Economy under Major

John Major's government had inherited a difficult economic situation at the end of 1990. The British economy was suffering from a declining manufacturing output, high interest rates, a steep rise in unemployment, and a slump in house prices. 

From mid-1991 to early 1992, unemployment rose from 1.6 million to 2.6 million. Many homeowners were trapped in 'negative equity' (having to repay their mortgages that were higher than the current value of their homes). Many had their homes repossessed. Unlike in the recession of the early 1980s, which largely hit the working class and northern communities, this affected traditional Tory voters. 

With an election imminent, Major's government resorted to high public spending. Half of this spending was forced, as a result of rising unemployment, but huge government borrowing was used for subsidies on transport and increased spending on the NHS. 

Major had been lucky that his honeymoon period lasted long enough until the general election of 1992. 

The Exchange Rate Mechanism. It was set up in 1979, and aimed to stabilise the exchnage rates between different currencies in the EEC by limiting how much their value could change. The ERM reduced inflation rates from 10% to 3.5% by 1992. 

Within a few months of winning the general election, Major's government suffered a severr crisis and Britain was forced to leave the ERM. What became known as Black Wednesday came to dominate the rest of Major's premiership. 

Britain joined the ERM in 1990 when Thatcher was persuaded that it would help to combat inflation which was starting to rise. The ERM required Britain to maintain a fixed exchange rate (2.95 German marks to the pound, the strongest economy at the time) with a narrow band allowed for fluctuations. It aimed to reduce inflation. However, this was inrealistically high and caused British exports to become overpriced. By September 1992, the British currency (together with several other ERM currencies) came under pressure. It reached a climax on the 16th September. Major's government was determined to avoid any devaluation of the pound and to remain within the ERM. But despite all the government's efforts, the pound continued to sink. At 7pm, Norman Lamont announced the decision to leave the ERM  live on television. 

The impacts of Black Wednesday on the British economy proved much less catastrophic than was feared at the time:

• Within a relatively short time, the economy stabilised and it could be seen that leaving the ERM had many beneficial effects. 
• 47,000 jobs had been lost in a single day. 

The political consequences were disastrous for the government:

• The long standing Conservative electoral asset of being trusted on the economy was thrown away. There was a steep drop in support for the Conservatives in the opinion polls. 
• John Major's personal authority was badly weakened. He was fiercely criticised by newspapers that had previously supported him, such as Hastings in the 'Telegraph'. 
• The Labour Party shot ahead in the polls, gaining a 15 point lead, and enjoyed 'Golden Thursday'.  
• Many observers, including Major himself, looked back at the events of the 16th September 1992 as 'the beginning of the end'. 
• The case for Britain's becoming involved in European monetary union was weakened. Also, the argument of the Eurosceptics against deeper integration to Europe, such as the Maastricht Treaty, was strengthened. In the longer term however, the economic benefits caused the membership of the EEC to be questioned again. 
• Cabinet divisions widened between Eurosceptics, principally Peter Lilley, Michael Portillo and Michael Howard, and pro-Europeans, such as Kenneth Clarke, Michael Heseltine and Douglas Hurd. 
• Lamont remained in office which was particualrly surprising. Major perhaps needed a scapegoat like Callaghan and Wilson in 1967 to prop up the Party's competence. 

Foreign exchange speculators buy and sell currency. If a lot of speculators want to buy pounds the pound will gain in value in comparison to other currencies. If they sell a currency it will fall in value. In September 1992, there was a wave of speculative selling of the pound on financial markets. The Chancellor, Norman Lamont, announced an increase in interest rates (already high at 10%) to 12% and then 15%, hoping to persuade foreign investors to buy again. The Bank of England spent huge amounts of reserves in buying up pounds. Overall, £30 billion of the UK's foreign reserves were sold. However these strategies were not too work, and Britain had no choice but to remove itself from the ERM as every minute they delayed the country was losing £18 million. 

Britain's economic situation started to improve almost immediately after Black Wednesday in 1992. Leaving the ERM prevented Britain from having to keep high interest rates to protect the stability of sterling and it allowed exchnage rates to float downwards, which helped British exporters. However, in 1993 Major had to add 8% VAT to domestic fuel, which went against the election promise. 

Unemployment rates slowed down and the housing market picked up again. 

The American economy was coming out of recession and world trade was expanding, allowing Britain to take this opportunity to make the economy thrive. The British economy was also benefitting from the impact of financial deregulation and flexible working practises which the Conservative Party had introduced since 1979. In comparison, the German economy was struggling with the huge costs of unification and had sluggish growth rates compared with Britain. 

By 1997, most economic indicators were positive:

• Unemployment was down from 1.75 million to 1.6 million. 
• Interest rates had decreased from 14% to 6%.
• Productivity was up, though not by much, and growth rates had increased from 0.5% in 1990 to 3.5% in 1997. There had been a drop in 1991 at -1.5%. France's growth rate was 1.5%, and Germany's was 2.0%. 
• Consumer spending went up.
• Car ownership increased.
• House prices rose and negative equity became a thing of the past.
• Business was supportive of government policies.

Yet people were surprisingly reluctant to give John Major's govenrmnet the credit, the 'feel good' factor was missing. Nevertheless, this allowed New Labour and Blair to inherit a golden economic situation. 

Germany had recently taken on the massive task of reunification after the fall of communism in the East, while the American economy was suffering over its own problems, causing Britain, and the ERM, to be caught in the crossfire. 

Immediately after sterling's collapse, France came under attack as well, though strong intervention by Germany protected the status of the franc, whilst Spain , Portugal and Ireland were obliged to devalue, and Sweden and Norway also withdrew from the ERM. By that stage, it was cleae to everyone that the whole enterprise had been doomed to failure from the start. Britain and Major simply had the bad luck of being negatively hit first. 

It was not just the Conservative Party who backed entry. The Labour Party, the Bank of England, the Confederation of British Industry, the TUC, the Lib Dems and most of the media, all urged entry into the ERM, believing it to be essential for the nation's economic well-being.