The UK economy in the 1990s

Approximate read time: 10 minutes

The early part of the 1990s saw a continuation of the macroeconomic instability experienced in previous decades, as the government grappled with a renewed bout of inflation. However, conditions gradually stabilised and consistently low inflation was achieved for the first-time in the post-war era. This article provides a brief overview of these events, considers the factors underlying this newfound macroeconomic stability and examines what it meant for UK households.

1. Recession, the exchange rate mechanism, and recovery

Annual GDP growth had been over 5% towards the end of the 1980s and the unemployment rate, which had been over 10% for much of the decade, had started to fall.^[1] Heading into the 1990s, the UK economy experienced a resurgence of inflation, which rose from 3.4% in 1986 to 9.5% in 1990. In common with previous inflationary episodes, the price of oil rose during this period, with crude oil rising from $15USD a barrel in 1988 to $24USD in 1990.^[2] Strong demand in the economy, arising from the deregulation of credit provision, was also noted as a contributory factor. The National Institute of Economic and Social Research assessed that, whatever benefits it may have had for individuals, consumer spending growth in this period was “far in excess of what was prudent from a national point of view”.^[3]

Ministers in Margaret Thatcher’s Conservative government (in office to November 1990) expressed unease at the rapid growth in consumer credit, but strongly preferred to raise interest rates to cool the economy, rather than reimpose credit controls.^[4] This policy preference was institutionalised with the UK’s entry to the exchange rate mechanism (ERM) of the European monetary system in October 1990. As part of its ERM membership, the UK committed to maintaining an exchange rate peg with the German currency, the deutschemark, at a rate of 2.95 deutschemarks per pound. In practice, this meant that UK monetary policy would effectively have to shadow German monetary policy. This was because any significant and sustained difference in interest rates would see significant capital flows between the two currencies and necessitate a revaluation of the exchange rate peg. Given that German monetary policy was conducted by an independent central bank, the Bundesbank, which had a strong reputation for raising interest rates to whatever level was necessary to maintain price stability, the government thought that joining the ERM would act as an “additional discipline for the UK economy” that would “reinforce” its counter-inflationary policies.^[5]

ERM membership was maintained for two years, but shadowing German monetary policy proved increasingly difficult as economic conditions in the two countries diverged. By 1992, inflation in the UK had fallen to 3.7%, but unemployment had risen to 9.9%, up from 7.1% in 1990. The economy also entered recession, with GDP growth averaging -0.2% from 1990 to 1992. Interest rates were lowered in response to these developments but remained at around 10% (figure 1). Further reductions may have been desirable, but this would have taken UK interest rates below those in Germany—where the Bundesbank had raised interest rates to check a post-unification surge in inflation—and was thus incompatible with continued ERM membership. This contradiction was resolved in September 1992 when the Major-led Conservative government (Major had succeeded Thatcher as prime minister in November 1990) suspended the UK’s membership of the ERM in the wake of financial market pressure to devalue the pound.^[6] This allowed the pound to depreciate and interest rates to fall, as illustrated in figure 1 below.

Figure 1. Interest and exchange rates, 1990–95

These developments helped facilitate an economic recovery. From 1992 to 1994 export growth significantly outpaced import growth, supporting overall GDP growth and effectively closing the trade deficit that had opened up in the late 1980s.^[7] Separately, the reduction in interest rates supported domestic consumption, as the proportion of income that households saved and spent on debt interest costs fell (table 1). And so, after three years of relative stagnation, the economy recovered to grow by 2.3% in 1993 and 3.4% in 1994.

Table 1. Savings rate and debt servicing costs for households, 1990–99

(Debt service cost data from Bank of England, ‘Financial stability report—November 2017’, 28 November 2017; savings ratio data from ONS data series ‘DGD8’, 28 June 2024)

2. The ‘NICE’ period

In addition to helping the economy recover in the short term, these developments helped inaugurate the so-called ‘NICE’ period, which was to last into the 2000s. NICE was an acronym, coined in 2003 by the then governor of the Bank of England, Mervyn King, (now Lord King of Lothbury) meaning ‘non-inflationary consistent expansion’.^[8] The ‘NICEness’ of the post-1992 period can be observed in figure 2 below—GDP growth and inflation both remained (largely) within a range of 2–4% from 1993 onwards.

Figure 2. GDP growth and inflation, 1990–99

As the creation of the acronym suggests, the NICEness of this period was unique in the post-war era. Growth had been higher in previous decades but at no time had it been so consistent and coincided with such consistently low inflation. In explaining this stability, it is possible to point to a few factors which were not consistently present during previous decades:^[9]

• Favourable commodity prices. The crude oil price finished the decade at $18USD per barrel, down from $24USD at the start.^[10] Similarly, the World Bank’s non-energy commodity price index fell by 13% over the same period.^[11]
• Industrial calm. The organised labour movement had been significantly weakened by the 1990s, reducing its capacity to bargain for higher wages for workers. In total, 6.6mn days were lost through industrial disputes and strikes in the 1990s, by far the lowest of any decade in the post-war era. (The decade with the next lowest figure is the 1950s at 32.1mn.)^[12]
• Inflation targeting. Following the UK’s exit from the ERM, the government put in place a new macroeconomic framework. It issued a mandate for price stability, with a target range of inflation (later to become a specific target rate), and the Bank of England was tasked with using monetary policy to achieve that target. Up to 1997 the government retained final responsibility for setting interest rates, giving it the power to override the Bank’s advice. However, in 1997 the incoming Labour government, led by Tony Blair, gave the Bank full operational independence to meet the inflation target set by the government.^[13]

The first two factors ensured stability on the supply-side of the economy, with no price shocks generated during this period from general challenges to the profitability of industry. The third factor ensured stability on the demand-side of the economy, with governments no longer able to provoke or sustain inflation with an overly expansionary macroeconomic policy. Even if the government of the day threatened to do so with the remaining macroeconomic tools at its disposal (fiscal policy), the Bank would be mandated to counteract this with the tools given to it by the government (monetary policy).

3. Fiscal context

The economic difficulties of the early 1990s led to a significant deficit in the public finances. Public sector net borrowing rose from 1.1% of GDP in 1990/91 to 6.3% of GDP in 1992/93.^[14] As can be seen in figure 3 below, this was caused by both a fall in tax receipts and a rise in public spending as a share of the economy. The two figures gradually converged over the course of the decade as tax receipts recovered and government spending was reduced, with the public finances moving into surplus by the end of the decade.

Figure 3. Taxation and public spending (% GDP), 1990–99

Taxation as a share of GDP was raised to 35.8% of GDP in 1999/00 to help achieve this surplus. However, this figure was still substantively lower than its average over previous decades, 37.7%.^[15] The upshot of achieving a public finance surplus with taxation at this comparatively reduced level was reduced public investment. By the end of the 1990s gross public sector investment had fallen to 2.8% and net public sector investment (which takes account of the depreciation of public sector assets) had fallen to 0.5% of GDP. These figures were around half of what they had averaged in the 1980s: 5.1% for gross investment and 1.3% for net investment. These figures were themselves significantly down on their average for the three decades before that: 8.4% for gross investment and 5.0% for net investment.

The public finance deficit combined with a lack of GDP growth during the early years of the decade led to the government’s debt-to-GDP ratio rising substantively for the first time in the post-war era, from 21.6% of GDP in 1990/91 to 31.1% in 1993/94. As growth returned and the deficit was reduced, the ratio gradually stabilised, ending the decade at 32.5% of GDP.

4. Slower and more concentrated living standards growth

As implied by the ‘NICE’ designation, the 1990s were far more stable from a macroeconomic perspective than previous decades. However, this stability did not translate into improved living standards growth. Real disposable household income per head, a key measure for living standards, grew by 20.7% over the course of the decade, significantly lower than the growth experienced in the 1970s (29.7%) or 1980s (28.9%).^[16] These figures broadly mirrored overall GDP growth across each decade—in the 1990s growth averaged 2.2% per year, compared to 2.7% in the 1970s and 2.6% in the 1980s.^[17]

One apparent factor behind this 1990s slowdown is that growth became increasingly regionally concentrated. Throughout the post-war era, London consistently remained the richest region of the UK, however, all regions of the UK experienced substantial growth, and the gap between London and the remaining regions of the UK became narrower. As can be seen in table 2, the difference in GDP per person relative to London was smaller in 1990 than it was in 1950 for all regions. However, in the 1990s this progress was reversed as GDP growth in London significantly outpaced the rest of the country. By 2000 the gap was greater for many regions than it had been in 1950.

Table 2. Regional GDP per person relative to London

(Centre for Economic Policy Research, ‘Rosés-Wolf database on regional GDP (version 6, 2020)’, 3 November 2022)

This divergence in regional outcomes can be linked to evolving sectoral and trade patterns. By the 1990s, the UK economy had been shifting away from manufacturing and towards services for decades, and the continuation of these trends was encouraged by global economic and financial integration, which accelerated during this decade.^[18] Financial services, business services, rent and real estate continued to rise as a share of the economy, from 28.4% in 1990 to 33.2% in 1999, and UK service exports rose as a share of the world’s total over the same period, from 7.9% to 8.6%.^[19] Conversely, manufacturing as a share of the economy shrank from 19.4% to 15.3%, with UK manufacturing exports falling as a share of the world’s total, from 6.2% to 5.4%.^[20] This increased specialisation in services at the expense of manufacturing may have helped secure the NICE period, as financial and business service exports supported growth and imported low-cost goods from newly industrialising countries, such as China, helped restrain inflation.^[21] However, it disproportionately benefited the area where financial and business service activity was concentrated—London—while further weakening a sector that had hitherto been an important source of provincial economic activity—manufacturing.^[22]

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Cover image by Felix O on Wikimedia Commons.