1968–74: the struggle to understand

The change in emphasis towards the money supply began shortly after the devaluation of sterling in 1967, when the International Monetary Fund arranged a seminar with the Bank and the Treasury. The seminar was arranged ‘to examine the theory of the relationship of financial factors to the national income and balance of payments, and the implications of these relationships for the techniques of economic forecasting’, but went beyond these terms of reference.² The IMF had been unimpressed with the ability of the UK authorities to control monetary growth prior to the devaluation, and a lot of discussion centred around the amount of importance that should be attached to the money supply. The seminar was uncomfortable for the majority of the officials in the Bank and the Treasury, not least because they were uneasy about accepting sharper and higher movements in interest rates as a trade-off for greater control of the money supply.³ Although the authorities initially prevaricated on a number of issues, chiefly whether the IMF’s preferred definition of the money stock in an open economy – domestic credit expansion – could be applied to Britain, they did acknowledge that they had paid too little attention to monetary policy after 1945 and needed to adopt a clearer position on the money supply.⁴

This manifested itself in two key ways by the turn of the 1970s. First, there was a change in priorities in the gilt-edged market. In the 1960s the authorities had become more concerned with creating an orderly market for gilts, as they wished to prevent higher levels of interest rates. As the authorities came to realise that higher nominal interest rates in a period of inflation did not signify higher real interest rates, they became more prepared to move interest rates more rapidly. Greater interest rate flexibility was meant to be one of the features of the new method of monetary control, Competition and Credit Control, introduced in 1971, but upward movements became politically unacceptable.⁵ Second, in 1969 the then Chancellor, Roy Jenkins, published a Letter of Intent to the IMF stating that he intended to keep DCE within a figure of £400 million in 1969/70. In his April 1970 Budget, Jenkins set a £900 million limit on DCE for 1970/71. It is important to stress that this was not a target for the money supply, although some commentators took this to mean that the Bank of England was assuming a specific money supply target.⁶ At this early stage there was no formal commitment by either political party to a target, and when the Conservatives took office in June 1970, led by Ted Heath, they were urged to take a more ‘resolute and scientific grip’ on the movement of the money supply.⁷

As the briefing paper on monetary policy for the incoming government in 1970 made clear, the new emphasis on money after 1967 ‘did not represent conversion to Friedmanism, or indeed any greater degree of certainty as to the nature of the relationships between monetary changes and changes in the main components of national income and expenditure’.⁸ What it did signify was a gradual realisation by the authorities (via the influence of the IMF) that, if the growth of the money supply was restricted, the domestic economy and the external position could be improved. Thus, while there was no groundswell of officials converted to Friedman, there was a pragmatic acceptance that there should be a more important role for monetary policy.⁹ In turn, the work of successive Bank/Treasury Monetary Policy Groups during the 1970s was testament to this, even though the work was steeped in Keynesian demand management, and far too often reverted to tortuous first principles just as it appeared that progress was being made.

From the outset of the 1970s there were misgivings expressed about money supply targets, even down to semantics. As one Treasury official noted, ‘Something may depend on the interpretation put upon the word “target”. Certainly if it is meant to be something aimed at and hit (and by extension something which would cause concern if missed), then we cannot have “money supply targets”.’¹⁰ In October 1970 Treasury officials were asked to supply their Minister of State, Terence Higgins, with a list of objections to having money supply targets for internal use. Noting that they did not want to preclude the discussions of the Treasury/Bank Group on Monetary Policy (which spent some time discussing this in 1971), officials felt that there were a number of theoretical and practical objections.

First, they didn’t know enough about the causal relationships between the real economy and the monetary system to know whether it was ‘sensible’ to have a money supply target. Second, there was ‘ignorance’ about knowing what the optimum growth of the money supply should be and where the target should be set. Third, the monthly and quarterly figures for the money supply were prone to distortion, and ascertaining any underlying relationship between money supply growth and a target would be difficult. Fourth, even if sufficient relationships could be established, there would be considerable difficulties in knowing when to tighten monetary policy to achieve the money supply target. It was also impractical to ‘fine-tune’ the money supply.¹¹

To this might be added another objection that found its way into policy papers, namely that high interest rates might be required to hit a money supply target. As this is a ‘politically and socially sensitive subject…it is unlikely that any government would pursue a true money supply target if there was a chance that nominal interest rates might rise to such levels that institutions normally immune from small changes in rates…may suddenly be affected’.¹² The paper went on to argue that the Bank of England was concerned that ‘violently fluctuating rates would damage the gilt-edged market’ – objections that were raised later when it came to the discussions surrounding monetary base control in the early 1980s.

The Treasury knew it had to engage with the wider debate about monetary policy and the interest that this was beginning to have for economists outside government.¹³ There was a movement towards accepting that money could play a valuable role in controlling demand and bolstering the reserves, but with the caveats that ‘it cannot work miracles’ and ‘a lax monetary policy creates the sort of flabby environment that frustrates other policies’.¹⁴ This non-technical language was gradually replaced as a younger cohort of more technical economists inside the Treasury and the Bank began to dissect the work of Friedman and others on the relationship of monetary variables to income, output and prices and the practical possibility of monetary control. Generally, the Treasury was slow to accept that there might be an argument for expressing a money supply target as a percentage of annual growth, and was even more reluctant to tie this to a specific time period.¹⁵

Outside the Treasury and the Bank, financial practitioners, most notably W. Greenwell & Co., were paying attention to the money supply. Greenwell had begun to focus attention on the money supply from the autumn of 1968, and over the next few years conducted a major research project into the use of financial statistics.¹⁶ The significance of this research project was that one of their partners, Gordon Pepper, who had trained as a Keynesian at Cambridge, ‘reluctantly’ became a monetarist, abandoning Keynesianism after a monetarist forecast for the United Kingdom turned out to be more correct than the Keynesian one.¹⁷ Greenwell was also consulting a network of financial economists in the City, which included John Atkins of CitiBank, Graeme Gilchrist of Union Discount, David Kearn of NatWest Bank, David Tapper of Hambros Bank, Brian Williams of Gerrard and National and Peter Wood of Barclays Bank. It was through Greenwell’s Monetary Bulletin, however, one of the most widely read monetary publications produced in the United Kingdom, that monetary policy began to be taken seriously by the core executive.

In March 1971 the Financial Times proposed that there should be annual targets for the money supply. This attracted the interest of Heath’s Chancellor, Anthony Barber, and Frank Cassell in the Treasury conceded that, ‘if the target were expressed as an annual rate of increase, the growth of credit through the year would probably be smoother and the authorities might perhaps also have a little more flexibility in adjusting credit policy later in the year’.¹⁸ A little later in the month, however, Cassell was quite happy to draft a speech on the Budget debate for the Minister of State in which he noted that ‘by refraining from setting targets here and now for the full financial year we have given ourselves greater flexibility for adjusting the course of the money supply and credit later in the year’.¹⁹ This sort of confusion even led to criticism from government supporters: a leader in the Yorkshire Post, a newspaper described by Barber as ‘almost a Conservative Central Office news-sheet’, professed to being ‘baffled’ by the Chancellor’s views on the money supply.²⁰ The fear in the Treasury was that announcing or publishing money supply targets would be seen as a ‘hostage to fortune’, or worse.²¹ Things had not improved eighteen months later when, in November 1972, the Financial Secretary to the Treasury, Terence Higgins, cautioned the Chancellor against publishing targets that would be seen to have been missed and ‘might be interpreted (quite wrongly) as conversion to the Powell heresy’.²²

The Heath government never got to grips with the technicalities of monetary policy during its time in office. It was October 1970 before the Chancellor admitted that he needed to do some reading on monetary policy to prepare for a speech, and Treasury officials had to dust off the June 1970 briefing paper.²³ An initial muddle-through on monetary policy became more acute in the two years after October 1971, when the broad monetary aggregate (M3) grew by over 60 per cent. The increase during the first nine months was caused by the growth in bank lending; thereafter it was the rise in the public sector deficit that was the main cause, with only a third of the debt being sold to the non-bank private sector (in other words, the government was borrowing from the banking system). The consequences were asset price inflation (mainly in residential and commercial property), an enormous increase in real domestic demand in 1973 to 7.8 per cent and – as the monetarists had predicted – an increase in inflation after a long and variable time lag (to over 25 per cent in 1975).²⁴

In January 1973 Barber told the Cabinet of the increasing disquiet in European circles that the British had not taken more stringent measures to check the growth in public expenditure and to control the growth of the money supply.²⁵ The view in the Treasury, however, was that European thinking on a money supply target was ‘pretty primitive; it appears to take little account of the institutional difference between countries and of the complexities of the linkage between money and income’.²⁶ However primitive European thought was, the Treasury was completely unaware of the causes of growth in M3, and continued to express the view that money supply targets were difficult to implement and to publish, before conceding that ‘the difficulty of formulating a target at the moment stems largely from the obscurity of why money supply has risen so rapidly in the past year’.²⁷ Admitting to being ‘embarrassed’ by the rises in M3, and the very big rise in bank lending to the private sector in January 1973, the Minister of State, John Nott, suggested to Treasury officials that ‘the more we can play down the importance of M3 and emphasise its fickle nature, as the Bank of England have been doing, the better. I cannot really envisage the M3 figures being a help to us.’²⁸

The explosion in monetary growth between 1971 and 1973 was important for the rest of the 1970s for several reasons, not least because several Conservative politicians were determined that an asset price bubble should never be allowed to happened again. When Pepper gave a paper to the Bow Group at the end of March 1974 entitled ‘The economic threat to democracy’, Geoffrey Howe was sitting in the audience. Pepper’s attack on the monetary irresponsibility of the previous Heath government, the Treasury and the Bank of England resonated with Howe, and Pepper was introduced to Sir Keith Joseph and Robert Carr (the Shadow Chancellor).²⁹ Shortly afterwards Margaret Thatcher became Carr’s assistant spokesman on Treasury matters, and Pepper met her. His influence on Thatcher’s views on monetary policy, particularly in relation to MBC, was important.³⁰

1975–79: playing the game

After 1974 the relationship between the public sector borrowing requirement, the money supply and inflation began to be taken more seriously in some quarters. The Bank was clearly anxious to use money supply targets to control public expenditure. In July 1975 the Permanent Secretary, Sir Douglas Wass, had been informed that the Governor saw ‘a need for the enactment in public, and with an element of public drama, of a struggle to keep the [PSBR] figures down’.³¹ A few months later Bank Director Kit McMahon suggested that money supply targets would place ‘a tighter rope round the Chancellor’s neck’ to restrain public expenditure’.³² Although the Home Finance team in the Treasury were critical of the ‘accommodating policy’ towards the money supply and suggested that the PSBR needed to be cut if the intention was to reduce the growth of the money supply below money GDP, and thus reduce inflation, not everyone in the Treasury supported this line of argument.³³ Gordon Downey urged the Chancellor to recognise explicitly the connection between public expenditure and the control of the money supply in a forthcoming debate on the White Paper The attack on inflation, adding: ‘I do not possibly see how we can maintain credibility for our monetary objectives by referring to monetary instruments alone.’³⁴

By October 1975 Bank officials were noting that they had become ‘increasingly anxious about prospective monetary developments… [W]e feel that there is now an urgent need for a review of monetary policy.’³⁵ Although they did not concede to the monetarist arguments, noting that it was a ‘truism’ to say that inflation had to be a monetary phenomenon and that ‘the short-run relationship between monetary growth and inflation is tenuous at most’, they did acknowledge that ‘a commitment to restrain the rate of monetary expansion does give confidence over the medium term that inflation will be conquered’.³⁶ The final report of a Treasury/Bank working party reviewing monetary policy went further and recommended that a monetary target should be set, to secure a ‘reasonably stable path for growth of the monetary aggregates, particularly M3, in line with the secular growth of income and an “acceptable” rate of inflation’.³⁷

There was little genuine enthusiasm from either the Bank or the Treasury for any of this, however, and, in some cases, outright hostility to anything that smacked of monetarism. By the beginning of 1976 there was still no consensus on whether a money supply target should be publicly announced. Peter Middleton, a senior Treasury official, felt that this would be a ‘dangerous’ step, probably for the reasons that had been outlined in the Treasury since the early 1970s.³⁸ What finally convinced the authorities that they had to take the money supply seriously was the realisation that financial markets were placing importance on the growth of the money supply, and that controlling the monetary aggregates was needed primarily because of the effects ‘on the climate of opinion, expectations and attitudes’.³⁹

The Chancellor, Denis Healey, also shared this antipathy towards monetary targets.⁴⁰ During the sterling crisis of 1976 he announced in July that monetary growth should be around 12 per cent in 1976/77, but this was more a monetary forecast or guideline than a target.⁴¹ Despite the promise to tighten fiscal policy in 1977/78, the Treasury soon learnt that the United Kingdom’s attitude towards monetary targets was viewed by a significant part of the financial press, the foreign exchange market, numerous financial institutions, and economists ‘as lukewarm, our willingness to stick with them as slight, and the targets themselves as too high’.⁴² Ironically, in the months that followed Healey’s July announcement the financial markets began to view the 12 per cent figure as a target. By the autumn of 1976 some in the Treasury realised that only a tighter fiscal policy and a lower figure for the growth of the money supply target would placate the financial markets going forward.⁴³ As the discussions with the IMF for a loan concluded in December 1976 the Chancellor announced DCE targets for the year to 20 April 1977 and the year to 19 April 1978: £M3 was forecast to grow on a banking month basis by between 9 and 13 per cent in 1976/77. In little over a year, through a combination of market pressure, IMF insistence and political pragmatism, the monetary authorities had been forced to make the move and publicly announce money supply targets. As Wass ruefully commented at the end of 1977, ‘It was no longer practical politics to contemplate abandoning monetary targets.’⁴⁴

1979–81: false start and policy confusion

The election of Thatcher’s Conservative government in May 1979 ushered in an administration committed to reducing inflation through the control of the money supply. It was the intention of the authorities to select a broad money target (£M3) and to raise interest rates if the growth of the money supply appeared excessive. As part of this strategy, the authorities intended to use fiscal policy as a means of influencing interest rates for a given monetary target: by reducing the PSBR as a percentage of gross domestic product, the money supply would not grow so quickly, and interest rates could be kept low.⁴⁵

During the first two years of this ‘monetarist experiment’ money supply targets were missed, public expenditure continued to rise and the economy entered a steep recession, accompanied by an overvalued exchange rate.⁴⁶ £M3 grew rapidly because of several distortions in the financial system, and the authorities responded to the upward growth by raising Minimum Lending Rate by two percentage points in June 1979, and a further three percentage points in November 1979, when it stood at a post-war high of 17 per cent. Consequently, the early optimism about the monetary strategy expressed by the Chancellor, Geoffrey Howe, to his colleagues soon evaporated, and the evidence from the official papers shows the extent of the frustration within government.⁴⁷ Not only did senior ministers have to convince their colleagues that the strategy was on the right path, they also had to demonstrate this publicly.⁴⁸

The launch of the Medium-Term Financial Strategy in March 1980 provided a framework for the government’s economic strategy. The intention was to provide financial objectives for fiscal and monetary policy. Charles Moore has suggested that Margaret Thatcher was always ‘nervous’ about the MTFS, and she later admitted that she didn’t believe the strategy was needed.⁴⁹ The move away from discretion to rules was an essential break from the policy making that had characterised the British economy since 1945, however.⁵⁰ Unfortunately, if the rules were broken then the MTFS had limited value, and, with the overshooting of the money supply targets, the government faced a very difficult task in maintaining its economic credibility.

The £M3 target for June 1979 to April 1980 was 7 to 11 per cent, and the outturn over the target period was 9.6 per cent; the outturn over the financial year was 12.5 per cent, however, largely as a result of increased money growth in April and May 1979. The target range for £M3 from February 1980 to April 1981 was the same as the previous year, but the outturn overshot considerably for both the target period and the financial year, at 19.1 per cent and 18.5 per cent, respectively. There is not the space here to conduct a full counterpart analysis, but David Cobham has suggested that the main reason for the overshoot in 1979/80 was above-target growth in the PSBR, and increased bank lending to the private sector, which was not totally compensated for by public sector debt sales to the private sector. In 1980/81 there was a very large overshoot of the PSBR (which the 1981 Budget intended to address), and a smaller overshoot on bank lending (owing to post-‘corset’ reintermediation and the squeeze on the corporate sector), which were only partly offset by higher than planned debt sales.⁵¹

The difficulties with achieving the monetary targets added urgency to an overall review of monetary policy.⁵² Soon after taking office the Prime Minister expressed her dissatisfaction with the target range for the money supply and pressed hard for a system known as monetary base control, which she believed would lead to greater control of inflation and lower interest rates.⁵³ Pepper and other monetarists had influenced her thinking on this; she found limited support for this option in the Treasury, however, and hostility in the Bank.⁵⁴ She later complained that officials had ‘thrown sand in her eyes’ about MBC.⁵⁵ The Prime Minister’s economic adviser, Alan Walters, was a strong supporter of MBC in principle, and he was actively sending material to the No. 10 Policy Unit to be passed on to Thatcher even before he took up his position.⁵⁶ Walters was instrumental in the decision to get Jürg Niehans, the distinguished Swiss monetary economist, to prepare a study on UK monetary policy.⁵⁷ Niehans’ conclusion, that monetary policy had been too tight and should be loosened quickly, was also followed with a recommendation that the money supply target should be expressed in terms of the monetary base instead of £M3.⁵⁸

The head of the No. 10 Policy Unit, John Hoskyns, claims that Niehans’ conclusion surprised both the No. 10 Policy Unit and the Treasury.⁵⁹ It should not have come as a surprise to anyone. Although the Prime Minister was clearly irritated with an article by Pepper in The Observer in August 1980 in which he argued that monetary policy was too tight, W. Greenwell & Co. had been arguing on these lines since May 1980 in the Monetary Bulletin, copies of which went to the Chancellor and the Prime Minister.⁶⁰ Walters records that he had said at a seminar and briefing in the United States in October and November 1980 that he judged monetary policy to be too tight, as had Tim Congdon (Chief Economist at L. Messel & Co.), who was no supporter of narrow money.⁶¹ The conclusions of monetary economists who monitored the situation closely were very different from the impression given by the behaviour of the published data for £M3 relative to its target.

Taking stock at the end of 1980, the Chief Economic Adviser to the Treasury, Terry Burns, admitted that the reputation of £M3 had suffered during the last twelve months.⁶² This was a huge understatement. The rapid growth of broad money, and the slow growth of narrow money (M1), coupled to the strong exchange rate, were not what the Thatcher government had foreseen at the start of the year. Moreover, monetarists had repeatedly argued that velocity was stable in the medium run and that any monetary expansion, after a lag, would be inflationary. The non-appearance of inflation following the rapid monetary growth in 1980 was therefore puzzling to policy makers. Burns suggested that there were two interpretations of events. There was the optimistic version, in which rapid growth of broad money affected inflation only when it led to a weak exchange rate and an increase in aggregate demand. In a recession, with a high exchange rate and low growth of M1, an acceleration of inflation in the future was unlikely to occur. The alternative, and more pessimistic, interpretation was that a rapid growth of broad money would lead to a weak exchange rate and a faster growth of narrower aggregates. Once interest rates fell and the economy began to recover, the exchange rate would fall sharply and the excess liquidity would cause inflation.

The problem facing the authorities was whether they should make allowance for the behaviour of M1 and the exchange rate when deciding the monetary target for 1981/82 and how much (if any) of the monetary overshoot it was possible to claw back. For Burns, it had reached the point at which a more flexible approach was needed for the short-run monetary targets while maintaining anti-inflationary financial discipline over the medium term. By the turn of the year Middleton, now Deputy Secretary in the Treasury, was prompted by Burns’ note of 22 December to instigate a series of papers on the behaviour and significance of the narrow aggregates; to review the use of the wider aggregates as a guide to fiscal policy and interest rates; and to explore the significance of other indicators, particularly the exchange rate. He conceded that the danger with this work would be that ‘everything provides some relevant information without providing a guide to policy’. The key for Middleton was to produce work that should ‘revive the monetary strategy and express it in a way which increases its credibility rather than make it so diffuse that it becomes meaningless’.⁶³

The Bank and the Treasury spent some time considering various monetary aggregates. Intellectually, many in the Bank were inclined towards M1 as a target, insofar as they even accepted the importance of the money supply.⁶⁴ The Bank’s Chief Adviser, Charles Goodhart, recognised the enormous difficulties that financial innovation could have for the monetary aggregates; the Bank undertook a study of a new M2 monetary aggregate, both from the statistical aspect and from a conceptual economic viewpoint.⁶⁵ The Treasury became impatient with the length of time it was taking the Bank to define M2: Rachel Lomax, a senior economic adviser, told Nick Monck, who was liaising with the Bank, that ‘what they need from us, now, is a shove. No more meetings until we see some action.’⁶⁶ What the Treasury wanted to see was the removal of wholesale deposits from £M3, as there were shifts in and out of £M3 in response to relative interest rates, which had little or no economic significance. The Treasury felt that M2 would be more stable in relation to expenditure, nominal income and prices than £M3, and might be used as a control variable in a mandatory MBC system.⁶⁷

Although £M3 had been given pride of place at the launch of the MTFS, it began to have less importance in the monetary strategy over the next six months. Senior Treasury officials urged a reduction in MLR, but this could not be justified on the grounds of success in hitting the £M3 target, which was breached by a considerable amount.⁶⁸ Conscious of this, Howe was keen that the government should not appear to be abandoning its monetary strategy with this interest rate cut.⁶⁹ The damage was done, however: the two percentage point reduction in MLR in the 1980 Autumn Statement was a clear indication to markets that changes in £M3 did not appear to have much influence on interest rate decisions. Effectively, from this point the government gave priority to the presentation of policy, which led to considerable difficulties in trying to reconcile this with monetarist theory. There were three developments leading up to the 1981 Budget that demonstrate the significant relaxing of the ‘monetarist experiment’.

First, despite the robust defence of the government’s monetary strategy by the Financial Secretary, Nigel Lawson, in a speech to the Zurich Society of Economists in January 1981, Treasury officials had finally reached the point at which they did not see £M3 as an adequate measure of monetary conditions in the economy. Even Lawson had admitted in Zurich that PSL1 was a better measure of broad money growth than £M3 (PSL1 captured the unwinding of the ‘corset’), and, although Treasury officials favoured PSL2, Andrew Britton argued that £M3 should be abandoned when M2 was in place and running in tandem with a PSL number.⁷⁰ Now echoing Niehans, Middleton was more minded to focus on the narrow aggregates, which, he argued, displayed a better relationship to the final objective of reducing inflation; £M3 could have a role as a medium-term objective to be achieved over the whole MTFS period.⁷¹

Second, officials were doubtful whether the £M3 growth target for 1981/82 (6 to 10 per cent) could be achieved, how the missed targets might be explained and how the monetary strategy should be presented. Howe’s Private Secretary, John Wiggins, asked Middleton: ‘How good a story can we tell based on stock adjustment models?’ He also asked: ‘Can we argue that personal sector holdings of £M3 are below an “equilibrium” level?’ In what was pure spin, Wiggins suggested:

At a meeting with the Prime Minister and senior officials on 10 February, Howe acknowledged that, for the ‘sake of credibility of the strategy’, the £M3 target could not ‘simply be abandoned’ in the Budget speech, but said that he would indicate that the authorities ‘would be moving as fast as they sensibly could in the direction of monetary base control’ (Thatcher was clearly unhappy with this, and wanted Howe to announce a ‘concrete plan’ for moving to MBC).⁷³

The setting of interest rates was the third area that vexed the authorities in the weeks leading up to the Budget. After initially ruling out a reduction in MLR in the Budget because of worries about a high figure for the PSBR, the Chancellor concluded that, while £M3 would retain ‘primacy in the presentation of monetary policy’ in setting interest rates, ‘other factors’ needed to be taken into account.⁷⁴ At this stage the other factors were not defined, but Lawson argued that short-term interest rates should be determined by M0 and real interest rates and there should merely be a ‘regard’ to £M3.⁷⁵ The problem for policy makers was that, apart from the exchange rate, all the other monetary indicators suggested that interest rates needed to be increased. In a draft of a note to the Prime Minister, Middleton conceded that it was ‘not easy’ to construct a case for a sustained fall in interest rates based on the projected growth of the monetary aggregates; Thatcher was seeking a one percentage point reduction – ‘no more than that’ – on Budget day.⁷⁶

Officials met with the Chancellor on 19 February to consider monetary targets and monetary control. Various opinions were given. Middleton argued that a PSBR of £11¼ billion with a reduction in MLR would put at risk the £M3 target of 8 to 10 per cent, and it was unlikely that growth would be within the 6 to 10 per cent range during the first few months of 1981/82.⁷⁷ He suggested that either the target should be qualified or the range extended. Howe wanted to reduce MLR because of the ‘psychological and practical effectiveness’, and to keep the PSBR as low as possible in pursuit of the monetary target in the MTFS. Lawson argued that the markets were already expecting the monetary target to be overshot in the early months of 1981/82 and wanted some reduction in interest rates as part of the Budget. In discussion, it was noted that the markets had to be given ‘sufficient assurance’ that the authorities were trying to control monetary growth and that the target range could be widened if monetary growth was at the top of the range and the exchange rate was rising. The meeting concluded that, in pursuit of the monetary target and in determining nominal interest rates, ‘the authorities would also have regard to movements in the narrower monetary aggregates, in real interest rates and in the exchange rate’.⁷⁸

The Governor admitted that he was ‘relieved’ when he was told by Wass on the same day as the Chancellor’s meeting that the existing monetary target was going to be qualified with reference to other variables, as he had felt that the Treasury had locked itself ‘in too unqualified a manner’ to £M3.⁷⁹ On 23 February Gordon Richardson expressed anxiety about the quantification of the MTFS and the general thrust of the economic strategy. In particular, he felt that the growth prospect was ‘wishful thinking’ in relation to public expenditure and that there was incompatibility between the fiscal and monetary figures.⁸⁰ He argued that the MTFS was now seen as less attractive than in 1980, that credibility was much harder to sustain with the new numbers and that the original idea of the MTFS (a progressive strengthening of expectations of lower inflation) had not been met. Lawson retorted that there was ‘no escape’ from providing new figures for the MTFS.⁸¹

On 27 February Middleton suggested a two percentage point reduction in MLR on 10 March, but warned that £M3 would grow more rapidly and on the basis of present forecasts, and two percentage points was as much as could be managed in the entire year. The alternative was to cut by one percentage point, with the expectation of doing another percentage point cut later in the year. The advantage of this course of action was that the prospects of further interest rate falls might help to maintain favourable expectations in the gilts market. Middleton eventually came down on the side that a two percentage point cut in MLR was a ‘necessary ingredient to give a proper balance to the budget’.⁸² Noting that this was going to be a ‘pretty harsh budget’, the Second Permanent Secretary, William Ryrie, concurred with Middleton in a note to Howe, arguing that there should be some ‘tangible benefit apparently flowing from the harsh measures you are taking’.⁸³ On 2 March the Financial Secretary and Chief Secretary both supported the reduction of two percentage points, as did the Governor on 4 March.⁸⁴

Surprisingly, Wass was unconvinced by the argument for reducing interest rates, and supported the change only on political grounds, telling the Chancellor that ‘without a significant move on MLR the budget will be greeted with dismay by the industrial lobby; indeed many of your own supporters will be pretty upset too’.⁸⁵ He urged the interest rate cut to be firmly linked to monetary objectives, warning that, without this, the defence of an interest rate cut ‘could look particularly weak under cross-examination from for instance the Select Committee and even more from some of our monetarist critics’.⁸⁶ At a meeting with Howe and Richardson on 4 March, Wass thought it might be safer to go for a cut of only one percentage point.⁸⁷ In this, he echoed Walters, who would have preferred no cut in MLR at all.⁸⁸ Walters’ position was viewed by Leon Brittan, the Chief Secretary, as ‘quite extraordinary in view of his other public views’.⁸⁹ For Brittan, a one percentage point reduction ‘could be so disastrous politically that it ought not be to be contemplated unless all the economic evidence pointed in its favour’. Since there was not the evidence, the Chief Secretary supported a two percentage point reduction.⁹⁰

Conclusions

The story of the evolution of money supply targets in the United Kingdom is long and tortuous, and a short chapter cannot possibly do justice to the twists and turns in the authorities’ thinking after 1968. The reluctance to engage with monetary targets, unless they were forced to do so by external influences such as the IMF or the financial markets, was the most significant characteristic of monetary policy until 1979 and symptomatic of the Keynesian mindset that dominated most official thinking. As this chapter has suggested, a distinction might be drawn in the pre-1979 period from 1968 to 1974 and from 1975 to 1979. In the former period the sometimes bellicose stance of the authorities only really altered after the 1971–73 monetary explosion and its consequences. Between 1974 and 1979 there was a conversion to monetarism by some in the Conservative Party, and an acceptance by the Labour Party that money supply targets made for good politics with the markets and the IMF. There was no enthusiasm among senior officials in the Treasury or the Bank for anything that appeared to be Friedmanite monetarism.

There was clearly a determination on the part of several senior Conservative politicians to make monetarism work upon entering office in 1979. As has been argued elsewhere, however, ‘political monetarism’ dominated, and the number of ‘genuine monetarists’ in the core executive remained in the minority.⁹¹ Although Lord Howe has disputed such a characterisation he also concedes that he did not believe in monetarism.⁹² As this chapter has shown, the shift in focus away from £M3 began within six months of the launch of the MTFS, and the substance of the discussions surrounding monetary policy in the weeks before the 1981 Budget illustrates the extent of the pragmatism that had set in. A month after the Budget Nick Monck was forced to admit that monetary control was ‘rather bare’ and officials were now in an ‘uncomfortable situation… [W]e all seem to be agreed that the existing and emerging systems of control are weak and unreliable.’⁹³ For its supporters, there was always monetary base control, which, as soon as the ink was dry on the 1981 Budget, Walters wished to pursue, again with Thatcher’s support.⁹⁴ Clearly, the story about monetary targets in the United Kingdom does not end in 1981, and, in time and with more space, a more detailed account will be able to explore the post-1968 period in more depth.