Abstract
In October 1980 Margaret Thatcher rounded on the critics of her government’s economic strategy, proclaiming to the Conservative Party conference that ‘the lady’s not for turning’.3 Six months earlier, in line with monetarist prescriptions, her Chancellor, Sir Geoffrey Howe, had placed a series of declining money supply targets at the heart of economic policy, confidently asserting that ‘control of the money supply will over a period of years reduce the rate of inflation’, then running at nearly 20 per cent.4 By October, the money supply was overshooting its target range, inflation was still higher than when the Conservatives took office, and the British economy was in its deepest recession since the 1920s.5 With nominal interest rates at 16 per cent, the strong pound was pricing exports out of global markets.6 Britain would soon become a net importer of manufactured goods for the first time since before the Industrial Revolution. Unemployment was at levels not seen since the 1930s, and the Director-General of the Confederation of British Industry was threatening a ‘bare-knuckle fight’ with the government over economic policy.7 In 1980, monetarism was not working.
‘The supply of money’ — whatever that may be made to mean — is not by itself a reliable policy measure.
The Radcliffe Report, 1959.1
There would be no question of departing from the money supply policy, which is essential to the success of any anti-inflationary strategy.
Financial Statement and Budget Report, 1980.2
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Notes
Thatcher admits that her conference speech was also directed towards the critics within her own Cabinet, M.H. Thatcher, The Downing Street Years (London, 1993), p. 122.
T.N. Beckett, ‘Director-General’s national conference speech 1980’, 11 November 1980, London, The National Archives (hereafter ‘TNA’), PREM 19/490.
A.J. Wiggins, ‘Note of a meeting held at 11 Downing Street’, 20 November 1980, TNA, T386/547.
J.A.H.L. Hoskyns, Just in Time: Inside the Thatcher Revolution (London, 2000), p. 263 and p. 269.
N. Lawson, The View from No. 11: Memoirs of a Tory Radical (London, 1992), p. 111.
A.J.C. Britton, Macroeconomic Policy in Britain, 1974–87 (Cambridge, 1991), p. 53.
The point is too frequently made that a money supply policy was ruled out while sterling was fixed under Bretton Woods. However, as Robert Mundell showed in the early 1960s, an independent monetary policy is theoretically compatible with a fixed exchange rate when there are capital controls and sufficient currency reserves. In practice, as both J.H.B. Tew and Peter Browning point out, the return to current account surplus after 1970 meant there was less strain on the reserves. This meant monetary policy could increasingly be directed towards the domestic economy, R.A. Mundell, ‘The appropriate use of monetary and fiscal policy for internal and external stability’, Staff Papers — International Monetary Fund, vol. 9, no. 1 (March, 1962), pp. 70–79; J.H.B. Tew, ‘Monetary policy: part I’, in F.T. Blackaby (ed.), British Economic Policy, 1960–74 (Cambridge, 1978), p. 239; P. Browning, The Treasury and Economic Policy, 1964–1985 (London, 1986), p. 276.
P.A. Hall, ‘The movement from Keynesianism to monetarism: institutional analysis and British economic policy in the 1970s’, in S. Steinmo, K.A. Thelen and F. Longstreth (eds), Structuring Politics: Historical Institutionalism in Comparative Analysis (Cambridge, 1992), pp. 90–113; H. Pemberton, ‘Policy networks and policy learning: UK economic policy in the 1960s and 1970s’, Public Administration, vol. 78, no. 4 (Winter, 2000), pp. 771–92; M.J. Oliver and H. Pemberton, ‘Learning and change in 20th-century British economic policy’, Governance, vol. 17, no. 3 (July, 2004), pp. 415–41.
D.E.W. Laidler, ‘Mayer on monetarism: comments from a British point of view’, in T. Mayer (ed.), The Structure of Monetarism (New York, 1978), p. 133.
D.E.W. Laidler, Monetarist Perspectives (Oxford, 1982), p. vii.
The principal architects of the Radcliffe Report were Alec (later Sir Alec) Cairncross, Professor R.L. Sayers, and Lord Radcliffe himself. Sayers outlined some of the academic theory behind the Radcliffe Report, in R.S. Sayers, ‘Monetary thought and monetary policy in England’, The Economic Journal, vol. 70, no. 280 (December, 1960), pp. 710–24. For a less technical approach from another committee member, see O.S. Franks, Some Reflections on Monetary Policy, in the Light of the Radcliffe Report (Bombay, 1960).
M. Friedman, ‘The quantity theory of money — a restatement’, in M. Friedman (ed.), Studies in the Quantity Theory of Money (Chicago, 1956), pp. 3–21. The quantity theory has a long lineage, but mainly as an ‘equation of exchange’, for example, the Newcomb ‘transactions version’ popularised by Irving Fisher: MV = PT where M is the amount of money in circulation, V is the velocity of circulation, P is the price level, and T is an index of the aggregate transactions, M. Friedman, ‘Quantity theory of money’, in J. Eatwell, M. Milgate, and P. Newman (eds), Money (London, 1989), p. 4.
This was essentially an application of capital theory to monetary theory. In this case capital extended beyond financial capital to include, for example, human capital. Harry Johnson called this ‘probably the most important development in monetary theory since Keynes’ General Theory’, H.G. Johnson, ‘Monetary theory and policy’, The American Economic Review, vol. 52, no. 3 (June, 1962), p. 350.
The signs below the arrows represent direction. For example, an increase in the stock of money in the Keynesian transmission mechanism results in a drop in interest rates, while an increase in investment leads to increased income, A.A. Walters, Money in Boom and Slump: An Empirical Inquiry into British Experience since the 1880s (London, 1971), p. 19.
T.G. Congdon, Keynes, the Keynesians and Monetarism (Cheltenham, 2007), pp. 149–50.
Mundell, ‘The appropriate use of monetary and fiscal’, pp. 70–79; R.A. Mundell, ‘Capital mobility and stabilization policy under fixed and flexible exchange rates’, The Canadian Journal of Economic and Political Science, vol. 29, no. 4 (November, 1963), pp. 475–85; J.M. Fleming, ‘Domestic financial policies under fixed and floating exchange rates’, Staff Papers — International Monetary Fund, vol. 9, no. 3 (November, 1962), pp. 369–79.
R.J. Ball and T. Burns, ‘The inflationary mechanism in the UK’, The American Economic Review, vol. 66, no. 4 (September, 1976), pp. 467–84.
For an explanation of the key differences between the two, see J.J. Polak, ‘The two monetary approaches to the balance of payments: Keynesian and Johnsonian’, IMF Working Paper, WP/01/100 (August, 2001), pp. 1–25.
J.J. Polak, ‘Monetary analysis of income formation and payments problems’, Staff Papers — International Monetary Fund, vol. 6, no. 1 (November, 1957), pp. 1–50.
In its earliest incarnation, DCE went further than Friedman by incorporating the ‘classical’ approach of a constant income velocity of circulation of ‘one’. Friedman and Schwartz estimated that it took 12–18 months for troughs and peaks in money supply growth to translate into troughs and peaks in economic activity, M. Friedman and A.J. Schwartz, ‘Money and business cycles’, The Review of Economics and Statistics, vol. 45, no. 1, part 2, supplement (February, 1963), pp. 32–64; J.J. Polak and L. Boissoneault, ‘Monetary analysis of income and imports and its statistical operation’, Staff Papers — International Monetary Fund, vol. 7, no. 3 (April, 1960), pp. 349–415.
F.H. Capie, The Bank of England: 1950s to 1979 (New York, 2010), p. 645.
For this and other criticisms of Capie’s Bank of England, see G. Hacche, ‘The Bank of England 1950s to 1979’, Economica, vol. 80, no. 318 (April, 2013), pp. 372–78.
M0 comprises the monetary liabilities of the Bank of England, coin issued by the Royal Mint, and the fiduciary note issue of the Scottish and Northern Irish banks; C.A.E. Goodhart, Monetary Theory and Practice: The UK Experience (London, 1984), p. 200. Chapter 6, ‘Analysis and the Determination of the Stock of Money’ was first presented in 1972, p. 16.
While Quantitative Easing is certainly ‘monetary base creation’, it is far from clear that it is ‘monetary base control’. The Bundesbank abandoned a brief experiment with monetary base control in 1973 after it endangered the stability of the German banking system. The Swiss National Bank implemented monetary base control in November 1979 after suspending its M1 targets a year earlier because of the rapid appreciation of the Swiss franc. J. von Hagen, ‘Monetary targeting in Germany’, Journal of Monetary Economics, vol. 43, no. 3 (June, 1999), pp. 681–701; V.E. Argy, A. Brennan, and G. Stevens, ‘Monetary targeting: the international experience’, Economic Record, vol. 66, no. 1 (March, 1990), pp. 37–62.
More recently, Tim Congdon has written ‘The monetary base is — and long has been — determined by what is happening in the economy; it does not determine what banks, the money stock or the economy will do in the future’, Congdon, Keynes, the Keynesians and monetarism, pp. 152–53; D.E.W. Laidler, ‘Review: Dow and Saville’s critique of monetary policy - a review essay’, Journal of Economic Literature, vol. 27, no. 3 (September, 1989), pp. 1147–59.
W.A. Allen, ‘Recent developments in monetary control in the United Kingdom’, in L.H. Meyer (ed.), Improving Money Stock Control: Problems, Solutions, and Consequences (Boston MA., 1983), p. 104.
HM Treasury, ‘Report of money supply and inflation research group’, 9 December 1980, TNA, T388/195; I.D. Saville and K.L. Gardiner, ‘Stagflation in the UK since 1970: a model-based explanation’, National Institute Economic Review, vol. 117, no. 1 (August, 1986), pp. 52–69; Britton, Macroeconomic policy, pp. 272–81.
D.E.W. Laidler and J.M. Parkin, ‘Inflation: a survey’, The Economic Journal, vol. 85, no. 340 (December, 1975), pp. 741–809.
This curious view is repeated by both Margaret Thatcher and Alan Walters. Capie, Bank of England, p. 6; Thatcher, Downing Street Years, p. 43; A.A. Walters, Britain’s Economic Renaissance: Margaret Thatcher’s Reforms 1979–1984 (Oxford, 1986), p. 77.
E. Nelson and K.O. Nikolov, ‘Monetary policy and stagflation in the UK’, Journal of Money, Credit and Banking, vol. 36, no. 3 (June, 2004), pp. 293–318; Batini and Nelson, The U.K.’s rocky road.
E. Nelson and K.O. Nikolov, ‘UK inflation in the 1970s and 1980s: the role of output gap mismeasurement’, Journal of Economics and Business, vol. 55, no. 4 (July/August, 2003), pp. 353–70; A. Orphanides, ‘Monetary policy rules and the Great Inflation’, The American Economic Review, vol. 92, no. 2 (May, 2002), pp. 115–20.
D.W.G. Wass, Decline to Fall: The Making of British Macro-economic Policy and the 1976 IMF Crisis (Oxford, 2008), p. 46.
Goodhart, Monetary Theory, pp. 91–121. See also C.A.E. Goodhart, ‘The Bank of England over the last 35 years’, Bankhistorisches Archiv, Beih. 43, Welche Aufgaben muß eine Zentralbank wahrnehmen: historische Erfahrungen und europäische Perspektiven (Stuttgart, 2004), pp. 29–54.
C.A.E. Goodhart, ‘The Bank of England and the 1981 Budget’, in D.J. Needham and A.C. Hotson (eds), Expansionary Fiscal Contraction: the Thatcher Government’s 1981 Budget in Perspective (Cambridge, 2014).
D.H. Gowland, Controlling the Money Supply (London, 1982), pp. 94–96.
C.A.E. Goodhart and A.D. Crockett, ‘The importance of money’, BEQB, 10, 1970, pp. 159–98; L.D.D. Price, ‘The demand for money in the United Kingdom: a further investigation’, BEQB, 12, 1972, p. 43–55.
Goodhart, Monetary Theory, p. 96; C.A.E. Goodhart, ‘A central bank economist’, in P.D. Mizen (ed.), Central Banking, Monetary Theory and Practice (Cheltenham, 2003), p. 26.
J.C.R. Dow and I.D. Saville, A Critique of Monetary Policy: Theory and British Experience (Oxford, 1990).
G. Hacche and C. Taylor (eds), Inside the Bank of England: Memoirs of Christopher Dow, Chief Economist 1973–84 (Basingstoke, 2013), p. 61–62.
C.J. Allsopp, ‘Macroeconomic policy: design and performance’, in M.J. Artis and D.P. Cobham (eds), Labour’s Economic Policies, 1974–1979 (Manchester, 1991), p. 30.
C. Gordon, The Cedar Story: The Night the City was Saved (London, 1993), p. 144.
M. Moran, The Politics of Banking: The Strange Case of Competition and Credit Control (London, 1986), p. 94.
As the asset-price boom of 1972–73 came to an end, a number of secondary banks found themselves over-exposed to falling property prices. The Bank launched the ‘Lifeboat’ in December 1973 shortly after coordinating the individual rescues of London and County Securities and Cedar Holdings. At the peak of the crisis in March 1975, the Bank had arranged £2.3 billion of funding, largely from the clearing banks. Of the 26 financial institutions that were offered help, 8 were allowed to fail, ‘How the “Bankers’ Lifeboat” came to the rescue’, Financial Times, 29 January 1974; M.I. Reid, The Secondary Banking Crisis, 1973–75: Its Causes and Course (London, 1982); Capie, Bank of England, pp. 524–86; Gordon, The Cedar Story.
D.J.S. Hancock, ‘Note of a meeting between the Chancellor and the chairmen of the London clearing banks’, 12 September 1969, TNA, T326/964.
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Needham, D. (2014). Introduction. In: UK Monetary Policy from Devaluation to Thatcher, 1967–82. Palgrave Studies in the History of Finance. Palgrave Macmillan, London. https://doi.org/10.1057/9781137369543_1
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