Margaret Thatcher’s monetarism and the challenge of disinflation��Ian M McDonald� �University of Melbourne�

The Asia Pacific Economic and Business History (APEBH) Conference

February 2023 Sydney

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Prime Minister Thatcher

• 4 May 1979: Margaret Thatcher became prime minister
• She liked to boast of being the first scientist to be prime minister
• Two auto-biographical volumes
• The Downing Street Years, Thatcher (1993)
• The Path to Power, Thatcher (1995)

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Mystique at Number 10

• “On Wednesday 3 September [1980] Geoffrey Howe and I met to discuss the monetary position”, Thatcher (1993, p. 125)
• They were concerned about the excessive growth of M3
• A bizarre waste of time by the two most senior politicians in the UK
• M3 is an input – not a component of well-being
• The growth of M3 and its relation to inflation is a technical issue to be analysed by social scientists, not chemists
• For reducing inflation monetarism is flawed
• “hardly anyone knew what [M3] meant” Engel (2022, p.263)

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The instinctual basis of Thatcher’s monetarism

• Monetarism “was completely in harmony with my fundamental instincts”, Thatcher (1995, p.568)
• She said her “experience of life in the Roberts household was the decisive influence” on her views on economics” [ie in her childhood] Thatcher (1995, p.565)
• Not very scientific

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Thatcher’s monetarist policy

• The Medium-Term Financial Strategy (MTFS)
• announced in March 1980
• A progressive reduction of the M3 target growth rate
• 7-11% in 1980-81
• 4-8% in 1983-84
• A progressive reduction in the PSBR target
• To release resources to the wealth-creating private sector
• Incomes policy abandoned

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Monetarism’s disinflation claim

• “let the monetary authority choose a target rate of unemployment that is above the natural rate, and they will be led to produce a deflation, and an accelerating deflation at that”, Friedman (1968, p.10, my emphasis)
• This claim is based on Friedman’s belief in the power of excess supply in the labour market (the power of outsiders) to reduce wages
• It is the fundamental flaw in monetarism

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Friedman in reviewing the MTFS persisted making his claim of ‘disinflation with modest cost’

• “a modest reduction in output and employment will be a side effect of reducing inflation to single figures by 1982”, Friedman (1980, p.14, my emphasis)
• In his Memorandum to the Select Committee reviewing the Government’s medium term financial strategy

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Keith Joseph and Thatcher made the claim of ‘disinflation with modest cost’

• In Thatcher’s approving words, Joseph argued in 1974 that “control of the money supply to beat inflation would temporarily risk some increase in unemployment”, Thatcher (1995, p.256, my emphasis)

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BUT

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The Thatcher contraction��Unemployment increased by 5% points=immodest��High unemployment did not cause "accelerating deflation”�

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Phillips (1958) was a warning to avoid the fundamental flaw

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The Volker disinflation: another ‘immodest’ contraction with no “accelerating deflation”

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Thatcher’s road to monetarism

• Instinct
• The Roberts’ household
• Lack of economic training
• She did the wrong degree
• Combative nature
• Seeing macroeconomics as Keynes versus monetarists encouraged Thatcher to take a side
• Thatcher ideologically opposed to unions and incomes policy
• Monetarism claimed that for reducing inflation, unions and incomes policy could be ignored
• Confirmation bias/self-serving bias
• eg Centre for Policy Studies
• Was Thatcher deceived by monetarism?

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Lack of economic training

• At Oxford, she didn’t study economics
• One needs formal training to understand a subject
• Thatcher mentions reading ‘the seminal works of liberal economics’ and ‘armfuls of books’ but that is not enough
• Thatcher lacked “a trained economist’s sense of the subject’s intrinsic fallibility”, Campbell (2008, p.81)
• For example, “her scientist’s literal belief in money as a finite substance that must be able to be measured”, Campbell (2008, p.81)

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Economics is not a hard science

• “in a hard, exact science … the subject itself has a self-cleansing property which renders harmless” the aberrations of a misguided methodologist” Samuelson (1964, p.ix)
• It may be that the simple chains of causation in chemistry, eg the litmus test, put Thatcher on the wrong track of thinking of inflation as a simple reaction to money
• And that the money supply is an exact concept

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Simple slogans can be persuasive

• “inflation was a monetary phenomenon”, Thatcher (1993, p.33)
• “too much money chasing too few goods” is persuasive
• Even though it obscures the asymmetric nature of the inflation-unemployment relation
• “too many goods chasing to little money” is never mentioned because in recession too many goods are not produced

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To persuade, the monetarists presented their chains of causality in an evasive fashion.

• “had these rates of growth persisted, they would have been consistent with inflation rates of over 15%”, Walters (1986, p.137, my emphasis)
• “would have been” invites an interpretation of causality
• Implicitly accepts the possibility that trade unions can cause inflation

However

• In her retrospective 1995 volume, Thatcher acknowledges this complicated causal chain

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Fundamentally, Thatcher got economics wrong

• Thatcher defined the objective of economic activity as wealth creation
• Economists define the objective of economic activity as human well-being
• by making the maximisation of individual preferences the basis of economics

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Thatcher’s combative nature

• Thatcher instinctively looked for sides to take. Them and us. Enemies within. Thus, she saw macroeconomics as monetarism versus Keynesianism, and took a side
• It was monetarist side because of the other reasons I put forward
• Thus, Thatcher joined a long line of anti-Keynes documented by Zachary Carter (2020), motivated by greed or ideology

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The “Special military operation” against Keynes gave Thatcher support for taking the monetarist/anti-Keynes side

• Hayek ‘The Road to Serfdom’ (1944): Keynes is a step on the slippery slope to totalitarianism
• Ideological, no empirical evidence
• However the increasing power in the 1970s of Scargill and other extreme left union leaders/politicians was suggestive of the slope
• “Hayek’s attack on the political implications of Keynesian economics [in 1944] would be a turning point in twentieth century thought” Carter (2020, p.341)
• ‘The Road to Serfdom’ promoted by:
• Readers Digest
• National Association of Manufacturers
• Harold Luhnow

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Thatcher ideologically opposed to unions and incomes policy

• Thatcher saw incomes policy as an example of the road to serfdom
• Incomes policy is an aspect “of the … collectivist programme which, if taken to its ultimate conclusion, would jeopardize not just economic freedom but political freedom as well”, Thatcher (1995, p.140).
• Monetarism: incomes policy would be fighting a losing battle against market forces eg Friedman’s evidence in 1980
• For Thatcher the impotence of unions with respect to inflation may have added to the attraction of monetarism. She could blame inflation onto monetary growth and unemployment onto the unions.

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Confirmation bias/Self-serving bias

• “To develop these instincts either into a coherent framework of ideas or into a set of practical policies for government… Keith [Joseph] and I established the Centre for Policy Studies”, Thatcher (1993, p.14, see also p.221).
• The Centre for Policy Studies describes itself as “a right-wing think tank…built around promoting…ownership”
• Ideological, unscientific
• Thatcher sought confirmation of her views, not empirical support

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Thatcher’s unscientific rejection of experts

• Monetarism was a minority view of the economics profession
• The Central Policy Review Staff – abolished
• “a government with a firm philosophical direction was inevitably a less comfortable environment for a body with a technocratic outlook”
• Bank of England ‘bawled out’
• the governor, Gordon Richardson, bawled out on his return from holiday about the excessive growth of M3
• Which, according to The Times, still reverberated around ‘the corridors and salons’ five weeks later (Campbell 2008, p.81)

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Thatcher’s approach to economics contrasts with her approach to war

• During the Falklands War, Thatcher gave her commanders “her absolute political support”, recognising “her own complete ignorance of military matters”, Campbell (2008, p.139)
• “a closer personal interest in the minutiae of monetary control than any previous Prime Minister”, Campbell (2008, p.81).
• “on her Lilliputian scale…a better war leader than Churchill”, Campbell (2008, p.139)

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Conclusion

• Thatcher’s road to monetarism was ideological not scientific
• Even though she liked to boast of being the first scientist to be prime minister
• Her belief that monetary contraction would reduce inflation with modest cost was metaphysical
• Was she deceived?
• In practice the Thatcher contraction did not follow the monetarist prediction
• Only when unemployment was increasing did inflation decrease
• When unemployment was high there was no accelerating deflation

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The relevance for today

• The inflation Thatcher was trying to control was cost-push due to union pressure
• Increased job-insecurity reduced inflation
• witness the close down and threat of closedown of plants
• Today’s inflation is also cost push but with no force such as union power to make it persist
• And so it will be temporary and there is no need for an aggressive restriction of aggregate demand

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