The Lawson Boom of the late 1980s

When I was studying economics as an A level student, I was fascinated by how politicians could make really basic economic errors.

A good example of this was the Lawson boom of the late 1980s. Basically, in the Lawson boom the UK economy grew very rapidly, but, this growth proved to be unsustainable leading to inflation and later a recession in 1991.

The Lawson boom followed from the devastating recession of 1981. This recession particularly affected the manufacturing sector, and caused unemployment to rise to 3 million. By 1985, unemployment was still over 2.5 million people. However, from 1986 the government made various decisions which helped to inflate the economy causing an inflationary boom.

Causes of a Boom



Exchange Rate Mechanism ERM.

This was big issue. Mrs Thatcher didn't want to join, however the Chancellor Nigel Lawson, wanted to follow an unofficial exchange rate of 3 DM to £1. This often proved to be a factor in preventing interest rates from rising. The Chancellor didn't want to increase interest rates, because it would break the 'unofficial exchange rate'

Tax Cuts

Nigel Lawson took the popular steps of reducing the basic rate of income tax. He also reduced the higher rate of income tax; the effect was a fiscal stimulus which helped to increase consumer confidence, Aggregate Demand and boost economic growth.


'The Economic Miracle.' which failed to Materialise

During the 1980s, the government felt that they had presided over an 'economic miracle'. They felt that the last recession had removed alot of inefficient firms. They also felt that supply side policies, such as privatisation, had been effective in increasing the productivity of the economy and had increased the long run trend rate of growth. This belief in their own success encouraged them to believe the economy could grow at a much faster rate than previously. Therefore, when growth increase above 4%, they did little to slow down an overheating economy. They believed (or hoped) that the long run trend rate of economic growth had miraculously increased from 2.5% to 4% +

Low Interest Rates.

In October 1987 there was a stock market crash. In one week 25% of the stock market value was wiped out. There was no obvious economic cause of this. But, the government was worried of its macro economic implications. As a result interest rates were kept low, to avoid any downturn. As it happened the stock market crash had little macro economic effect and the economy continued to grow very fast.

The Housing Boom.

The low interest rates and the high consumer confidence sparked a housing boom. During the boom years, house prices rose by 300% (and more in places like London). This boom in house prices further fuelled the economic boom. Equity withdrawal rose to record levels. Furthermore, this housing boom was based on low interest rates. When interest rates would later rise, it would prove to be a very costly experience for those who had taken out a large mortgage.

By 1988 and 1989, the economy was growing at 5% a year (almost double the long run trend rate) Despite signs of overheating the government were very reluctant to react. Partly they believed their own rhetoric of an economic miracle. Also Nigel Lawson, didn't want higher interest rates to boost the value of the £ above the 'unofficial exchange rate' This was a policy known as shadowing the D-Mark. However, the fast growth meant that inflation started to creep up, eventually reaching 11% in 1990.

I will post what happens next (the recession) tomorrow.

Related

UK economy under Mrs Thatcher 1979-1984
Lawson Boom at Wikipedia

The awful warning of the Lawson Boom - pdf
Perma Link | By: T Pettinger | Thursday, January 31, 2008
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