“Rising unemployment and the recession have been the price that we have had to pay to get inflation down. That price is well worth paying.”
It was May 16, 1991 when Norman Lamont, then finance minister in John Major’s Conservative government, uttered his infamous words as the consumer prices index of inflation peaked at over 8%.
Thirty one years later, uncomfortable parallels are emerging. The Bank of England expects CPI to hit 7.25% in April and policy makers face similar dilemmas. Will inflation become entrenched, how much pain can households absorb, how severe will the interest-rate squeeze be, might tackling it require a recession?
With inflation at a 30-year high, policy makers face difficult trade-offs.
The comparisons are not precise but, for Lamont, 79, who now sits in the House of Lords, the lessons are clear. “You have to give priority to reducing inflation,” he said in an interview with Bloomberg. “Because a lot of time has passed, and people have got used to stable prices, they have forgotten the horrors of compound inflation. It is always a danger.”
In 1991, memories of the 1970s -- when prices were spiralling upwards at annual rates above 20% and the UK’s stagnating economy was falling behind European peers -- were still vivid. Margaret Thatcher’s Tory government raised interest rates above 15% to address the problem, after which growth, productivity and business investment recovered. But the cost of success was a recession in 1980.
“Having gone through that, people were worried it had all been for nothing,” said Douglas McWilliams, then chief economic adviser at the Confederation of British Industry who now runs the Centre for Economic and Business Research consultancy.
Ben Broadbent, deputy governor for monetary policy at the BOE, acknowledged this month that tackling inflation involves a trade-off. The central bank could “have pushed inflation down” by raising rates earlier but that “would have involved much lower wage growth and higher unemployment,” he said.
The BOE has raised its benchmark rate from 0.1% to 0.5% since December and markets expect close to 2% by the end of the year, while the central bank begins to unwind its 875 billion pounds ($1.19 trillion) of quantitative easing, the fastest pace of monetary tightening in the Group of Seven.
But Lamont fears “today’s leaders lack the courage to douse the inflationary fire.”
“With QE, the bank has become much more a driver of demand than before, which leaves it with the hideous dilemma: ‘Will we kill the recovery?’ Under the previous regime [before QE] they would have been much more focused on inflation. Do we have the determination to beat it now?”
The Thatcher government took a drastic step to curb inflation. In October 1990, Britain joined Europe’s Exchange Rate Mechanism, tying sterling to a tight range around Germany’s Deutsche mark. But the rigor came at a cost to exporters, which struggled to compete on global markets. By the end of the year, the UK was back in recession.
On Black Wednesday in September 1992, the UK crashed out of the ERM in a moment of national humiliation because it could not afford to defend the pound. But, by then, inflation was under control. “Did membership of the ERM prolong the recession? I think it did,” Lamont said.
“But it did reduce inflation. Judged by that, it did deliver its objective.”
About the Author: Philip Aldrick is a journalist for Bloomberg Economics