It could be different this time
Thursday 06 August 1998
THE MEMBERS of the Bank of England's monetary policy committee probably do not realise it, but when they gather this morning they might care to mark a significant anniversary for the Bank.
Almost 10 years ago to the day, on 8 August 1988, the Bank (in those days on the instruction of the Chancellor) announced a half point rise in its base rate, from 10.5 per cent to 11 per cent. The move was hardly unexpected. In fact, base rates were moving upwards with alarming regularity. Between the beginning of June and 8 August, base rates were increased no less than seven times. People thought rates had peaked after the August move, but they were wrong. Two weeks later there was another rise, then another.
Surprisingly, even in the midst of such a severe squeeze, there was still a debate as to whether the Treasury and the Bank would succeed in engineering a soft landing for the economy. It was a debate that raged on for the best part of the next year, as interest rates carried on rising.
Now once again we have a war of words between the soft landers and the hard landers. And the protagonists are the same. The warnings of a hard landing come from the business community, fearful of what lies in store for their order books and their profits. The assurances of a soft landing come from government, hopeful that the economy can be slowed without being stopped dead or even put into reverse.
It is instructive to see what did happen last time the argument was raging. In 1990 the economy stagnated. In 1991 output fell sharply and in 1992 it carried on falling. In those two years consumer spending fell nearly 2.5 per cent. New car sales fell by 13 per cent in 1990 and by over 20 per cent the next year. Unemployment, on the claimant count, rose from 1.6 million in 1990 to 2.9 million in 1993. The people who were arguing about whether the economy was heading for a soft or a hard landing were both wrong. What we got was a crash landing.
An analysis of the previous recession provides a similar picture. The economy contracted sharply in 1980 and 1981. Consumer spending showed no growth. New car sales dropped by nearly 15 per cent in the two years and unemployment went from 1.3 million in 1980 to 2.8 million 1983.
Again that was not a soft landing nor a hard landing. It was an economic crash. In fact if you look at a long run of output figures for the UK, one thing is very clear. The UK economy has not had a soft landing or a hard landing for nearly 30 years. Every landing has been of the crash variety. It is what the current government has come to label the boom- and-bust cycle, with the emphasis on the bust. The question now is whether we have embarked on a re-run of British economic history or whether something new is at work.
Certainly one thing is new, and this brings us back to today's meeting of the Monetary Policy Committee. It is the first time the task of piloting the landing has been taken out of the hands of the government of the day and handed to someone else - the independent Bank of England. But what sort of difference should that make? The answer to that question depends on the answer to another. What role do policy-makers have in determining the sort of recession an economy has to live through?
Again a look at the past two recessions is instructive. Every industrial nation goes through an economic cycle. But something about the British economy or the way it has been managed has ensured that we have been subjected to crash landings, whereas elsewhere they have been much more successful at engineering soft landings.
Take for example the recession of the early 1990s. It was clearly an international phenomenon. But while we were seeing output crash over a period of three years, Germany, France, and the US suffered a loss of output in only one year, while Japan showed positive growth throughout. For the G7 nations as whole there was not even a single year when output turned negative. The worst of the world recession was 1993, when G7 growth slowed to 1 per cent. In the recession of the early 1980s it was the same story. We crashed, the rest glided.
The inevitable conclusion is that in the UK we have developed an unenviable capacity to turn a cyclical downturn into a full-blown crisis. But why, and how? The answer is that we have in the past made horrendous policy errors, which have succeeded in making things much worse than they need be.
Just recall what happened in the run-up to the recession of the early l990s in the UK. One policy mistake, the Lawson boom, was followed by a second and third policy gaffe. Interest rates were ratcheted up to 15 per cent by the end of 1989, and for a full 12 months they were left unchanged at that level.
John Major was the Chancellor, and industry was pole-axed. The pound sailed abovethree marks and to two dollars. The policy turned a recession into a crash. And there was worse to come. In his last act as Chancellor, Mr Major put Britain into the exchange rate mechanism. It was the wrong decision at the wrong time and at the wrong rate. The crash was inevitable.
Ten years earlier, the previous recession was also policy induced. That time it was an overvalued pound, another interest rate peak of 17 per cent, and on top of that a severe fiscal squeeze that did the trick.
So if recent history is anything to go by the real danger to the British economy is not the economic cycle but policy-making blunders And that is the context in which we should judge the Bank of England's Monetary Policy Committee.
For all the fuming and fulminating by the Bank's critics, for all the claims that the committee members are "too academic" and "out of touch with the real world", the Bank can hardly be said to have blundered badly so far. It can be argued that rates should have been increased more quickly, or that they should have gone higher so that by now we would be contemplating falling interest rates. But these are arguments around the edges of policy.
If rates do go higher, by perhaps another quarter or half point, before they come down it will bring more complaints from industry. But it will hardly be a disaster on the scale of previous blunders made by the politicians when they were in charge. This time round, if the Bank holds its nerve, there is for the first time in a generation the chance that Britain might actually experience what other countries regard as normal, a soft landing for the economy. And 10 years on that would be a real reason to celebrate.
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