MMemories flooded in when George Soros castigated Vladimir Putin and Xi Jinping in Davos last week, although 30 years ago it was more authoritarian rulers than arch-speculator who had his sights set.
As 1992 progressed, pressure on the pound intensified until, on September 16, it was expelled from the European Exchange Rate Mechanism (ERM). John Major’s government never recovered from what was quickly dubbed 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 tarnished by the scandal that whatever happens between now and election day, defeat is inevitable?
In some ways, the outlook for Johnson is bleaker than for Major. Black Wednesday forced the government of the day to abandon a policy it had hitherto called non-negotiable: membership of the ERM. This policy, under which the pound was only allowed to trade within a narrow range against the German mark, had required that interest rates be kept higher than they otherwise would have been, prolonging the recession of the early 1990s.
Leaving ERM was good for the economy. Interest rates fell sharply and the pound lost value. Fears of a spike in inflation proved unfounded because the recession had left so much slack in the economy. Higher taxes in the budgets that followed Black Wednesday were unpopular, but ensured that lower interest rates helped producers rather than encouraging consumer spending.
Once the course was set, nothing was done to change it. By the time of the 1997 elections, unemployment was down, growth was robust, and the large balance of payments deficit accumulated during the boom of the late 1980s had been eliminated. Even so, the Tories succumbed to a Labor landslide.
Rishi Sunak’s U-turn last week over a bumper tax was not comparable to his departure from ERM in September 1992, but it was damaging enough. For months, the Chancellor has resisted the idea of taxing the profits made by North Sea oil and gas companies on the grounds that it would deter investment. Similarly, Sunak said he would wait for the fall budget before deciding whether to offer more assistance to households struggling with rising energy bills.
This strategy is now abandoned. In a deafening echo of the crisis 1970s, there have now been three mini budgets since early February as the government caught up with the cost of living crisis.
Up to a point, what Sunak did made perfect sense. Only the Treasury had the wherewithal to prevent millions of households from sliding into fuel poverty and the £15bn of extra purchasing power could save the economy from a recession later this year.
However, there are significant downside risks. The first is that injecting additional demand into the economy will add to inflationary pressure, prompting the Bank of England to be more aggressive when it comes to raising interest rates.
The Bank believes that the current inflationary pressure is caused by a series of supply-side shocks, including a loss of workers due to Brexit and the pandemic, bottlenecks as demand picks up after the shutdowns, the zero-Covid policy pursued 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 MPC concerns.
In theory, changing the policy mix is a good thing. There are good reasons to say that monetary policy (what the Bank of England is doing) has been too loose and fiscal policy (what the Treasury is doing) has been too tight. But the picture is not as clear cut as it was in the wake of Black Wednesday, when a mix of loose monetary and tight fiscal policy did the trick. With an annual inflation rate already at 9%, the Bank’s credibility is at stake. There is a danger that Sunak’s loosening of fiscal policy will result in excessive monetary policy on the part of the Bank.
Even if, by some miracle, the policy mix turns out to be perfect, there won’t be the kind of recovery seen after Black Wednesday. Living standards will fall again this year even after Sunak’s latest measures, but not as much. Paul Dales of Capital Economics says that before the mini-budget, real household disposable incomes were on track to fall 2% in 2022, but will continue to fall 1% even after energy bills are reduced .
Black Wednesday shattered the Conservative Party’s reputation for economic competence. Major received no credit for the recovery that followed, as it only happened because the British government abandoned austerity policies which he said were non-negotiable.
Johnson is in an equally bad situation. After Black Wednesday, a largely effective new framework for controlling inflation was quickly put in place. Today, the government’s economic policy is rudderless, with flip-flops and short-term announcements making headlines in place of long-term strategy.
Sunak says he’s a fiscal conservative but doesn’t act like one. Courtesy of the Prime Minister and Chancellor, ‘Big Government’ is back in fashion, a result first of the pandemic and now of Russia’s invasion of Ukraine.
Ministers speak the language of the right but – usually after much kicking and shouting – end up acting like an incompetent left party. Voters probably wouldn’t forgive Johnson for Partygate even if the economy boomed by the next election. They certainly won’t forgive him if the economy struggles, which is far more likely to be the case.