The first is that since the referendum there has already been a material hit to the supply side of the economy in the form of a reduction in Total Factor Productivity (TFP), which is the efficiency with which companies put their labour and capital inputs to use. This would reduce output per worker, and hence real wages. It would also reduce future profitability, thus deterring investment. A reduction in TFP would have a lasting effect on productivity and hence the supply side of the economy, reducing the rate at which it can grow without generating above-target inflation. Like most economists I expect Brexit to have a negative impact on TFP for a variety of reasons, including the need to reallocate resources toward supplying new customers or new products, and the general effect of  6  All speeches are available online at www.bankofengland.co.uk/speeches  6  2  reduced openness . But these are effects that, like the effects of capital deepening on productivity, will tend to either build over the long run or only really take hold after our trading arrangements have changed. So, while they can be expected to have a material impact on productivity by the end of the MPC’s forecast horizon, I’m not convinced they can fully account for the additional weakness in productivity we have already seen. It shrank by 0.2% in the year following the referendum compared to growth of 0.5% on average in the preceding seven years.
Realised losses related to these investments have, as mentioned above, have been limited. The flipside of large book losses is that this portfolio has a high return, reflecting not only the increase in credit risk but also high liquidity premiums and fears and uncertainty in the market. The return, measured as the difference in the effective interest rate between the actual portfolio and the benchmark portfolio, is now close to two percentage points. History has seen a number of deep financial crises, and market conditions will return to normal in time. The final results of the management of the Fund’s fixed income portfolio since the beginning of the financial crisis cannot be deduced from the quarterly results while the crisis is at its peak. Values are not lost as long as borrowers fulfil their obligations. The Fund is prepared to retain ownership of a large volume of bond holdings until they mature in a few years. Moreover, unless the economic outlook goes from bad to considerably worse, the Fund will record a substantial excess return in the years ahead. Conclusion The Norwegian Pension Fund has been hard hit by the crisis. Norges Bank’s management results in 2008 were weak in both absolute and relative terms. Relative returns were significantly worse than might have been expected based on the investment strategy chosen. In the management of the fixed income portfolio, the crisis in the financial system revealed that risk exposure in the various mandates was not sufficiently independent.