2024-08-18 04:00:12
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Margaret Thatcher entered Downing Street in 1979 determined to curb runaway inflation. She embraced monetarist orthodoxy, arguing that controlling the money supply should achieve this goal at little cost. But when inflation was finally brought under control, unemployment doubled to more than 10%, where it remained for much of the 1980s. The worst recession since the 1930s led to the collapse of the manufacturing sector, which lost a quarter of its workforce. These traumas still reverberate in British politics today.
British economic history is littered with macroeconomic blunders, from the return to the gold standard in 1925 to the tragicomedy of Liz Truss’s 49 days in office in 2022. Curiously, Thatcher’s first two years in office, when she pursued her monetarist philosophy with the greatest resolve, are usually not included in the list. Instead, Conservative mythology frames this period as one of dogged heroism, with Thatcher’s refusal to listen to her critics setting the blueprint for leadership against the weak and incompetent leadership of the establishment “bigwigs”. Yes, it was painful, but ultimately her refusal to change course reversed decades of unbridled decline.
Anyone who believes this myth should read Thatcher’s Monetarism Experiment Written by Tim Lankester, who served as Margaret Thatcher’s economic adviser, this is a quietly shocking insider’s book about the theory and practice of monetarism during this critical period: a story of economic mismanagement in which the protagonists often had no idea what they were doing.
To understand this poor theory, Lankester gives us a brief introduction to the deceptively simple theory of monetarism. At its core is one of the simplest equations in economics: MV = PY, which states that the cash value of the economy’s output (P, the price level, multiplied by Y, real GDP) is equal to the amount of money in circulation (M) multiplied by the velocity of money (V).
If prices are out of control, the monetarist prescription is to limit the growth of the money supply, M. The most influential person to infuse monetarism into the Conservative Party was Milton Friedman, the Nobel Prize winner who called for simple rules for the growth of money. Make it clear that you can’t break the rules, and that the economy only needs to slow “modestly” for inflation to be contained.
It looked simple, but it went wrong almost immediately. Money grew far beyond target, while the economy fell into recession. The government, obsessed with the monetary figures, was determined to squeeze the economy further by tightening the budget and raising interest rates. As one academic put it, it was like “watching a man scald to death in a bathtub, then running into hotter and hotter water because he was reading the thermometer scale backwards.”
This exposed problems with the theory that critics of Keynesianism had long predicted. Lankester carefully analyzed the unknowns hidden in this simple equation. Politicians could not agree on a definition of money or understand how it should be controlled; Thatcher absurdly rejected the idea of raising interest rates. The velocity of money could not be measured directly, and it was steadily falling as a result of other Thatcherite financial reforms. The debate over whether the money supply drove economic development or vice versa intensified.
Lankester remained calm and even-handed. Unlike Thatcher’s more uncompromising critics, he did not question the need for some deflationary measures. The Conservatives succeeded a Labour government that had been overwhelmed by union bosses: one of them told the prime minister: “It’s your job, Jim. [Callaghan]to reduce inflation to 2%; my job is to get inflation to 18% for my members.” This mentality needs a serious beating to overcome.
Lankester also acknowledged that Thatcher’s economic reforms had been beneficial. Her government was sometimes portrayed as indifferent to the damage done by the recession, but in his account they were shocked and dismayed. The point was that they thought they had a clever economic package that would beat inflation effortlessly. None of them expected the dole to reach £3m.
It is clear from this account how important Thatcher’s own dogmatism was to the disaster. She insisted, without qualification, that the money supply drove the economy, not the other way around, and refused to discuss the issue before her. She mistook real uncertainty for ideological weakness. When she eventually gave up direct involvement in monetary affairs, the ministers who took over – notably her greatest chancellor, Nigel Lawson – were more pragmatic.
The operation of monetary policy is no longer a matter for politicians. The new Labour government, led by Sir Keir Starmer, is occasionally derided as a hard-nosed institutionalist, all too willing to let technocrats take the helm. Memories of the early 1980s remind us why this is a good thing. Politicians’ blind steering can cause untold damage.
Lankester witnessed the disaster firsthand and worried that he had pushed “too hard” in favor of a policy he knew would fail. Based on this brilliant account, it is clear where the blame lies.
Inside Thatcher’s monetary experiment: Promise, failure and legacy By Tim Lankester Policy Press, £19.99, 228 pages
Giles Wilkes, former Downing Street adviser and current senior fellow at the Institute for Government
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