Inflation is Caused by Governments

Preston, September 5 1974

Inflation is threatening to destroy our society. It is threatening to destroy not just the relative prosperity to which most of us have become accustomed, but the savings and plans of each person and family and the working capital of each business and other organization. The distress and unemployment that will follow unless the trend is stopped will be catastrophic. There is a risk moreover that political parties which preside with well-intentioned ineffectiveness over such a universal frustration of expectations will pave the way for those who will offer solutions at the cost of freedoms.

[Footnote: The Current Inflation. Harry G. Johnson and A.R. Nobay (eds.), Macmillan, 1971. Inflation: Economy and Society: Twelve Papers by economists, businessmen and politicians on causes, consequences, and cures. Institute of Economic Affairs, 1972.]

It has happened elsewhere.

[Footnote: German 1923, Hungary 1946, China 1937 and 1949, Brazil 1960, Indonesia 1948–67; Notes on Three Typical Hyperinflations, P.B. Lilley. W. Greenwell & Co., 1974.]

It could happen here. Our proud achievements, our great history, our still superb national talents do not render us immune to the processes of despair and disintegration which ultimately invite dictatorship.

Our fate lies in our own hands. If we recognize the nightmares which galloping inflation brings, we can abate it. It is a question of priorities. Mr. Heath and Mr. Carr and all of us say that inflation is the most important issue before the country. We say this, not only because inflation destroys jobs by destroying employers, not only because it savages the vast majority of our population in their savings and plans, but also because all other social and economic objectives will be lost unless inflation is abated. Growth, social peace, full employment, regional balance, social services – no one of these aims can be sustained if inflation is allowed to continue at its present or anything like its present pace.

But, you may ask, if inflation is so pernicious, why was it allowed to get a grip in the first place? Why did successive governments for the last score years, led by well-intentioned and intelligent people advised by conscientious officials and economists, take a course which led inexorably and predictably to the present nightmare? I say predictably, because there were warnings as far back as 1950, charting with painful accuracy the course on which the country embarked.

Political and economic historians will pronounce in due course. As a participant in the process, I may lack their perspective. But at least I know how things seemed to us, why we acted as we did, and with the vision of hindsight where we went astray. So, as a participant, [end p1] retracing my steps seems the best introduction to the problem.

I begin by accepting my full share of the collective responsibility. It is not right for government to claim credit for what goes well unless they accept their share of the blame for what goes badly. For over the past 30 years governments in this country have had unprecedented power over economic life. It is only fair that we should accept correspondingly heightened responsibility for what has gone wrong.

A Self-inflicted Wound

In retrospect it seems to me that inflation is largely a self-inflicted wound. I once believed that much of our inflation, particularly recently, was a product of rocketing world prices – and they certainly made things much more difficult – but they are not the dominant cause. In general terms you could say that inflation is the result of trying to do too much, too quickly. In more specifically economic terms, our inflation has been the result of the creation of new money

[Footnote: In 1972 and 1973 the annual increase in M3 was 15 and 25 per cent.]

– and the consequent deficit financing – out of proportion to the additional goods and services available.

When the money supply grows too quickly, inflation results. This has been known for centuries. Until a few years ago I should not have had to labour the point. Now an influential group in Whitehall, Cambridge and the National Institute of Economic and Social Research seem to deny the proposition. I had understood that the laws of supply and demand are basic economic truths. Certainly, Maynard Keynes recognized that excessive creation of money is inflationary.

[Footnote: The General Theory of Employment, Interests and Money. Macmillan 1936. Chapter 21.]

I should here emphasize that changes in the relationship between demand and supply do not instantly effect prices and employment. There is a time lag of many months, or even as much as a year or two.

It has always been known that to create too much money – “excess aggregate demand” is what the economists call it – is to court the danger of inflation. But government after government chose to take the risk, for several – in themselves not ignoble – reasons. The assumptions were probably always the same; that the inflation would only be mild; that it could be stopped; and above all, that mild inflation seemed a painless way of maintaining full employment, encouraging growth and expanding the social services – all highly desired objectives. We see now that inflation has turned out to be a mortal threat to all three. In this speech I am concentrating on employment. I shall discuss growth on another occasion.

Incomes Policy No Cure

It was feared that the apparently high levels of unemployment and the low rate of growth which resulted whenever sound money policies were essayed would create intolerable social and political tensions. Experience has shown that far more menacing tensions are generated by inflation itself and that, in circumstances of excess demand, they cannot be cured by incomes policy.

[Footnote: A Brief Survey of Price and Wage Controls from 2800 BC to AD 1952, Robert L. Schuettinger, The Heritage Foundation, 1974; Rise and Fall of Incomes Policy, F.W. Paish, Hobart Paper 47, IEA, 1971. Incomes Policy Phase Four Sir Richard Clarke, Manchester Business School, 1974.]

[end p2]

With the wisdom of hindsight – and if we do not all have the wisdom of foresight, let us at least have the wisdom of hindsight – I now see that any effective incomes policy must be based on sustaining the overall balance between demand and supply. By this I mean demand for and supply of goods and services at a level of full employment which can be sustained. If supply and demand are not in balance, if money is being pumped into the economy at a faster rate than the growth of goods and services, no incomes policy can conceivably mitigate inflation, let alone prevent it.

Even if the administrative and political power of government can hold down wages in some sectors inflation will emerge with redoubled force in other sectors less susceptible to control. We have seen the process at work – some wages controlled (with difficulties and distortions) while house prices, interest rates, and pay which cannot be controlled of people like building workers, secretaries, engineers on piece rates, all rocket. Let us not forget the understandable outrage and the widespread resentment at the soaring rise of property values – a by-product of inflation – felt by those whose income was held down. The property values have since been eroded, but the resentment remains.

Incomes policy alone as a way to abate inflation caused by excessive money supply is like trying to stop water coming out of a leaky hose without turning off the tap; if you stop one hole it will find two others. We tried incomes policy – more than once; Labour tried incomes policy. The great and the good favoured it – and many still do. But bitter experience reinforces elementary economic logic – with excess demand it will not work. All this I spelt out when winding up the debate on the Pay Board for the Opposition on July 18 this year. The all-party Parliamentary sub-committee came recently to the firm conclusion that incomes policy is neither desirable nor workable. I wish their admirable report and the evidence on which it was based were widely read and digested.

[Footnote: Public Expenditure, Inflation and the Balance of Payments, HC 328, HMSO, 1974.]

But long before this year, we knew all the arguments. We had used them in Opposition in 1966–70. Why then did we try incomes policy again? I suppose that we desperately wanted to believe in it because we were so apprehensive about the alternative: sound money policies.

The Shadow of Unemployment

To us, as to all post-war governments, sound money may have seemed out-of-date; we were dominated by the fear of unemployment. It was this which made us turn back against our own better judgment and try to spend our way out of unemployment, while relying on incomes policy to damp down the inflationary effects. It is perhaps easy to understand; our post-war boom began under the shadow of the 1930s. We were haunted by the fear of long-term mass unemployment, the grim, hopeless dole queues and towns which died. So we talked ourselves into believing that these gaunt, tight-lipped men in caps and mufflers were round the corner, and tailored our policy to match these imaginary conditions.

[end p3]

For imaginary is what they were.

[Footnote: How Much Unemployment?, John B. Wood, Research Monograph 28, IEA, 1972.]

There never was serious unemployment since the war on anything remotely like the scale or conditions of the 1930s – and could not have been had we not seriously debilitated the economy by prolonged inflationary policies.

Since the war until this present critical period there has been virtually no unemployment on Keynesian terms on a national as opposed to a regional scale. For practically the whole period we have had full employment on any meaningful yardstick. Indeed, for much of the time we have had negative real unemployment, that is a shortage of labour – what you might call fuller-than-full employment.

But you will ask, how do I square this with the monthly unemployment statistics which receive banner headlines and strike gloom into politicians hearts – 500,000 – 600,000 – 800,000 – fears of one million unemployed? Is this not ample justification for reflation – for spending our way out of unemployment – as Keynes is said to have prescribed in those days when he overthrew classical economics?

No, it is not. And if we wish to fight the battles of the seventies with the weapons of the thirties we would do well to find out what was actually said and done in the thirties, not least by Keynes himself. We owe that much to the memory of a great man.

Unlike many of his followers Keynes was discriminating in his definitions of unemployment.

[Footnote: Lord Kahn, “Unemployment as seen by the Keynsians”, Proceedings of the Durham Conference, 1974. Royal Economic Society. [To be published soon]

He never dreamed of aggregating all categories of registered unemployed as a basis for prescribing policies. On the contrary, he stressed, and all reasonable men in his day accepted, that there were widely differing phenomena included under the umbrella term “unemployed”, and that each needed its own specific treatment. What helped one kind, would not necessarily help another, and could even harm.

Categories of the Unemployed

First, Keynes recognized that there was temporary unemployment. He called it “frictional”. Men left one job – or it left them – on Friday afternoon; they would rarely be in another by the following Monday morning. Nor would they necessarily take the first job offered. They would shop around, they might even take a few days' additional holiday. The more jobs going, the longer they can afford to look around. They have savings, there is unemployment benefit, there are tax repayments, in a number of cases there are redundancy payments. At most times in recent years, frictional unemployment as variously defined will have accounted for a quarter to a third of all registered unemployed.

Then there is a whole spectrum of people who are not easy to place or keep at work. They range from the inadequate who need help, through the “difficult to place” – due to age or ill-health or other factors – to the actual scrounger. A recent study reported in the Monthly Gazette of the Department of Employment – March issue 1974

[Footnote: Characteristics of the Unemployed: Sample Survey June, 1973.]

– describes a part of this group as “somewhat unenthusiastic in [end p4] their attitude to work” and estimates that the voluntary unemployed – as this whole collection of groups is known – in total accounted for a third of all registered unemployed over a period.

Here again I am not suggesting that we should be complacent about this situation. It is bad for society, bad for the economy and demoralizing for the people concerned, especially for children who grow up in such an atmosphere. What we can do about it is another matter. We have probably not made the problem easier by raising the relevant benefits. They have risen over a period of years from about a half to over three-quarters of the net average income of a breadwinner with a wife and three children.

[Footnote: Social Trends No.4, 1973, HMSO. Table 47.]

As the scale has risen, we have increased the proportion of relatively low earners with large families who would be better off unemployed, and of the many more who would scarcely be any better off if they were at work. In the light of this, we should express admiration for the hundreds of thousands of lower-paid workers with sizeable families who resist the demoralizing influence of our well-intentioned welfare system and go on doing a fair weeks work regardless.

We should be gratified that the actual scroungers – however infuriating – constitute such a relatively small proportion of the labour force.

[Footnote: Report of The Committee on Abuse of Social Security Benefits, Cmnd 5228 1973.]

I was nearly four years at the DHSS and found no tolerable way of doing much about this small but costly minority. But the answer certainly does not lie in increasing the money supply.

Just as the frictional unemployed merges into the voluntary, so the voluntary merges into what Keynes called “hard-core” and we sometimes call “unemployables.” They are people who cannot obtain or hold down a job even if they try. Some are not up to it physically, some mentally or temperamentally, quite a few are elderly. Some are in and out of prison. Here again, we should not give up our efforts to rescue these people wherever possible and help them become productive members of the community. But creating excess demand for labour by printing money is certainly no way of doing it.

Then, there is fraudulent unemployment, that is to say, people who draw benefit while earning money. There is evidence of this in casual occupations like the building industry. It helps explain why at one period the statistics showed 100,000 unemployed in the building industry while builders all over the country complained of a labour shortage. There are the drifters and hippies who draw “welfare” but engage in activities to earn money, legal or illegal. From time to time the Ministry carries out local checks, and suddenly the number of registered unemployed melts away. How many fraudulent unemployed there are at any given time can only be estimated, but they probably account for at least a tenth of the registered unemployed at normal times. We ought to do more about such people, but expanding demand will not turn them into honest men.

Another group, which accounts for half the non-manual unemployed, consists of white collar workers compulsorily retired at 60 with occupational pensions but required to stay on the register till 65 if they [end p5] are to be excused the national insurance contribution and still be entitled at 65 to the retirement pension. And at some times in the year students seeking temporary jobs in the vacation appear on the register.

Only when we have deducted all these categories, the frictional – say up to eight weeks between jobs – the unenthusiastic, the unemployable, the fraudulent and the elderly who are obliged to register – do we have the real involuntary unemployed in the Keynsian sense, that is to say people who are both willing and able to work and who have been unemployed for over eight weeks. During the post-war period, their numbers will have fluctuated between 100,000 and 300,000 or so. They tend to be unskilled, semi-skilled or less skilled, older than average, and a substantial proportion of them are in the less prosperous areas.

[Footnote: Wood , J.B., op.cit.,]

Labour Shortages

Now as against these, there have been something like a million unfilled vacancies for most of the period; it has only rarely dropped below 600,000. As the Department's own statisticians recognize, vacancies registered with Employment Offices account for about a quarter to a third of all vacancies. These are, for the most part, vacancies in the sort of job at the kind of pay and conditions which keep these jobs substantially though not fully manned. Everyone can give examples: there is the building industry, public services all over the country – transport, hospitals, driving – including London; steel works and shipbuilding in Scotland and the north east of England; many engineering works. All these labour shortages co-exist with large numbers of registered unemployed and much smaller numbers of involuntary unemployed in a Keynsian sense.

It is therefore quite fair to say that for almost the whole of the postwar period there were on a national basis several times as many real vacancies as involuntary unemployed, to use Keynes' term. We have had most of the time fuller than full employment, we have had nationally an overall shortage of labour.

How otherwise should we have been able to absorb over one million workers from overseas? Most of them have been unskilled or semi-skilled, as were the majority of our registered unemployed. If so many could find work at any given time, there must have been work.

Paradoxically the self-same Socialists who constantly criticize the allegedly high level of unemployment over the years have continued simultaneously to justify Commonwealth immigration on the grounds of a labour shortage.

Throughout the period, a disproportionate number of the involuntary unemployed have been in the development areas. These deep pockets of unemployed cannot be floated to work by any conceivably practicable level of national demand. That is why we use regional policies; that is why we use training and re-training schemes – the Conservative programme for training was the largest and most ambitious ever;

[Footnote: The Campaign Guide 1974, pp 156–176, Conservative Central Office, 1974.]

that is why we use local development schemes and encourage mobility of labour and youth employment projects – all to reduce unemployment [end p6] in the black spots. In recent years, we have had more serious pockets of unemployment in the midlands and south east too.

We should indeed be concerned about each one of the different groups. Each group and each sub-group raises different problems which we should try to solve for social as well as economic reasons. We should not become reconciled to the current or higher rates of unemployment – frictional, structural or regional, voluntary or fraudulent. On the contrary, in the quest for individual self-respect and economic health, we should try to ensure that as near as possible the whole labour force is employed.

Alas, since the war successive governments have allowed all sorts of rigidities and obstacles to grow up which make this harder than it need be

[Footnote: Economics and Economic Policy in Britain 1946–1966. T.W. Hutchison, Allen and Unwin, 1968; State Intervention in British Industry, 1964–68, Frank Broadway, Kaye and Ward, 1969.]

– but on that I will talk another day. What I am saying now is that every form of unemployment needs its own specific treatment – and that we have brought upon ourselves over the last 20 years' desperate inflation by too often expanding demand above supply as the single cure for a whole variety of forms of unemployment. This panacea has helped to bring about just the very evils that we feared.

Over-reaction to temporary recessions

Now from what Keynes wrote it seems likely that he would have disowned most of the allegedly Keynsian remedies urged on us in his name and which have caused so much harm. His thesis was that even when there was large-scale medium and long-term involuntary unemployment, the proper way of dealing with it would not necessarily be to increase the money supply or demand.

He placed greater emphasis on achieving better distribution of demand rather than increasing it, different techniques for depressed areas or branches of industry.

So much for what Keynes advised. What was said and done in his name has been quite different. For much of the past 20 years, successive governments, faced with a rise in registered unemployed, have deliberately increased public sector spending. This has been financed not by real savings but by Bank of England operations.

Every time successive governments have tried this policy it has been brought to a forced halt. This has usually been through a sterling crisis, which itself has been a result of excess demand at home. Of course, in a boom all kinds of unemployment are for a brief period reduced. But the boom is a cruel deception on those whom it is designed to help. During its course people do find jobs more easily than they otherwise would. But these are short-lived. The other side of the coin is that there are grave shortages of labour (and therefore goods) long delivery dates, waiting lists, increased imports and all the rest of the familiar troubles. Sterling sinks and import prices rise. The jobs gained in the boom or “go” year have inevitably been lost in the next recession or “stop”. Wages and prices alike are much more sticky in the face of downward pressures than when market forces are pushing them upwards. The result is that the rate of inflation increases rapidly every time we [end p7] allow demand to overtake supply, but slips back only slightly during the subsequent brief recession. As for unemployment, the effect of these spurts of monetary expansion followed by drastic “stops” is simply to create cycles around an underlying level which has not improved but, if anything, deteriorated. And as each cycle progresses, the less efficient or skilled workers, the less efficient firms, the less economic areas find themselves in the same disadvantaged positions.

If the argument seems abstruse, just check it by the facts. In each upswing the rate of inflation has gone to higher levels – we used to think 5 per cent. very worrying. We would now regard 10 per cent. as an enormous change for the better. Unemployment on the other hand has, taking the good years with the bad, actually shown an upward trend. The effect of over-reacting to temporary recessions has been to push up inflation to ever higher levels, not to help the unemployed, but to increase their numbers.

Excessive Injections of Money

Thus excessive injections of money, undertaken by intelligent and enlightened men with good intentions, have wrought great havoc in our economy and society. The benefits have been largely temporary – and in any case cruelly reversed in the inevitable “stop” that follows, but the evil has lived on. In many Latin American countries, where inflation rates are very high and very volatile, the end results of budget deficits and credit creation are so well known that they cease to give even a temporary boost to output and employment. Their entire and immediate effect is on the price level. If a patient is given the same doses too frequently, his system will become immune.

Let me pose the choice with which successive governments have been faced on several occasions since the war. On the one hand, unemployment figures have risen by, say, a quarter of a million or even 300,000 to 400,000. As we have seen, unemployment statistics overstate the real number of involuntary unemployed – in the Keynsian sense – at this stage in the cycle at least twofold. Home demand is still in excess of supply; this is reflected in the level of balance of payments deficit and by the contrast between the numbers of involuntary unemployed and the real current vacancies – a multiple of those reported to Employment Offices.

On each occasion, the government – by which I mean almost every post-war government – has chosen to boost home demand by deficit financing, in spite of the virtual certainty that the additional balance of payments deficits generated would oblige them to call a halt fairly soon and thereby lose at least as many jobs as they were creating, while keeping the additional inflation.

My point is that (by logic of hindsight) on such occasions governments should weigh the short-lived – I repeat short-lived – benefits they may bring to a quarter of a million or even 300,000 to 400,000 men and their families, against the permanent – and I repeat permanent – repercussions of such deficit financing on the whole population of 55 [end p8] million people. All these 55m. people have on each such occasion since the war seen inflation increasingly stimulated and savings increasingly eroded.

If policies are to be judged by the criterion of the greatest good of the greatest number, then excessive expansion of the money supply has been tried and found wholly wanting, in practice and theory alike.

I may be told that making even temporary work for a few hundred thousand people is the top priority; that getting people off benefit and into temporary jobs will be, in 1975, more important than anything else. The condition of 55m. people is even more important. We cannot talk about fighting inflation as the over-riding priority and then in the same or another speech say that we can take no monetary action which might threaten some jobs. We cannot have it both ways.

Let me emphasize that I am not saying, have never said and do not believe that we need a certain level of unemployment to avoid inflation. I believe that full employment is compatible with stable prices, collective bargaining and a sound balance of payments. A healthy economy in a world with normal trade conditions should sustain full employment and all these other objectives. What I am saying is that it is the methods that successive governments have used to reduce registered unemployment – namely expanding aggregate demand by deficit financing – which have created inflation, and without really helping the unemployed either.

What we have to do is to set a level of domestic demand sufficient for that level of full employment which can be sustained without inflationary pressures, and then to work within it to deal with specific employment problems, while helping to soften the potentially harsh process of change by generous short-term unemployment, resettlement and retraining grants, and particularly by help to individual areas. In a basically healthy economy, it is much easier to deal with pockets of unemployment or depressed areas. Once you overheat the economy and create a “stop-go” cycle, all other aims are made more difficult to achieve.

Tightening the garrotte on industry

This is the background. I now turn to the present position and prospect. Both to reduce the balance of payments deficit and to slow down inflation, the previous government cut public expenditure in late 1973, and so Mr Healey was able to reduce the public sector borrowing requirement by £1,500m.

[Footnote: Estimates of public expenditure on goods and services in 1974–5 have been revised upwards by £550m.]

But the methods Mr Healey chose to achieve his reduced borrowing requirement were, either from malice or from misunderstanding, such as to intensify sharply the squeeze already imposed on employers generally by inflation and price control. The tax on profits was increased

[Footnote: Corporation tax for 1973/4 raised by 2 per cent. to 52 per cent.]

and companies were forced to pay tax a year ahead of time, when profits were already under heavy pressure from inflation. I explained in detail in my speech at Leith how companies are being taxed on profits which [end p9] do not really exist. The Chancellor chose to tighten this garrotte at a time when the cash needs of companies have never been so high, and the ability to meet them from the banks and the capital market never so constrained. This kind of budget may have bought Mr Healey some temporary popularity, but its legacy will be felt in our jobs and living standards for a long time to come.

Over and above the budget damage, industry has been having to put up with the anti-business, anti-profit attitudes of Ministers and the threat of state grab and state interference to every large firm. Mr Wilson may play down the centralizing, nationalizing intention while an election looms, but he will not have eased the anxieties of those who run our industries and are responsible for our exports, investment and employment.

The total effect of all these influences can be seen in the plunge in Stock Market prices.

[Footnote: The downward trend has continued. On January 6, 1975, the Financial Times Industrial Ordinary Index plunged to 146.0, the lowest since April 30, 1954.]

Some rich and very many not so rich people may have lost a lot of money; so certainly millions of ordinary citizens find their pensions and insurance policies at risk. But above all, a fall of this size reflects a catastrophic loss of confidence in business prospects. The losses of a few rich people will be no consolation to those who are going to lose their jobs because investment and expansion plans are cancelled for lack of finance which the Stock Exchange could otherwise have provided.

It is a fallacy to suppose that these hammer blows to confidence, to profits, to survival can be muffled by any number of budgets, mini or maxi, designed to increase “home demand” – even if we could afford such budgets when we are spending overseas every day £12½m. more than we are earning. The first necessity to restore confidence is for Labour to drop their vendetta against business and to treat it sensibly.

I have argued that there are strong forces working both for high and rising unemployment and for worsening inflation. The present slow upward trend in unemployment, disregarding seasonal influences, up by 36,000 adults in the last three months is likely to accelerate.

[Footnote: November 1974 total of unemployed in GB was 622,000. Because of a civil servants' dispute the December figures have not been calculated but an estimate of 700,000 would be regarded as true.]

The question that businessmen, trades unionists and economists are asking is not whether unemployment will go above a million, but how far above it and how soon. The self-same inflationary policies which have accustomed us to a two-figure rate of inflation are now facing us with the prospect of seven-figure unemployment into the bargain.

The Labour Chancellor, Mr Healey, certainly shares these fears about our future. He was sufficiently alarmed to introduce a reflationary mini-budget in July; and he has promised another for the autumn if he is still at the helm.

[Footnote: Third budget during 1974, announced on November 12, 1974.]

But he or his successor have small room for maneouvre. This country – with its inflation, its debts, and its dependence upon foreign credit – no longer has the option of spending its way out of unemployment. That way lies accelerated inflation, the decapitalization of industry, the disappearance of jobs, the loss of foreign confidence. If we try to solve our problem by printing money we will end up with Latin American rates of inflation and mass unemployment.

[end p10]

If Labour were re-elected, they could not escape these realities. They might try to insulate us from the rest of the world, to establish a siege economy. At best they would buy a few months at the price of much worse long-term damage.

Here again, we come to the time factor. By extending ever since the war government intervention we have increasingly politicized our economy. A result is that longer-term considerations have since the war often been subordinated to short-term political convenience. The old saying “not in front of the children” has become “not in front of the electors – at least until after the election”. But an election, even more than any other time, should be the occasion for thorough analysis of the main problem – its cause and cure. Now surely is the time for all who have views to explain them fully and clearly to the country – now before the electors are asked to make their decision. We shall be living here after the election and wish the country to be fit for our children and grandchildren to live in. Our present plight is in good measure the result of putting short-term political convenience so high. On several occasions over the past 20 years, Socialist exaggeration of unemployment levels, together with marches on Parliament, invoking the memory of the 1930s, has stampeded us into rash over-expansion with resultant price increases and economic dislocation. We must not be stampeded again.

What must be done

On all this I will end by making a few comments. First that inflation at its present pace cannot be abated entirely painlessly. Secondly, the cure by gradual abatement would be infinitely less painful than what would happen if we reflate as Labour now seems committed to do. Thirdly, there is one thing worse – far worse – than stopping inflation, and that is not stopping it.

It follows from these considerations that the next government should adopt a broad but gradualist strategy to phase out excess demand – and stick to it, refusing to be stampeded. That is essential. Because the money supply has been too sharply checked

[Footnote: Reduction of M3 from 25 to 15 per cent.]

there should within this general policy be scope for some necessary relief to the company sector and the jobs that depend upon it; this must be given soon, while we are working towards a non-inflationary monetary growth rate.

It is quite true that the growth in money supply was apparently sharply checked – and certainly the Labour budget has savagely withdrawn money from commerce and industry. But at the same time, the government has been increasing public spending, in relation to tax revenue. So the budget deficit

[Footnote: Currently running at £4,500m.]

, with all its inflationary implications, may not turn out to have been so much reduced as Mr Healey announced on budget day. But this in turn is likely to start off again the zig-zag movement of the money supply and of the growth of spending, from which we have suffered so much. The existing vast [end p11] overhang of money in the economy will continue to fuel inflation and the balance of payments deficit for many months to come. Thus, once again, fiscal and monetary policies are pointing in opposite directions – a sure recipe for disturbance and inflation.

But if we can in fact gradually start moderating the trend rate of growth of money supply – which entails also moderating the budget deficit – then the balance of payments deficit, and after a lag, the rate of inflation will start to ease. In due course, and without any artificial stimulus or reflation, spontaneous in-built correctives will begin to make themselves felt. The treatment that will gradually eliminate the balance of payments deficit and the treatment that will gradually abate inflation and the treatment that will gradually give us a firm basis for progress are all more or less the same. Then as domestic spending power is stabilized, exports and the replacement of imports will absorb some of the displaced labour – “redeployment”, as Mr Wilson called it in 1966. There will be jobs for others of those who are displaced in the public utilities which are crying out for more staff. Those who argue that even a minor curb on the trend of the money supply would generate deflation, lower real incomes and reduce investment, should be helped to realize that the effects they envisage would be largely temporary, while the economy adjusted to running at a lower but stable and soon generally expanding level of domestic demand. The first period of self-restraint by the Chancellor will be the worst, but it will be the beginning of the cure.

No one can be sure how long it will take to secure anything approaching stable prices and to reverse the downturn in employment. A great deal will depend on the attitude of the trades unions. They have it in their power, as Mr Heath emphasised, to price their members or fellow workers out of jobs; and no monetary or fiscal policy can prevent this. There is a case for an educational pay board, as I suggested in my speech on July 18th to spell out the implications. If the consequences for incomes and jobs of gradually reducing excess demand are to be understood and accepted, then we would be wrong not to use any instrument that could help in this process.

It may be that by measures of improved threshold agreement and by indexation of the tax system, we can allay some of the underlying worries. The whole issue of indexation, or insurance against inflation, needs to be debated much more thoroughly than democracy.

[Footnote: Four articles appeared in the National Institute Economic Review, November, 1974, pp. 38–75; Indexation of Fixed-Interest Securities, OECD, 1973; Monetary Correction, Milton Friedman, IEA, 1974.]

But it is no panacea, and if it were introduced as such it would do more harm than good. Escalator clauses will help only if total demand – money supply – is under firm control. We cannot expect any increase in living standards while we are in such deficit, so any cost-of-living compensation could not be complete while we are in this difficult phase.

If I had to give a personal guess about the total time horizon of a successful anti-inflation policy, I would say three or four years. A healthy economy – and more still an economy that needs to recover health – requires a reasonable time scale. Fine-tuning, quarterly budgets, short-term adjustments have not worked and will not work. [end p12] We have the most frequent budgets in western Europe – and the least successful economy. The time has surely come to turn for advice to economists, critical but constructive, who proved painfully right in their forebodings.

It seems to me that all this is common sense, though I know that some will label my line of argument monetarist. If this means that the growth rate of money spending must be gradually brought closer into line with the growth of our production, I will gladly accept the label. If it means that we need a long-term strategy to do this, without self-defeating changes of direction every few months, again I am ready to stand up and be counted. And surely more and more people are coming to realize that there is no hope of controlling the growth of spending if the government does not control its own deficit, especially if it allows that deficit to be financed by money creation by the banking system.

The monetarist thesis has been caricatured as implying that if we get the flow of money spending right, everything will be right. This is not – repeat, not – my belief. What I believe is that if we get the money supply wrong – too high or too low – nothing will come right. Monetary control is a pre-essential for everything else we need and want to do; an opportunity to tackle the real problems – labour shortage in one place, unemployed in another; exaggerated expectations; inefficiencies, frictions and distortions; hard-core unemployment; the hundreds of thousands who need training or retraining or persuading to move if they are to have steady, satisfactory jobs; unstable world prices. There is no magic cure for these problems; we have to cope with them as best we can.

This prescription will not be easy nor enjoyable. But after a couple of years we should be on to a sounder basis and be able to move forward again.

Conversely, if we do not get the trend of the increase of the money supply over the next few years on to a steady and low rate, more and even more rapid inflation will follow. We will destroy our monetary system; we will make all our existing problems worse – and will add as yet undreamed nightmares beside. Continued rapid inflation will destroy every plan and every prospect; jobs and savings will evaporate; society will be fractured. It was not for nothing that Lenin recommended inflation as the arch destroyer of what he called bourgeios democracy and we call democracy

[Footnote: The Economic Consequences of the Peace, pp 148–9, The Collected Writings of John Maynard Keynes, Macmillan, 1971.]

We need a government with strong nerves to set broad policy lines and stick to them. Then we can recover our footing, and then the road to realism, stability and steady spontaneous progress will be open to us again; the harm of our excessive post-war pursuit of growth will be gradually remedied and the soundness of our economy – on which jobs, standard of living and social services all depend – will be restored.

Can we expect the socialists to do this even if they think it to be necessary? No! In the first place, for them, economic policy is a perpetual popularity contest. Promise today, disappoint tomorrow, and then blame industry, finance, the banks, anyone but their own [end p13] exaggerated promises and spendthrift policies. Electioneering breeds inflationeering. We, the Conservatives, are not without blemish, I freely admit, but how much of this derives from bi-partisanship, from middle of the road policies, from confusing a distinctive Conservative approach with dogmatism.

The socialists by and large hold to the Platonic myth, that rulers should tell the masses only what is good for them. Tories have traditionally favoured trusting the people, telling them the truth as we see it. Can we afford to? Experience leads me to ask, can we afford not to?

Preston, September, 1974

[end p14]