mmemories came flooding back when George Soros criticized Vladimir Putin and Xi Jinping in Davos last week, even though 30 years ago it was sterling rather than authoritarian leaders that the arch speculator had in his sights.
As 1992 progressed, pressure on the pound mounted until it was blown out of the European Exchange Rate Mechanism (ERM) on September 16. John Major’s government never recovered from what was soon to be called Black Wednesday, so complete was the humiliation and loss of public confidence.
The question now is whether Partygate will do for Boris Johnson what Black Wednesday did for Major. Has the reputation of the Conservative party been so damaged by the scandal that, whatever happens between now and Election Day, defeat is inevitable?
In some ways, the outlook for Johnson is more grim than for Major. Black Wednesday forced the then government to give up a policy it had previously said was non-negotiable: membership in the ERM. That policy of only allowing the pound to trade within a narrow range against the Deutschmark had resulted in interest rates being kept higher than they otherwise would have been, prolonging the recession of the early 1990s. .
Leaving the ERM was good for the economy. Interest rates fell sharply and the pound fell in value. Fears that inflation would rise proved unfounded as the recession had given the economy so much leeway. Higher taxes in the budgets that followed Black Wednesday were unpopular, but made sure that lower interest rates helped producers rather than encourage consumer spending.
Once the course was set, nothing was changed. By the time of the 1997 elections, unemployment had fallen, growth was robust and the large balance-of-payments deficit created during the boom of the late 1980s had been eliminated. Yet the Tories succumbed to a Labor landslide.
Rishi Sunak’s turnaround on a windfall tax last week was not the same as leaving the ERM in September 1992, but was damaging enough. For months, the chancellor opposed the idea of taxing the profits of oil and gas companies in the North Sea, saying it would deter investment. Likewise, Sunak said he would wait until the fall budget before deciding whether to provide more assistance to households struggling with rising energy bills.
That strategy has now been abandoned. In a deafening echo of the crisis-ridden 1970s, there have now been three mini-budgets since early February as the government has caught up with the cost of living crisis.
To a certain extent, what Sunak did made perfect sense. Only the Treasury had the resources to prevent millions of households from sinking into fuel poverty, and the £15 billion in additional purchasing power could save the economy from recession later this year.
However, there are some significant downside risks. One is that injecting additional demand into the economy will increase inflationary pressures, causing the Bank of England to be more aggressive when it comes to raising interest rates.
The Bank believes that current inflationary pressures are caused by a series of supply-side shocks, including job losses due to Brexit and the pandemic, bottlenecks as demand picks up after lockdowns, the zero-covid policy being waged by China and – more recently – the war in Ukraine. What matters for short-term interest rate policy is what the Threadneedle Street Monetary Policy Committee (MPC) thinks will happen to inflation. And what Sunak did last week will add to the MPC’s concerns.
In theory, changing the mix of policies is a good thing. There are strong arguments to say that monetary policy (what the Bank of England does) has been too loose and fiscal policy (what the Treasury does) has been too tight. But the situation isn’t nearly as clear-cut as it was in the aftermath of Black Wednesday, when a loose monetary/tight fiscal policy mix did the trick. With annual inflation already at 9%, the Bank’s credibility is at stake. There is a danger that Sunak’s fiscal easing will lead to an overkill of the Bank’s monetary policy.
Even if, by some miracle, the policy mix turns out to be perfect, there won’t be the kind of recovery we see after Black Wednesday. Living standards will still fall this year, even after Sunak’s latest measures, but not by much. Paul Dales of Capital Economics says that before the mini-budget, households’ real disposable income was on track to fall by 2% by 2022, but will still fall by 1% even after the energy bill is abolished.
Black Wednesday shattered the Tory party’s reputation for economic competence. Major was not credited for the subsequent recovery, as it only happened because the British government had abandoned austerity policies it had claimed to be non-negotiable.
Johnson is in an equally bad place. After Black Wednesday, a new and largely effective framework for controlling inflation was quickly put together. Today, government economic policies are out of control, with flip-flops and short-term announcements making headlines, taking the place of long-term strategy.
Sunak says he’s fiscally conservative, but doesn’t act like that. Thanks to the Prime Minister and the Chancellor, the “Big Government” is now back in vogue, the result first of the pandemic and now the Russian invasion of Ukraine.
Ministers speak the language of the right, but behave – usually after much kicking and yelling – like an incompetent party from the left. Voters probably wouldn’t forgive Johnson for Partygate, even if the economy boomed between now and the next election. They certainly won’t forgive him if the economy struggles, as is much more likely the case.