Large scale document archive

The 1981 Budget - background & documents


The 1981 Budget is one of the defining moments in the history of Margaret Thatcher's government.

This page is designed as an aide-mémoire of economic policy from May 1979 to March 1981, with links to the many original documents now available on the topic.

1979 jun 12: howe's first budget

The "Not for Turning" speech (Oct 1980)
- MT's annotations

The new Chancellor, Sir Geoffrey Howe's, first budget was on 12 June, barely a month after the General Election and pretty much the earliest feasible date.

Treasury ministers planned the budget around a substantial reduction in income tax, aiming to improve incentives and hence economic performance. The basic rate was cut from 33p to 30p; the top 'earned' rate of 83p and the top 'unearned' of 98p were cut to 75p. Thresholds were increased by an average of 18 per cent, well above inflation, taking 1.3m out of income tax altogether and 550,000 out of the higher rates.

The 8 and 12.5 per cent VAT rates were unified at 15 per cent, putting around 3.75 per cent on the RPI. There was also a 7p increase in petrol duty, adding 10p to a gallon when VAT was added in. (For RPI reasons, alcohol and tobacco duties were left untouched.) The oil companies were tapped: Petroleum Revenue Tax (PRT) was increased from 45 to 60p and BNOC lost its exemption from the tax.

There were £2.5b reductions in planned spending totals (housing the biggest single cut), holding the projected PSBR for 1979/80 to £8.25b (4.5 per cent). Howe minuted MT on 21 May that the effect of the measures would be "quite severely contractionary ", given that the outturn for 1978/79 had been £9.25b (5.25 per cent). In the event the outturn for 1979/80 was much worse than the projection, closer to £10b. £1b in asset sales were announced, mainly from selling a further tranche of BP shares.

The papers show that while generally MT accepted the logic of the direct/indirect tax switch, which she had publicly endorsed, she worried mightily about the political and economic effects on the RPI. Instead she argued passionately for further spending cuts - notably in a meeting with all the top Treasury ministers and officials on 16 May when they were told they were being "not nearly tough enough" - in the hope of holding the VAT increase to 12.5 per cent. She also sought ways not to backdate income tax cuts and even suggested deferring them altogether to the following year. But Howe did not yield.

On the monetary side, the budget lowered the existing £M3 target range of 8-12 per cent (for the year to mid-Oct 1979) to 7-11 per cent (mid-June 1979 to mid-Apr 1980). To deliver this target, alongside action on the PSBR, MLR was increased from 12 to 14 per cent.The Supplementary Special Deposit Scheme, a.k.a. 'the corset' was extended a further three months. (Final abolition was in June 1980, of which more below.) The budget also saw the first step towards abolition of exchange controls, easing restrictions on individuals and small outward investments. From the outset the Bank of England strongly encouraged the new government to ease exchange controls, but initially showed wariness of full abolition.

The unpublished National Income Forecast on 1 June predicted that the "UK economy is likely to move further into recession. The volume of GDP is unlikely to rise much and is more likely to fall from the level reached in second half of 1980. Manufacturing output may fall significantly". The recession is now judged to have begun in the third quarter of 1979 and ended in the second quarter of 1981.

1979 jun-nov: mt's advisers; mlr & mortgage rates; the "gilt strike" of nov 1979

The files show that on monetary questions MT was mistrustful of the Bank of England and the Treasury from the very first. She always sought an alternative perspective, and frequently preferred it. In her early months in office this often came from stockbroker and gilt market analyst, Gordon Pepper, a tenacious advocate of monetary base control (MBC). Senior officials raised eyebrows, particularly in the run-up to the budget when it was suggested that if he visited No.10 he should use the Cabinet Office entrance. In time the visits pretty much ceased. But figures like Brian Griffiths and Alan Walters were also in close contact with MT and they consistently urged MBC, as did the Centre for Policy Studies and some foreign economists influential with her, like Karl Brunner and Allan Meltzer.

It seems to have been by an initiative of Alfred Sherman's in Apr 1980 that Walters was finally persuaded to leave Johns Hopkins and the World Bank to take up his position as MT's economic guru at No.10 in Jan 1981, Keith Joseph handling the financial modalities. The Bank files contain a note of a fascinating phone call from Wass to Richardson in May 1980 recording that Howe had once considered him for Chief Economic Adviser and that Howe had the impression he was again being offered the opportunity to employ Walters at the Treasury. According to Wass, the Chancellor refused, proposing instead that he go to the Bank, which (Wass suggested) should also refuse, on the ground that it had just hired John Flemming. Wass's solution was that Walters join Keith Joseph at Industry, drawing the reply: "The Governor felt that would probably be the best place for him as he was not in Mr Flemming's class". In fact there is little question that Walters was always intended as MT's personal adviser and would not have returned for any lesser role. Perhaps Joseph gave Howe nominal first refusal to make it harder subsequently for the Treasury to object to Walters' employment at No.10.

Hitting monetary targets would require painful measures, a fact made apparent early into the new government when the Chancellor minuted MT that a 2 point interest rate increase was urgently needed. Even Labour's old monetary targets were being overshot, let alone the tighter version about to be announced by the new government in its first budget. MT resisted fiercely, questioning both the timing and the date, forcing postponement till budget day and only reluctantly conceding that the increase would be 2 points rather than 1.5.

The tussle paved the way for a more serious argument at the end of the month. Roused by reports in the Sunday papers on 24 June that mortgage rates might shortly rise, MT sent Howe a handwritten note of instruction: "This MUST NOT happen. If necessary there must be a temporary subsidy (as in 1973) from the contingency reserve to keep the rate where it is". A meeting was held to consider this proposal, at which Willie Whitelaw and Michael Heseltine (as the minister responsible for housing) were present as well as Treasury ministers. In later years it is hard to imagine such a line-up. In the event Heseltine backed the Treasury's rejection of the scheme, Whitelaw sitting silent, and the whole thing was watered down into a contingency scheme, never to see the light of day - though it was agreed that the Building Societies were to be "pressed hard" by Heseltine and Lawson in tandem to keep mortgage rates unchanged till September. In fact they had already agreed to do just that in private discussions with the Treasury ahead of the meeting with MT.

As early as June 1979 the Treasury was warning No.10 of its concerns for the gilt market. Over the summer the market was stable, despite press stories that the government was ready to interfere with mortgage rates. But by September there were unmistakable signs of strain as the markets absorbed month after month of high bank lending and government borrowing figures, £M3 growing well above the 7-11 per cent target range set out in the June budget. The crunch came in early November. On the 5th Howe minuted MT about the monetary figures for October. These had been expected to be good: in fact they were "worse than disappointing", with poor tax receipts, record bank lending, high monetary growth, against a background of increasing interest rates in Germany and Japan. The PSBR was expected to exceed the £8.25b estimated in the budget. Market expectations swiftly became deep rooted that the authorities would soon have to increase interest rates, and increase them substantially. Sale of government debt simply ceased as the markets waited for the higher rates: a "gilt strike" had begun.

A blizzard of painful crisis meetings followed to construct an emergency package, Treasury officials discerning political cracks when Whitelaw attended one on MLR. The Deputy Governor of the Bank, Kit McMahon, urged a shockingly sharp rise in rates to ensure 'overkill' and in fact exactly that approach was adopted. Interest rates were increased from 14 to 17 per cent, the largest one day increase in British history, before or since. The overshooting budget deficit was addressed by a technical change to advance payment of PRT, an expedient rejected by the Treasury earlier in the year, while the £M3 targets were rolled over a further four months. Although the 'bill leak' and final abolition of exchange control (on 23 Oct) raised obvious doubts as to the effectiveness of the corset, it was extended a further six months in view of the uncertainty. The Bank sought to square the circle through an 'informal' approach from the Governor to the banks requesting that they not take advantage of exchange control abolition to evade SSD ("all were left in no doubt that the fullest compliance with the spirit of it was expected"). An examination of MBC was also announced, under pressure from No.10, which was also pressing for action on consumer credit and a range of other direct controls.

The gilt strike was ended swiftly, but the government had had to pay a high price to secure credibility in the markets. MT was furious with the outcome, and quickly fastened on the role of the Bank (which Gordon Pepper criticised sharply in a speech of 19 Nov). Her relationship with Geoffrey Howe was quite frayed at this time, but as to the blameworthiness of the Bank they found a large measure of common ground, the Treasury telling No.10 it was conducting a post mortem of Bank tactics in the gilt market and using the opportunity to review monetary policy in general.

MT's mistrust of the Bank may well have been increased by the fact that in the meeting which decided to lift what remained of exchange controls the Governor had tried to still prime ministerial doubts by placing a hopeful gloss on the upcoming October monetary figures, which in fact turned out so bad. Moreover the meeting itself was held rather late in the day, leaving No.10 feeling a little bounced as well.

1979-81: sterling - overview

Sterling was trading at around $2.10 at the time of the June 1979 budget, barely changed since the election. The low for 1979 had been $1.98 on 1 Feb, at the depth of the Winter of Discontent. It had then climbed during the election campaign, following a decision on 5 April not to check upward pressure resulting from the Iranian revolution, and there was further strong upward movement after Howe's first budget. It hit a peak for the year at $2.33 in late July 1979 (DM4.23, ERI 74). Even at $2.10 the Governor - writing to Howe on 4 May - had thought the rate a threat to the manufacturing sector. By late July 1979, with sterling in the $2.30s, Bank officials were trying to think of ways to justify a cut in MLR, though fully accepting that this would not be consistent with the new regime of monetary targetting. Howe himself publicly expressed the hope that conditions might justify relaxation by year's end.

It was Bank doctrine at this time that there should be no systematic intervention to drive sterling down and that such intervention could not be sterilized. Again, from Richardson's opening letter to Howe, 4 May 1979: "We should emphatically not recommend a course, sometimes suggested, that the exchange rate could be reduced below what it would otherwise be by a more aggressive intervention policy .... It is something we have never done, because of the dangers of destabilising the exchange rate ..." Rather, "it could and should be an object of policy to moderate fluctuations, but there are strict limits as to how far one can go in resisting fundamental trends". This approach seems to have prevailed, echoed in the Treasury where the counterinflationary advantages of a strong pound were never out of mind and often paramount in these years. That said, intervention apparently averaged $250m a month over the eighteen months to mid-Oct 1980, a not insubstantial sum.

The pressure eased during Aug 1979, with sterling losing ten cents in the month. October saw a similar fall, the rate coming down to $2.09-2.11 after the end of exchange control, where it stayed during the Nov 1979 gilt strike. Following the 3 point MLR increase it swiftly rose, however, reaching $2.31 by late Feb 1980 during which period there was some belief in the markets that the Bank had an informal ceiling of $2.30, a suggestion denied by Richardson in private conversation with Howe on 22 Feb. Although, as the Governor later said, a "conscious choice was made to hold the level of MLR" in Feb 1980, monetary overshoots left the possibility that the authorities might find their hand forced, in which case there would have been fiscal consequences for bank profits, as Howe warned the Governor on 14 Mar: "He said flatly that if they did go higher he believed it would be politically impossible to avoid a tax". There was then a further period of weakness, Feb-Apr 1980 (the low point for the year was $2.15 in early Apr), before the final, steady rise through the $2.20s and 2.30s till the peak of $2.4645 on Friday 24 Oct 1980. In real terms the rate had risen more than 25 per cent since the election. RPI peaked at 21.9 per cent in May 1980.

For the following nine months sterling fell more or less continuously. With more than half an eye on the exchange rate, MLR was cut by 1 point on 3 July - with strong encouragement from the Bank, Howe opposing a bigger cut on RPI grounds - and a further 2 points on 25 Nov 1980, neither move wholly justifiable within declared policy as Howe privately acknowledged (0f which more below). Another part of the Bank's purpose here was to encourage market expectations that rates were headed down, thereby promoting gilt sales and, via 'overfunding', reducing growth of £M3, which was overshooting chronically. Indeed, following the abolition of the corset in June 1980 reintermediation rendered policy almost threadbare, monetary targets being massively missed - £M3 "had grown grotesquely", the Governor admitted to Howe on 4 Aug, McMahon dropping in a word for M1.

The rate fell to $2.37 by year end and was at $2.23 on budget day, 10 Mar 1981 (DM4.69, 98.6 ERI as rebased in Feb 1981). RPI exhibited a similarly downward trend: at 12.6 per cent on budget day it had fallen 9.3 per cent from the peak of 21.9 in June 1980 (though it made little further progress during 1981, ending the year at 12 per cent). By early August 1981 sterling was down to $1.80, with the Volcker squeeze in Reagan's first year playing its part, the US Federal Funds Rate peaked at 20 per cent in Jun 1981. MLR had to be increased from 12 to 14 per cent on 16 Sep 1981, reversing the cut on budget day, and by a further two points only a fortnight later. Sterling hit its 1981 low of $1.79 on 24 Sep, but recovered into the $1.80s during October, permitting half point MLR cuts on 14 Oct, 10 Nov and 3 Dec. At year's end MLR stood at 14.5 per cent and sterling was trading at $1.91 (DM4.30, ERI 90.9).

No great attention within government was given to the EMS in these years. In an early meeting with the Governor (16 May 1979), Howe predicted that "political imperatives could inexorably drive the Government to participate in the exchange rate mechanism - as an earnest of its commitment to Europe and the means of making progress on the problem of our net contribution". But this had no immediate significance for policy. It quickly became apparent that EMS membership would win no tricks in the European budget argument and MT's hostility was a large obstacle, apparent from the very beginning of the EMS in 1978/79 when she was Leader of the Opposition. Briefing the Governor for another meeting with Howe on 16 Jan 1980, the Bank's executive director for home finance, John Fforde, wrote: "HMT wants to push EMS well into the future. FCO does not."

The Governor himself firmly favoured EMS membership, partly because there was no alternative monetary framework that he considered satisfactory, partly because he felt we would have more leverage over European monetary policy than we had over that of the US. Generally, opinion at the Bank was more divided, some stressing conflict between monetary targets and an exchange rate regime, others noting that some EMS members had "serious monetary targets". Faute de mieux the Bank favoured a discretionary regime enabling the exchange rate to be taken into account. But it had neither means nor desire to drive the pace on this question.

1979 nov - 1980 Mar: Monetary Base Control green paper

Following the Nov 1979 measures, the Bank began drafting a Green Paper on MBC, building on work done for a Quarterly Bulletin article earlier in the year. Care was taken to leave a number of issues open - EMS membership, the future of monetary targetting. The Bank attempted not to reach a wholly negative conclusion on MBC. But a good summary of its true position can be found in an internal document by Fforde, who described contemporary debate over monetary policy as "either a waste of time or an exercise akin to Potemkin's construction of villages". The price mechanism generated politically painful results, he thought, but it was the only real way for the Bank to control monetary expansion in "one of the two broadest wholesale money markets in the world". For him MBC was an attempt to evade this hard truth, as was the whole creaky apparatus of direct controls, actual (e.g., the 'corset') or projected (e.g., inflow controls). Some of his colleagues perhaps saw a function for direct controls on a fire-fighting basis, but otherwise this seems to have been pretty much the collective wisdom at the Bank.

Although Treasury ministers were keen to see MBC thoroughly explored - Middleton detected from Nigel Lawson a wind blowing in that direction as early as July 1979 - any great hopes they might have had for MBC at this stage seem to have been squashed by the Bank's arguments, which carried weight in substance but also because they came from the institution that would be charged with implementing the policy, atheists making bad bishops. In Jan 1980 Howe thought it was possible MBC "would help the authorities to live with their problems a little more easily, even though it would not solve them", but even this much was uncertain and he was clear that the Green Paper should leave the question genuinely open. Papers the same month suggest that Lawson no longer saw any value in MBC and was increasingly focussed on the PSBR and the introduction of indexed gilts. And certainly the official Treasury seems to have been unenthusiastic, notably Peter Middleton. That said, Treasury minds were not absolutely closed and a step towards MBC, and particularly towards automaticity of rate setting, received a further look later in the year, not least because interest rate changes (like monetary policy generally) were such politically fraught topics with No.10. For similiar reasons greater automaticity was almost the only aspect of MBC in which the Bank itself saw any merit. One of the arguments which it made with most conviction was that MBC would be unworkable unless ministers were really prepared to relinquish control of short-term rates.

When published at the time of the 1980 budget, the Green Paper drew a mixed response from supporters of MBC - Friedman was strikingly rude about it - but MT's interest in the concept seems not to have been diminished. Formally, a process of consultation now began, involving seminars of academic economists and "foreign monetarists", as the Bank termed them. From the Prime Minister's point of view the question of whether to move to MBC remained open, though perhaps increasingly nominal, well into 1981 (and the hankering for it never went away). She may well have seen a tactical value in keeping MBC alive, pressure from No.10 for direct controls of one kind or another over the coming year probably gaining some traction from the lurking threat. For example, during winter 1979/80 the Treasury worked up contingency plans to introduce consumer credit controls in case the politicians decided further increases in MLR required that they show that consumers were sharing the pain being heaped on industry and mortgage holders, the relevant official cheerfully describing the plans as 'nonsense' in a chat with the Governor. Howe and Lawson could see the problems, but conceded that they might simply have no choice politically. There were similar arguments as to whether to introduce two-tier interest rates and inflow controls. Albeit for different purposes, there are hints that Treasury ministers may also have found MBC a useful lever in their dealings with the Bank. At the end of the year Middleton reflected, chatting with Fforde, "that officials found it very difficult indeed to weave the wide variety of Ministerial wishes into a coherent and internally consistent fabric".

1980 mar: howe's second budget & THE MTFS

The centrepiece of the 1980 budget was the publication in the Red Book of the Medium-Term Financial Strategy (MTFS). Work on this began well ahead of the MBC Green Paper, with the Treasury leading. Nigel Lawson's memoirs record that it would have been ready for publication as early as Nov 1979 had it not been for internal Treasury opposition, which included Wass and Atkinson (the outgoing Chief Economic Adviser). Instead a seminar of "outside economists" sympathetic to the idea was held on 5 Oct 1979, including Burns (shortly to succeed Atkinson), Budd, Congdon, Griffiths, Minford, Pepper and the stockbroker Tony Rudd, a group at least three of whom known to have the ear of the PM, who had her doubts about committing to published targets, stoked by Biffen who angered Howe by voicing similar views in a letter to her. It is often said that one of the functions of the MTFS was to help maintain cabinet cohesion behind an austere financial stance. It is perhaps also true that the Treasury began to see advantage in checking the tendency for No.10 to seize the steering wheel on tricky bends. The Bank was sceptical throughout the process, with Goodhart unimpressed by the academic work underpinning the MTFS (a view widely shared among his colleagues) and the Governor warning against the 'rigidity' of the targets and the danger of adopting "a posture of complete inflexibility" in case wages did "not accommodate to the declining monetary path". The Bank maintained resistance to within weeks of publication in the 1980 Red Book. The final decision to go ahead was taken at a meeting between MT, Howe and Richardson at No.10 on 7 March 1980 in which the latter's objections were firmly overruled, MT telling him that "she hoped that [he] would be able to live with this".

The MTFS offered a target range for £M3 growth starting at 7-11 per cent in 1980/81 (based on Feb 1980) and descending by 1 per cent per annum to 1983/84 (4-8 per cent). A not much-noticed but heavily pregnant footnote to the table remarked: "As the Green Paper on Monetary Control (Cmnd. 7858) explains, the way in which the money supply is defined for target purposes may need to be adjusted from time to time as circumstances change". On the fiscal side, there was a projection for PSBR (explicitly not a target), with the commitment that "Fiscal policy will be operated so that the PSBR for any particular year will be consistent with declining monetary growth in the particular circumstances of the time". An "implied fiscal adjustment" suggested room for significant tax cuts in the last two years of the Parliament. Public spending was predicted to fall below 40 per cent of GDP by 1983/84 on a cautious expectation of 1 per cent growth.

Aside from MTFS, Howe's second budget was far less dramatic than the first. At one stage reform of capital taxation might well have been a central part: in December the Treasury was proposing abolition of the Investment Income Surcharge and significant reductions in Capital Gains and Capital Transfer Tax, but the proposals were abandoned on grounds of cost (full year £600m) and a lesser package fell foul of MT, who took up a warning from David Wolfson to beware a cry of "another give-away to the rich", although on a second front she fought doughtily to protect the company car. Direct tax changes brought anxieties from No.10 when Howe warned that he would abolish the 25p reduced rate band levied on the first £750 of income to fund full uprating of income tax thresholds (18 per cent). That only got approval when he was able to show that redistributive effects were defensible. Even so, it was central to the budget that individuals should bear more of the burden, given real income growth of 3 per cent over the year, and full indexation of tax and benefits was not contemplated. North Sea oil was again tapped, through an increase of PRT from 60 to 70 per cent. A levy on bank profits was considered but ruled out, perhaps narrowly, Howe warning the Governor on lines already noted. More helpfully to the banks, Howe used the budget to announce that the corset was finally to be cast off in June 1980.

Whether the difficulties of the non-oil manufacturing sector should be addressed in the budget was the subject of an internal argument in the Treasury, Burns and Middleton predicting a situation for exporters as bad as 1974-75 and urging a signficant cut in the National Insurance Surcharge, financed from the oil sector. Interestingly MT got hold of their paper and read it carefully, at Lankester's suggestion, only to be told by the Chancellor's Private Secretary - in a comprehensive demolition - that the "balance of opinion" in the Treasury was that a serious NIS cut would involve increases in personal taxation, that the situation was not as bad as suggested and that the budget should aim not to help industry but to avoid making things worse. On an altogether smaller scale, the budget announced the first 'Enterprise Zones'.

The PSBR in 1979/80 overshot by just under £1b (£9b against £8.2b, 4.75 per cent). The aim for 1980/81 was £8.5b, or less than 4 per cent. The Governor of the Bank later complained to Douglas Wass that ministers had quietly led the press to expect such a figure and so wasted the opportunity to outperform market expectations, which were of £9b or more. One begins now to hear among MT's advisers a theme that grew progressively stronger over the coming year and which, they claimed, achieved full expression in the 1981 budget. John Hoskyns, head of the No.10 Policy Unit, told her on 12 March: "public expenditure cuts have not created enough manoeuvring space for anything but a tinkering Budget - redeemed, I hope, by a medium-term forecast. There must be a strong possibility that we will have to do something else on more Hayekian lines some time in the next year (ie along the lines of the 'shock package' I suggested in January)".

1980 mar - dec: swiss influences; carpeting the bank; nov 1980 measures to cut mlr

After the budget sterling resumed its long climb into the $2.40s, reached in early September 1980. Inflation peaked at 21.9 per cent in May, falling a full four points when the 1979 VAT increase dropped out the following month. As noted, with the abolition of the corset in June reintermediation placed ever more pressure on the monetary framework, dramatically bad £M3 figures feeding speculation as to further MLR increases, although in Oct 1980 McMahon offered the Governor the Bank's preferred view as to the source of the overshoot: "Taking the longer run, what appears overwhelmingly, is simply the erratic nature of the PSBR". On holiday in Switzerland MT continued her pursuit of alternative policies in conversation with the Swiss banking fraternity (who could reasonably claim to possess the only working example of MBC) and she lunched also with Karl Brunner in the heavenly surroundings of Lake Zug on 20 August, an informal meeting in the company of her one-time constituent, Yehudi Menuhin. Brunner warned MT against the wicked ways of the Bank and suggested two economists she might employ as a personal adviser, one of them Alan Walters. Her reply was: "he has already agreed to come".

Returning from Switzerland, MT summoned Richardson. There followed a series of meetings of the most uncomfortable kind, legendary in the history of the Bank, in which the Governor and his chief officials were interrogated in punishing style and thoroughly told off for subverting the monetary policies of the elected government. "He is feline, she is canine", someone once said of the relationship between Governor and PM. After a particularly painful encounter Richardson rang Lankester to receive reassurance: "This sort of thing has happened before both on the foreign and the domestic side and the Governor should not be alarmed about it". Pressure on the Bank was also coming from the Treasury, however, as Lankester told MT on 26 Sept: "from conversations I have had with Peter Middleton and Terry Burns, I think they are determined to get some changes in the way the Bank controls the clearers. The worry is that the Bank dig their heels in; if they do, we will be faced with the difficult decision of whether to insist on changes, given that they have to operate the system".

Within the Treasury the level of sterling had become a preoccupation. A "Secret & Personal" note in the Bank's archive tells (on Ryrie's account) of a démarche to ministers by Wass, Ryrie and Burns on 22 September 1980 urging that they reduce MLR "on many grounds", requiring, to be credible, "action to reduce the PSBR" of which the centrepiece "would be a low ceiling for central government and local government pay". "Wass apparently argued most hawkishly but ministers, supported by Ryrie and Burns, were inclined to go for 8% or something near it", arguing that this would probably be in line with the private sector and so avoid the kind of catch-up problems usually generated by a freeze. An increase in employees' NICs was also receiving official thought, with ministers proving "very reluctant", Nigel Lawson preferring a purely monetary package, with indexed gilts, consumer credit and inflow controls the key elements. Many of these proposals finally reached No.10 in mid-November in a paper by Wass, Policy Options, which included an exchange rate target and a pay freeze across the whole economy. Also included was the earlier proposal to shift some of the tax burden from companies to persons, via NICs or the NI Surcharge - so much associated by now with its authors that Adam Ridley referred to it simply as "Burns-Middleton".

A package of financial measures emerged from these many and painful discussions, announced to the Commons by Howe on 24 Nov 1980, with the goal of providing a credible basis for a 2 point cut in MLR. It was always clear that this was quite a stretch. In the run-up to the statement Howe admitted to MT that the MLR cut might not prove possible or would need to be reversed, in which case "it would probably be necessary to announce a package of inflow controls to show that the Government was 'doing something', even though he did not think that they would have any significant effect". (MT had pressed for them, hoping to find a mechanism to sustain two-tier interest rates.) At the core of the statement was the admission of a £3b deterioration in the PSBR forecast since the budget, from £8.5b to £11.5b (5 per cent of GDP), much of it due to the poor performance of the nationalised industries whose EFLs were significantly raised. A disappointing outcome to the annual public spending review was acknowledged. On the revenue side, a new Supplementary Petroleum Duty was announced from 1 Jan 1981, raising £1b, and there would be a 1 per cent increase in employees' NICs from 1 Apr. On monetary policy, it was acknowledged that the existing £M3 target range of 7-11 per cent had been comprehensively missed - even allowing for post-corset distortions the annualised rate of growth Feb-Oct 1980 had been over 20 per cent - but the targets would not be raised, £M3 growth being expected to slow sharply over the remainder of the period. A new target would be announced in the budget. The Reserve Asset Ratio was to be phased out (long desired by the Bank). Notes by Lankester for PMQs included the following: "the strategy [MTFS] is not to be interpreted as a slavish and mechanistic concentration to the path of the £M3 statistic. We must look at other aggregates and also see what is happening elsewhere in the economy".

1980 dec - 1981 mar: reshuffle & genesis of howe's third budget

There are signs that government morale and cohesion were now beginning to slide even at the very top. At this time Keith Joseph very deliberately spoke in public of the government having had a "lost year": alerted to this by the Press Officer at Industry, Bernard Ingham replied: "I believe that [the Prime Minister] agrees with Sir Keith but for the sake of the Government and confidence in it does not say so". Although the MLR cut survived market reaction, Howe received a battering for the November statement in party and press, and it registered upon him. When John Biffen publicly distanced himself from the MTFS at a meeting of Conservative backbenchers on 9 Dec ("it is all a foreign tongue to me"), the Chancellor understandably resented it and made clear his concern to Ian Gow. Biffen's removal from the Treasury, shifted to Trade and replaced by Leon Brittan, was perhaps the most significant component of a surprise reshuffle on 5 Jan 1981, which also saw Francis Pym removed from Defence, paying the price for successfully blocking Treasury efforts to check defence spending in the 1980/81 expenditure round. The sacking outright of Norman St John Stevas sent an even blunter signal to the wets. But morale continued to fall among allies of MT. The published diary of John Hoskyns contains accounts in March 1981 of ministers generally thought close to her openly voicing personal criticism - Norman Lamont and Cecil Parkinson, for example. Gordon Reece warned MT to be ready for an approach from party grandees telling her to stand down.

An argument between the memoir writers has broken out as to the paternity of the 1981 budget - Howe and Lawson argue that it was a Treasury production, MT and Hoskyns that the Treasury's hand was forced by pressure from No.10 (newly beefed up by the arrival of Alan Walters), aided perhaps by the CPS-commissioned Niehans report. Hoskyns in fact is arguing that MT had to be pushed into it, by Walters, Wolfson and himself, the PM eventually siding with her advisers to decisive effect. A secondary dispute exists over the 2 point MLR cut announced on budget day, MT arguing, then and after, that the tightening of fiscal policy made possible an immediate and beneficial easing of monetary policy, the Treasury side responding that the cut was not essential to the success of the budget and pointing out that it had to be more than reversed within months, MLR ending the year half a point higher than at the time of the budget. This point is made against Walters as well as MT.

On one narrow but important issue, the records bear out the No.10 interpretation: at the end of the budget making process the Treasury really was pushed hard by No.10 to reduce the PSBR below £11b, and seems to have responded to the pressure, reluctantly freezing income tax thresholds to fund it. But the gap (£750m) was not large, comparatively, indeed well within the margin of forecasting error: the PSBR outturn for 1981/82 was £8.5b and, to offer a political comparison, Healey had called for a PSBR of £18b with a 4 per cent rate cut to round it off.

The argument about the MLR reduction is less clear, but there is more to it than the stark summary above, not least because a 2 point cut seems to have had strong support from the Bank, market expectations tilting heavily towards a cut between 2 and 4 per cut, to the discomfort of the monetary authorities. It is clear too that while MT was always wedded to the MLR cut, Alan Walters if anything leaned against one during most of the budget-making process, believing the PSBR insufficiently contained and that the best that could be hoped for was to avoid a future funding crisis and further increases.

Looked at more broadly, the Treasury's paternity claim has significant strength. In important respects the Treasury had arrived at the budget judgment independently and ahead of No.10, Niehans, etc, because the thinking behind the Nov 1980 measures - in the Bank as well as the Treasury - plainly anticipated and helped to shape the budget. By Nov 1980 both institutions had already reached the position that £M3 could not be controlled in the short-run, that it was a misleading indicator of monetary conditions, which were excessively tight by measures such as the real exchange rate, and that it probably responded perversely to rate increases (as a result of distress borrowing by business, for example). It was common ground between Treasury and Bank that a sustainable way now had to be found to reduce MLR within the existing framework of policy, which - assuming it was possible at all and that the markets were forgiving in the short run - meant a tightening of fiscal policy in large part at the expense of higher personal taxation, while preparing the ground for a reform of the framework itself.

On the monetary framework there was less agreement, the Treasury seeking to move towards a narrower monetary aggregate - perhaps a revived M2, but failing that M0 - the Bank preferring a discretionary approach. The Governor of the Bank had an unusually large number of meetings with the Chancellor in the run-up to the budget, evidently sensing the government's fading faith in £M3 and arguing for measures to reduce the level of sterling. The possibility of making monetary targets conditional on the exchange rate in some fashion was much discussed within the Treasury, with the consensus among officials that it would be best taken into account privately for fear of sliding towards an exchange rate target. There was a worry too that there might need to be a very substantial cut in interest rates to move sterling down. Such a change would be impossible to rationalise within the existing £M3 framework and there was a risk that if it was done, sterling might easily move too much, while relatively small movements in MLR (e.g., one per cent), and expectations thereof, had much greater impact on the market for gilts than foreign exchange. Greater automaticity of rate setting was agreed to be helpful by Bank and Treasury alike, decisions about MBC being put off for another day and Alan Walters seen off when he attempted to secure a commitment to move to MBC in the budget itself. In the longer run there lay the EMS, to which Howe, Lawson and Richardson were all attracted, though each for his own quite distinct reasons. For the immediate future, a tough budget was clearly envisaged from late Nov if not before, the 1980/81 PSBR continuing to deteriorate; by 11 Dec, barely a fortnight after the Nov statement, the forecast had increased by another £1b, to £12.5b.

Distilling the various memoirs & papers, the main events in the process of budget planning were these:

4 Feb 1981 (We): Howe minuted MT outlining budget plans. He anticipated a PSBR outturn for 1980/81 possibly as high as £14b, with 1981/82 forecast at around £11b, against £7.5b implied in the MTFS. The Treasury was then aiming for a PSBR somewhat under £10b, requiring a net £1-1.5b budget reduction, most of which would have to be achieved by tax increases, given the experience of the last expenditure round. An increase in VAT was ruled out. The basic rate of income tax would not be touched, but thresholds would be increased well-below the rate of inflation - perhaps 6 per cent as opposed to 15 per cent, or 9-10 ideally. There would be perhaps a double revalorisation of duties. Burns-Middleton was now given the nod, thanks to CBI pressure in large part, though expensive in a full year and poorly targetted. A bank levy (long in the offing) was now a firm proposal. Walters urged a somewhat larger reduction in PSBR, though not dramatically so.

10 Feb 1981 (Tu): MT met with Howe, Wass, Burns & Walters. The 1981/82 PSBR was now forecast at £13b. Howe suggested 6 per cent increase in thresholds, MT urged against the NIS cut, preferring a lower PSBR. No decisions were made, but Walters afterwards began arguing that the extreme volatility of PSBR forecasts and outturns required a budget judgment that did not leave a need for further measures during the year, as had happened in 1979 and 1980, forcing up rates and threatening a funding crisis.

12 Feb 1981 (Th): Professor Jurg Niehans presented his report to meeting of economists at Admiralty House - argued sterling overvalued due to excessively tight monetary policy, not North Sea oil. Also urged intervention to lower sterling.

13 Feb 1981 (F): MT met with Howe, Wass, Burns, Walters, Hoskyns & Wolfson. Howe gave a PSBR forecast of £13.5 - 13.75b - a deterioration of £500-750m in just three days - and proposed a package of tax increases to bring it to £11.25 or £11.5b. Below £11b he did not think it possible to go. Walters argued for a PSBR of £10b or so (anticipating overruns), financed by an increase in the basic rate of income tax. MT and Howe both rejected this. Hoskyns and Walters concluded MT was ducking a 'draconian' budget.

17 Feb 1981 (Tu): MT met with Howe, who now said he was minded to increase the basic rate by 1p in order to raise allowances by 10 per cent rather than 7.5 per cent, thus protecting those on below average earnings. MT agreed, though urged PSBR below £11b. MT cancelled a meeting with Walters, Wolfson & Hoskyns, who spent the evening "discussing how we were going to bring her to her senses, recognising that we were all going to have to resign quite soon" (Hoskyns diary)

18 Feb 1981 (w): Coal strike averted by government climbdown over NCB closure programme. Terrible press the following day.

23 Feb 1981 (M): Joint minute from Walters, Wolfson & Hoskyns urging MT to seek tougher budget, following similar effort on 20 Feb

24 Feb 1981 (Tu): MT met with Howe and Wass. (Walters apparently absent on other business [?what could have been more important than this], although he seems to have met her separately at some point during the day and argued for a lower PSBR, and left feeling she did not accept his case.) Howe still arguing for a £11.25b PSBR. MT responding that at that level MLR could not be reduced. Urged instead £10.5b with MLR cut, financed if necessary by a 1p increase in the basic rate of income tax. Howe now rejected an increase in the basic rate (MT accepting his judgment) and argued that a PSBR of £11.25b was acceptable (which she did not accept). Hoskyns diary: "… In the afternoon we heard (Alan told by Tim) of an amazing volte-face by MT. She started swinging back, in a budget bilateral with GH and Douglas Wass, to the need for a smaller PSBR and perhaps to raise income tax (so our onslaught bears fruit at last?) Then she says that this is their problem (because GH and DW have said it's politically impossible), it's up to them. Then, as they leave, she says words to the effect, 'If there's a funding crisis, then you (GH) are for the chop'. What she should have said, as Norman said, was, 'and so are you, Douglas'." After dinner Ian Gow and Keith Joseph called on Howe at Commons urging lower PSBR (Hoskyns diary 25 Feb).

25 Feb 1981 (W): Howe met with MT unscheduled just before she left for Washington (her first visit with Reagan as President). Announced he would aim for £10.5b PSBR financed by freezing of income tax thresholds rather than increase in the basic rate.

3 Mar 1981 (Tu): Not privy to budget details, Walters, Wolfson & Hoskyns compose joint resignation letter - never sent.

6 Mar 1981 (F): Final decision to go ahead with 2 per cent MLR cut on budget day

10 Mar 1981 (Tu): Budget. Prior strongly objected in Cabinet, but not well-supported. Detail of budget:

30 Mar 1981 (M): 364 economists wrote to The Times

links: documents on this site & other sources

Short list of relevant archive documents on this site

Long list of relevant archive documents on this site


MT memoirs on the 1981 budget

Lawson memoirs on the 1981 budget

2006 IEA 25th anniversary seminar on the 1981 budget (including Terry Burns)


1979-81 sterling vs dollar (graph)

1979-81 unemployment (graph)

1979-81 RPI (graph)


Lombard Street Research