 2022. Thereafter the GDP is predicted to growth along a trendline that is 2% lower due to "post-pandemic scarring".
A final point to note is the implied criticism of the Treasury models made by Lord David Frost, the UK's Chief Negotiator for Exiting the European Union and later co-chair of the Joint Committee monitoring the UK-EU Withdrawal Agreement and TCA, in a lecture at the Institute for European Studies in Brussels in February 2020. He criticised not only the structure of the Treasury models and the exaggerated size of the some of the key model parameters, but also the direction of causation of some of the key relationships in the models: and only marginally statistically significant.
All this provides further confirmation that the two Treasury reports were indeed very "dodgy dossiers".
Combining this with the evidence from Harry Western and the Office for Budget Responsibility on how successful the UK post-Brexit economy has been compared with the dire warnings in the Treasury reports confirms that the only purpose these two reports was to make astrology look respectable. And this needs to be placed on public record.