UK MACROECONOMY | IN FOCUS
a surplus, enabling the government to cut taxes. The resulting upturn is now known as the “Lawson boom” after the then Chancellor Nigel Lawson. In response the government started hiking
interest rates in late 1988 to control inflation and joined the European Exchange Rate Mechanism in October 1990, which tied the pound to the German mark. However this move came at a time when the UK and German economies were moving in different directions. As boom turned to bust, the UK again went into recession – this time accompanied by a crash in house prices. Unemployment surged back above three million. Attempts to keep sterling in the ERM at the rate of DM2.95 to the pound proved unsustainable and, despite raising interest rates to 15 per cent to defend the peg, sterling crashed out of the system on 16 September 1992 – a day now known as Black Wednesday. The ignominious events surrounding the
ERM exit left what CBI director-general Howard Davies called an “uncomfortable vacuum of policy”. The vacuum was filled by the strategy of targeting a measure of inflation using changes in the Bank of England’s interest rates supported by economic forecasts published by the Bank. This was reinforced by the decision of the Labour government in 1997 to give the Bank the power to control interest rates. Between 1993 and
The 2007 run on Northern Rock (opposite, top), and City victims of the banking crisis (opposite, bottom)
2007 inflation (as measured by the RPI) and economic growth have both averaged close to 3 per cent, just before the global financial crisis hit. Unemployment fell from a peak of 10.7 per cent in February 1993 to around 5 per cent in 2007.
THE GREAT RECESSION The stable “NICE” decade – an acronym for “Non-Inflationary Consistently Expansionary”, coined by Bank of England Governor Mervyn King – came to an abrupt end in 2007. An intense period of financial innovation, which had accelerated during the seemingly endless years of economic stability as investors looked for imaginative ways of making money in a low interest rate environment, resulted in an unparalleled financial crisis. On 9 August 2007 a French bank unexpectedly announced that its investors could not withdraw money from two of its funds because of a “complete evaporation of liquidity in the credit market”. Adam Applegarth, then CEO of Northern Rock bank, described it as the “day the world changed” and a month later saw a run on his bank – the first in Britain since 1866. The credit crunch that ensued forced the UK
government to intervene to save Northern Rock, Royal Bank of Scotland, Lloyds Bank and a host of smaller institutions. Other European governments followed suit while, across the Atlantic, the US government stepped in to bail out a series of banks including blue chip names such as Bank of America, JP Morgan and Morgan Stanley.
However, in September 2008 the authorities took the decision not to intervene to help Lehman Brothers. The collapse of that bank triggered what became known as the “great recession” that saw the UK economy contract by 5.2 per cent in 2009 while unemployment hit 2.68 million. The Bank of England cut interest rates to
0.5 per cent in March 2009 and pumped £375 billion into the economy by purchasing financial assets. While inflation-targeting remains at the heart of monetary policy, the Bank has been given powers to deliver financial stability by removing or reducing systemic risk in the financial system. The Coalition government embarked on its austerity programme to cut state spending and reduce the public-sector deficit – a strategy endorsed by the CBI. As Britain enters the eighth year after the onset of the financial crisis, the economy finally looks set for sustained economic growth. The challenge will be to achieve steady growth that boosts everyone’s living standards while avoiding the risk of a repeat of the boom and bust, especially in the housing market. As the CBI set out in its 2011 report, A Vision for Rebalancing the Economy, at the heart of this is the idea of rebalancing the economy so that the engines of growth are more balanced – in particular, with greater support coming from stronger exports and investment. The scale of the challenge is considerable but the prize will be the long-term sustainable growth that will boost living standards for all.
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