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Deregulation, Debt and Downturn in the UK Economy

Published online by Cambridge University Press:  26 March 2020

J.R. Sargent
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Abstract

The boom of the later 1980s was not due solely to financial institutions greater freedom to lend to the private sector. This was activated by over-optimism about the economy's performance. These two influences combined to cause the ‘over-heating’ for which the current recession is seen as the cure. Although the removal of restraints on financial institutions contributed, it was a once-for-all process which is now virtually complete. The case for returning to a regulated financial system is weaker than the case for living with an unregulated one, despite the higher debt ratios and other conditions which have resulted from the transition to it.

Type
Articles
Information
National Institute Economic Review , Volume 137 , August 1991 , pp. 75 - 98
Copyright
Copyright © 1991 National Institute of Economic and Social Research

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Footnotes

The Review is pleased to give hospitality to the deliberations of the CLARE Group but is not necessarily in agreement with the views expressed. Members of the CLARE Group are M.J. Artis, A.J.C. Britton, W.A. Brown, C.H. Feinstein, C.A.E. Goodhart, D.A. Hay, J.A. Kay, R.C.O. Matthews, M.H. Miller, P.M. Oppenheimer, M.V. Posner, W.B. Reddaway, J.R. Sargent, M.F-G. Scott, Z.A. Silberston, J.H.B. Tew, S. Wadhwani.

References

Notes

(1) The figures are compiled by the Department of Trade and Industry (Companies House Executive Agency), and refer to England and Wales. They include both compulsory and creditors' voluntary liquidations. Comparisons with the previous recession are complicated by the 1986 Insolvency Act, which enables businesses in difficulty to continue to trade, through the appointment of an administrator, for longer than they would have been permitted to do by the earlier legislation. In principle, this should have reduced the number of insolvencies, so that the 1990 percentage of 1.6 should be enlarged to make it comparable with the pre-1986 figures. In practice, the Act is not thought to have made much difference to them.

(2) These figures refer to the UK.

(3) The figures are compiled and published by the Council of Mortgage Lenders: see Housing Finance, May 1991.

(4) For the personal sector (table 2) identified borrowing in all the years shown is less than the apparent borrowing requirement, and the balancing item may well reflect changes in trade credit received by unincorporated enterprises which remains unidentified because the statistical information about them, and it, is thin. Some of this credit would be extended by industrial and commercial companies, leading to an underestimate of the outlay under ‘Other (net)’ in table 1 and a negative balancing item there. This has generally been the case in the 1980s, although with marked exceptions in 1989 and 1990. In the latter two years, a withdrawal of trade credit from unincorporated enterprises and other sectors (including the public sector and overseas) is a plausible explanation of the fact that industrial and commercial companies identified borrowing drops well below their apparent borrowing requirement. There is little sign, however, of (5) a corresponding movement in the balancing item for the personal sector.

(5) It is generally recognised that some part of the heavy borrowing in 1986-8 and possibly in other years, which in line 7 of table 2 is identified as for house purchase, in effect financed higher consumption as house owners cashed in some of the equity in their properties. It is also interesting to note that the personal sector has been a net seller of company securities in every year from 1979 to 1990. This maintains a long-standing tradition which appears to have survived Mrs Thatcher's ambition to make everyone into a shareholder. What has Sid been up to?

(6) An alternative explanation of why real interest rates did not fall is that in a relatively small open economy they would not be expected to. If sterling carries a given exchange-rate risk linked to a given relation between inflation rates expected in the UK and overseas, an initial reduction in nominal interest rates in the UK should be eliminated by international arbitrage. We doubt this alternative explanation because the process of arbitrage envisaged would imply an increase in net outflows of capital from the UK, which is contrary to what was observed in the 1980s.

(7) While this climate encouraged the borrowers, the lenders were not immune from it, although they were driven to a greater extent by the competitive forces which ‘financial deregulation’ released.

(8) See the Clare Group article by Posner and Sargent in the final issue of the Midland Bank Review (Winter 1987): ‘A Case of Euro-sclerosis?’ (table 1).

(9) ‘The plain fact is that the British economy has been transformed’: the Chancellor of the Exchequer (Mr Nigel Lawson) in the Budget speech, March 15th 1988. In 1986 Sir Alan Walters had published a book entitled: ‘Britain's Economic Renaissance’. In November 1990 Sir Geoffrey Howe wrote to the Prime Minister in his letter of resignation: ‘It has been a great privilege to serve under your leadership at a time when we have been able to change Britain's future so much for the better’.

(10) See page 77 above, item (3) or what has been stated as the ‘consensus view’ of the 1980s boom.

(11) C. Goodhart, ‘The Conduct of Monetary Policy’, Economic Journal, June 1989.

(12) Memorandum submitted by Mr Andrew Britton to the Treasury and Civil Service Committee of the House of Commons; see the Committee's second report, Session 1988/9, ‘The 1989 Budget’, p.114.

(13) Professor Tew points out that, while the regulatory measures in the box on page 77 have disappeared, financial institutions are now to be required to maintain an 8 per cent ratio of capital (of which half must be equity capital) to the risk-weighted sum of their assets. This was originally agreed among the members of the Bank for International Settlements, and is the subject of an EC directive which comes into force in 1993. Since financial institutions are currently moving towards compliance, it has become in present circumstances an effective constraint on lending. Its ostensible purpose, however, is to protect depositors rather than to influence the flow of spending and economic activity, for which it is not well-designed.

(14) The revival of the corporate bond market has provided funds mainly to the financial institutions themselves rather than to industry and commerce directly.

(15) Quarterly Bulletin, August 1990.

(16) See C.G.E. Bryant, Economic Trends, May 1987, ‘National and Sector Balance Sheets, 1957-85’. Using Bryant's series, the ratio fluctuates between 4.07 and 5.07 over this period. But his figures include intangible non-financial assets, such as tenancy rights, whereas these are not included in table 4. Comparisons with later estimates for overlapping years suggests that the exclusion of these intangible assets lowers the ratio by about 0.5.

(17) See however, Ermisch and Westaway, (National Institute Discussion Paper 190 ‘The dynamics of aggregate consumption in an open economy life cycle model’. Simulations with their model suggest that the relaxation of borrowing constraints may reduce the aggregate savings ratio by 1½ to 2½ percentage points in the ‘steady state’.

(18) C. Goodhart, ‘Financial Innovation and Monetary Control’, Oxford Economic Policy Review, Winter 1986.

(19) See G. Pepper, Money, Credit and Inflation, IEA Research Monograph 44, p.62.

(20) Evidence to the Treasury and Civil Service Committee of the House of Commons, April 8th 1991.