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sed their confidence, spending capacities and pushed up Aggregate Demand causing a boost in the economy.

Exuberance and over-confidence on the measures taken

The government believed that the recent recession had removed the “sick units” and privatisation of the economy was working effectively to increase the productivity of inefficient firms. This led to a false belief that encouraged them to believe that the economy could grow at a much faster rate than previously thought possible and they took no steps to slow down the rapid unsustainable rate of growth of the economy.

Low Interest Rates

The Government kept the interest rates low to ensure that there was no downturn due to liquidity crises in the market. 1987 saw a major loss in the stock markets of around 25% which happened without any logical macro-economic reasons but it ensured that the government kept a loose fiscal policy driving up inflation.

The Housing Boom

Low interest rates caused an increase in the demand for housing because of availability of cheap credit causing the house prices to rise by above 300%. Housing expenditure is one of the most important components of the consumer expenditure and hence this period also corresponds to high growth rates in the consumer expenditure s subsequently causing economic boom.

The Recession of 1991-92

The housing expansion of the Lawson Boom was based on low interest rates and was bound to falls apart if the interest rates rose and that is exactly what triggered off the next period of slowdown in the British economy and subsequently the consumer price expenditure. The economy was overheating but the government was reluctant to increase the interest rate fearing slowdown. The explosive growth of inflation peaked to pre-recession levels of 11% in 1990 and finally convinced the government to join the ERM (Exchange Rate Mechanism) in October 1990 at a rate of DM 2.95 to the Pound which aimed at keeping interest rates stable which in turn would

* Keep inflation lows

* Provide stability for exporters encouraging trade

Implication of joining ERM and the consequent recession

High inflation and deteriorating economic activity made the Pound unattractive and the government had to take steps to support the minimum price level as per the ERM. To do this it took a 2 pronged approach

* Increasing interest rates to attract investments

* Buying pounds with foreign exchange reserves

This policy was unsustainable and led to

1. Housing Sector Collapse

The high interest rates led to appreciation in house prices making mortgage payments unaffordable and hence caused defaults. This led to a fall in prices and large scale loss of wealth through insolvencies. The housing sector crisis is studied separately in detail as a part of this study.

2. Artificial Overvaluation of the Pound

The government because of its commitment to ERM kept the Pound artificially high in a recessionary environment. It lost a lot of money trying to maintain the required level of the Pound. The losses from this policy to the tax payer accumulated to around ￡3.5 billion while the loss of foreign currency reserves was to the tune of ￡27billion.

3. Black Wednesday

On 16'th Septemb