Recession, Black Wednesday, Interest Rates and all that
February, 10, 2008
The current coverage of the economy is full of references to Recession, Black Wednesday, the 1990’s and of course interest rates. They are all linked, but how and why?
Some of you may well have been at school or college during the early 1990’s and could be forgiven for being more interested in attending a rave in a field somewhere than scanning the business pages. On the other hand, some of our older readers might also have been far more interested in attending a rave in a field somewhere than scanning the business pages! This simple guide is just for you…
The 1990’s and Recession
Very roughly, a recession is when growth in the country’s Gross Domestic Product (GDP) falls for two quarters in a row. Imagine that for six months your pay was cut so you couldn’t afford food, rent and bills (etc). You’d be in your own sort of tiny micro-recession, so imagine what happens when this occurs to one of the world’s biggest economies. Governments will try all sorts of tinkering to steer an economy out of recession, but it’s a difficult balancing act.
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In the 1990’s the UK economy was in recession, with 1990 to early 1993 seeing the worst of it. Political factors included the first Gulf War and of course the decision to join (and later crash out of) the European Exchange Rate Mechanism (ERM).
Interest rates during this period were running up to an eye-watering 15% (yes, really). House repossessions were something that happened to your mates with alarming regularity and a top pub conversation was who had the biggest negative equity.
Given the pivotal importance of home ownership to the UK economy, you can see why modern politicians are utterly terrified of the ‘R’ word.
Black Wednesday
Black Wednesday is one of those things politicians and journalists throw around expecting everyone to know exactly what happened on September 16th 1992. A lot of us are vaguely aware that Something Very Bad Happened but not exactly what. Put simply, the then Conservative government had to withdraw the pound from the Exchange Rate Mechanism, a move which cost the taxpayer up to 27 billion pounds (this is a hotly disputed figure).
Why? In the early 90’s, before the Euro, one of the strongest European currencies was the German Deutschmark (DM). In 1992 the US Dollar was depreciating against the DM this caused problems in the relationship between the pound and the dollar. This was because both Sterling and the DM were tied into the ERM, preventing the badly needed adjustment of the pound / dollar valuation.
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The UK Government announced a cut in interest rates and currency speculators descended, making a fortune from the devaluation. Britain pulled out of the ERM completely.
Economists are still arguing about the economic impact of Black Wednesday, but politically it destroyed the reputation of the Conservatives as competent managers of the UK economy, and sounded the death knell of John Major’s administration.
That’s why it’s important now, as a reminder of how politicians can be irreparably damaged by poor economic management.
Commentators now point to Northern Rock as New Labour’s “Black Wednesday” because they know that it scares the wits out of the Government.
Bank of England “Independence” & Interest Rates
Gordon Brown, sitting in opposition in 1992, had seen how “boom and bust” economic cycles had damaged the UK economy. So one of the first things the New Labour government did in 1997 was give the Bank of England independence in setting interest rates so that it became an impartial economic as opposed to political decision.
And, of course, politicians had a win-win: if things went well they could claim credit for freeing the Bank of England in the first place. If things went badly they could blame the Bank.
So every month for over ten years the Monetary Policy Committee (MPC), decides whether rates go up or down. Of course, political pressure is there (and always will be) but technically it is an independent decision.
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What Now?
The legacy of these events still directly affects all of us. Interest rates remained fairly low during the New Labour years, making people feel wealthier, especially as property values rose dramatically.
Conversely, cheap credit and unrealistic expectations around that property equity led to massive personal debt and increased vulnerability to an economic downturn – exactly what has happened with the credit crunch.
Naturally, the Government likes to make their role in any failure as opaque as possible, as much as they like to take credit when times are good.
This is why commentators draw comparisons with this period, because it is within such recent memory. The early 1990’s directly shaped the economic and business landscape of today. And until Northern Rock came along, Gordon Brown had a pretty good time of it compared to his predecessors in the early 90’s. And as the man himself allegedly said, “There is no such thing as a successful Chancellor, just one who gets out in time!” 
SaveBorrowSpend Philippa Adam
