The Government's strategy for growth needs to restore our confidence.
This time last year I said that growth in 1992 would be close to zero. It is now plain that even that downbeat prediction was too cheerful. For a dismal Johnny like myself this was a shock.
In January I suggested that there were 10 reasons to be optimistic about 1992. Among these were the facts that inflation was down, the Anglo-Saxon economies of America, Canada and Australia appeared to be pulling decisively out of recession and the general election, whatever the result, would remove political uncertainty. Meanwhile, productivity growth in Britain had been maintained, even during the recession.
Sadly, the American economy, even with official interest rates down to 3%, proved unwilling to recover. And America's half-hearted recovery imposed an unwelcome burden on Britain's economy, in the return, if only briefly, of the $2 pound.
Furthermore, when it came to export markets, the anaemic recoveries of the Anglo-Saxon economies could not offset the slowdown in France, Germany and other European countries.
Low inflation did not bring about a spontaneous increase in spending, either by business or consumers. One can see now that this linkage was rather suspect, particularly when the process of bringing inflation down involved unprecedented weakness in, for example, the housing market. The lesson of 1992 is that there is a trade-off between inflation and growth.
As for political uncertainty, the brief flowering of economic activity immediately after the April 9 general election proved to be just that.
Enough of looking backwards. The position now is that economic uncertainty has been replaced by political uncertainty, the effects of which may be more serious. The collapse of the government's exchange rate mechanism (ERM) strategy on Wednesday 16 September produced a short-lived bout of euphoria. Surely, people said, a devaluation of 10% or more, in combination with lower interest rates, must bring recovery.
Why was this euphoria misplaced?
The first and most obvious reason was that, given high levels of personal and - to a lesser extent - corporate debt, if reducing interest rates from 15% to 10% had not done the trick, why should one suppose that cutting them to 9% or 8% should tip the balance?
As for sterling's post-ERM dive, we all know about the J-curve, in which a devaluation initially makes imports more expensive and worsens the trade balance. Only later do any benefits show through in stronger export growth. The Government's involuntary floating of sterling should eventually produce higher exports and greater import substitution. However, this rests on a number of imponderables, notably whether or not sterling stays at its lower levels, and whether foreign markets are expanding fast enough to allow more competitive British companies to increase sales.
Lower interest rates and a fall in sterling's value should, nevertheless, improve recovery prospects. However, recovery requires, not just these direct boosts, but the return of consumer and business confidence.
Companies, seeing lower interest rates and sterling's sharp fall, might have been expected to take a more optimistic view of prospects. But, in the days after Black Wednesday,we saw instead an acceleration of the process of retrenchment, particularly by manufacturing industry.
Consumer confidence, as the chart shows, began to dive again immediately after the election and 15% base rates, even though only in place for a few hours on that Wednesday, were enough to send it down further. If companies and individuals had seen the future, they also had apparently decided that the forced shift in policy made little difference. Or perhaps, and I think this is the version I favour, the loss of credibility in government policy was so great that it more than outweighed the benefits of lower interest rates and a falling exchange rate.
This presents a huge dilemma for the chancellor and his ministerial colleagues. Their response to the crisis was at first to pretend nothing had changed and then to declare their conversion to a strategy for growth. However, even this has not been accompanied by action to take full advantage of the new situation, by aggressive cuts in interest rates at a time when there is little danger of inflation. We are left with the worst of both worlds. It is little wonder that confidence is at a low ebb.
David Smith is economics editor of The Sunday Times.
