The Recession of 1980 and its Causes*

During 1980 total output fell by 5% per cent and manufacturing output by 16 per cent. By May 1981 manufacturing output was 20 per cent below its 1979 peak level. in this Briefing Paper we use the London Business School model to explain the current recession. We conclude that the main identifiable came was the rise in the price of oil. but output was also affected by the increase in VAT and the reductions in public investment. Those cawes directly explain a reduction in output of about 3 per cent in 1980 compared with what might otherwise have happened. We suggest that additional links (not fully incorporated into the model) increased the impact of those shocks and led to the severe fall below potential output. The first part of the paper describes briefly the events of I979 and 1980. in the second part we ask how far the economic developments were predictable and in the third part we set out our explanations.     

Options for ERM Entry

After years of being blocked, UK entry to the Exchange Rate Mechanism now looks very probable either later this year or early next. But if the issue of entry is largely settled, the form of entry remains open. We examine the different dimensions of this question, and consider five separate options for entry. We consider two strategies driven largely by political considerations, but reject them as too high risk. We also reject the 'deep-discount' option as being far too inflationary. Instead we argue for entry at a relatively high exchange rate in line with or slightly above the current market rate. With entry next spring, we would favour a narrow band. But if entry is in the autumn, entry in the lower half of a broad band is more appropriate, leaving greater room for manoeuvre in interest rates. But a move to narrow bands in the course of next year would then be required to give maximum anti-inflation benefits. On this strategy ERM entry will provide appreciable benefits in bringing down inflation, but it will not be costless: as our forecast suggests, the economy will undergo several years of depressed growth of output. But this should lay the basis for steady growth combined with low inflation from 1993 onwards.