Inside a Macroeconomic Policy Blunder


Already bored
with the election? Here is a bit of economic history instead.

To many readers of
this blog, 1979-83 will seem like ancient history. To some of us, it
was part of our formative history as adults. I joined the Treasury as
an economist in 1974, straight after finishing my undergraduate
degree. At the time a career in public service rather than academia
via a PhD seemed much more interesting and useful. In 1979 the
Treasury generously sent me to do a masters degree, on the condition
that I worked at least another two years at HMT. While I was doing
the masters Mrs Thatcher was elected Prime Minister, and the Treasury
I came back to was a rather different place to the one I had left.

Tim Lankester became
a Treasury civil servant just one year earlier than me, after working
for the World Bank. His talents obviously shone, and he became
private secretary to Jim Callaghan in 1978, and then private
secretary for economic affairs to Mrs Thatcher in 1979. He therefore
had a particularly interesting vantage point in which to view the
brief but highly significant UK monetarist experiment. He went
on to have a very distinguished career as a civil servant (becoming
permanent secretary at the Overseas Development Administration) and
then in education. This helps explain why it took a pandemic and
associated lockdowns for him to get around to writing
about those events some fifty years earlier

Being a civil
servant Lankester was no true believer in either Thatcher or
monetarism in 1979. Partly as a result his book, which relies on a
lot of very good research as well as personal memories, is a pretty
objective account of the monetarist period, as well as covering what
came before and ending almost at the present day. It is also very
well written and easily accessible to non-economists.

The book starts by
setting the scene in the summer 1981 with a cabinet meeting.
Unemployment has soared, firms are going bankrupt, inflation is still
high and money targets are being missed by miles. Minister after
minister asks Thatcher to change her economic course, and she is only
saved by Deputy PM William Whitelaw, who tells her restless cabinet
to give the policy more time. In reality it was near the end of what
Lankester calls ‘hard monetarism’.

The book also begins
on a more personal level with a London dinner party around the same time,
where Lankester is sitting next to Ben Bradlee, editor of the
Washington Post and famous for helping uncover Watergate. After
giving a standard defence of Conservative policy to a sceptical
Bradlee, a journalist opposite tells Bradlee very loudly that
Lankester is Thatcher’s Albert Speer. During a stunned silence
Bradlee whispers to Lankester “You either hit him or you have to
leave”, and he leaves. As Lankester walks home he wonders to what
extent he is complicit in Thatcher’s economic policies. He thinks
of Henry Neuberger (a good friend of mine) who left HMT to become an
advisor to Labour leader Michael Foot. I think it was Henry who wrote
that monetarism was like trying to control how much people ate by
regulating the supply of crockery. I too got out exactly when my two
years was up to work at the then fiercely anti-monetarist National
Institute. Not only did I think monetarism was foolish and dangerous
at the time, but I was also beginning to see the value in good
academic research. [2]

Of course the
monetarist policy failure had nothing to do with civil servants like
Lankester and everything to do with Mrs Thatcher and her Treasury
ministers. What I personally found most interesting from Lankester’s
account, perhaps because I experienced monetarism from a Treasury viewpoint,
was how much Thatcher herself was a dedicated monetarist. It is quite
fair to describe this episode as Thatcher’s monetarist experiment.

Part of the reason
Thatcher adopted monetarism, which was a distinctly minority view
among UK academics, was the failure of what went before: politicians
trying to override the Phillips curve by using Incomes Policy.
Lankester recounts a meeting between Callaghan and union leaders
months before he lost the election, when one union leader banged his
fist on the table and said “It’s your job, Jim, to get inflation
down to 2%; it’s my job to get 18% for my members”.

When Thatcher
defeated Heath to become Tory leader, she set up the Economic
Research Group (the first ERG!?) chaired by Howe. Although
politicians sympathetic to monetarism (including Lawson) were in a
majority, it didn’t help that those opposed advocated Incomes
Policy instead. But Lankester argues that “monetarism came
naturally to” Thatcher. The link between the money supply and
prices seemed obvious to her. Although she liked Freidman’s account
of monetarism as a ‘scientific doctrine’ akin to the law of
gravity, he suggests she was a monetarist by conviction. Lawson
called it ‘primitivist’ monetarism. For Thatcher monetarism just
had to be true. [3]

Lankester and
Thatcher’s views on both economics and society more generally were
quite different, but despite this they got on very well, I suspect in
part because Lankester was very good at knowing the limits of his
private secretary role. Thatcher made it clear that the only advice
she wanted from him was on points of interpretation and detail.
Lankester admired many of her personal qualities (e.g. her
self-belief, her drive and her personal integrity) as well as some of
her policy achievements, but he describes monetarism as her biggest
mistake. One of the downsides of self-belief is that you can imagine
that in areas where you have little knowledge your beliefs are
superior to the beliefs of the majority of experts

The mistaken basic
concepts of monetarism (the stock of money was a very poor indicator
of policy stance, and controlling an intermediate target was inferior
to controlling the policy objective) were compounded by tactical
errors by ministers. Chancellor Howe decided on a 7-11% target range for the money
supply, essentially because it was felt it had to be lower than the
8-12% adopted by the Labour government, even though for Labour these
targets were largely cosmetic. Yet wage pressure had increased, oil
prices were increasing, and the new government doubled VAT, which
meant that this target range was far too tight. Lankester suggests
that only Lawson understood this. Indeed he suggests Thatcher didn’t
understand the implications of such a tight target for interest
rates, which she hated to see going higher.

Interest rates went
higher and higher, yet money growth still exceeded its target. As an
anti-inflation policy it was a cold turkey strategy, not by design
but because the monetary target was sending completely the wrong

The famous 1981
budget was the last major act in the brief monetarist story, and
Lankester rightly describes its tax rises as a mistake because they
reduced the strength of the subsequent recovery. [4] The 1982 budget
raised the targets for monetary growth, as well as introducing
additional targets for different definitions of the money supply.
When Lawson became Chancellor, he in practice focused more on having
an exchange rate target, which he had argued for in the ERG as
preferable to money targets. That eventually led to a second major
macroeconomic blunder, but that is a different story (although it is
covered in this book).

The consequences of
the brief monetarist experiment for the real economy are well known.
Lankester recounts that his wife’s family-run textile firm was
forced into liquidation in late 1980. The combination of high
interest rates, and the impact of these together with North Sea Oil
on the exchange rate, crippled the traded goods sector. Unemployment
rose rapidly and didn’t come down when inflation eventually fell.
He argues, correctly in my view, that a more gradualist policy of
reducing inflation would have been far more preferable, because it
would have avoided such a large and long lasting increase in
unemployment, albeit with a more gradual reduction in inflation. In
addition my own view is that deflation early on using fiscal rather than monetary policy
would have avoided such a big hit to the traded sector.

One mistake some
opponents of Thatcherism often make is that high unemployment was all
part of the plan, and in particular a means to reduce union power. In
fact few of those advocating monetarism before it happened believed
it would have such devastating effects. Lankester writes that
“Thatcher was undoubtedly surprised and upset by the rise in
unemployment in the early 1980s”. Interestingly he also thinks that
if she had been told about those costs in advance, she would have
gone ahead with the policy anyway because she wouldn’t have
believed the predictions, because she had this primitivist belief in
monetarism and because she would not have been content with a more
gradual fall in inflation. She really did believe there was no

monetarist experiment was a macroeconomic policy blunder of the
highest order, because it ruined so many people’s lives and because
there was a better alternative. For those looking for a detailed and
objective account of this blunder, then this is an excellent book. It
was probably not the first time a Prime Minister or Chancellor had
pursued an economic policy that was opposed by most academic experts
and which had ruinous macroeconomic consequences, and unfortunately
it would not be the last. Over the last fourteen years we have had
two more (austerity and Brexit).

Yet the recent
example that reminds me most of Thatcher’s monetarism is Truss’s
fiscal event, which involved a Prime Minister’s primitivist belief
(for Truss that tax cuts had to be good and might pay for
themselves), a small band of economists with unconventional and
radical ideas not backed by evidence, a disdain for conventional
academic views or civil service advisors and a policy that
dramatically increased interest rates. Fortunately for us that fiscal
event was quickly reversed and its champion deposed, so it did not
create the lasting scars that Thatcher’s monetarism did.

[1] To give one
example, my first job in HMT included writing briefs for the
Chancellor, Dennis Healey, on other major economies for the
international meetings he attended. Healey wanted to know about macro
policy in each country, as well as how it was working. With a change
in government, where Howe replaced Healey as Chancellor, those briefs
now contained personal details about each finance minister, their
interests and hobbies etc, and included much less macroeconomics.

[2] To take just one
example, the incoming Conservative government chose M3 as their money
supply target in part because there seemed to be a close correlation
between it and prices two years later. HMT agreed to publish a paper
looking at this relationship, written not by HMT but by a named
Treasury economist, which turned out to be me under the supervision
of Chief Economist Terry Burns. The relationship fell
apart the moment it was econometrically interrogated

[3] For primitivist
monetarists, facts and research have little impact on their beliefs.
When the Treasury published my research on money to price regressions
(see footnote [2]), although there was no attempt to censor what I
wrote as the named author of a Treasury Working Paper, I had to focus
on the results rather than my interpretation of them. Any objective
reading would have quickly understood that my work undermined
government policy. Yet a day after publication Tim Congdon, a well
known monetarist, wrote a piece in the Times that suggested the

I was furious at
this, and asked to write a letter in response correcting his
misinterpretation. HMT said no. But Henry Neuberger, who as I noted
earlier was now working for Michael Foot, came to my rescue and wrote
a very similar letter to the one I wanted to write. To his credit,
Terry Burns also arranged a lunch between him, Congdon and me, where
I not only told Congdon why he was wrong but where Terry backed me
up. The results were eventually published in an academic journal

[4] My own personal
story as a Treasury economist in charge of looking at the economic
effects of the budget is described
. The story illustrates that most Treasury
economists, like the famous 364 academics who wrote the famous
letter, thought it was a bad budget.

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