Good evening. We have about seventy people and three tape recorders this evening, so I apologise to those of you who can’t get seats.
There could be few budgets in history, I think, the twenty-fifth anniversary of which could be marked, firstly, be an event such as this, with so many people attending, and, secondly, by extensive coverage in the Guardian, the Independent, the Sunday Times, The Times, the Daily Telegraph, and BBC news programmes.
But then the 1981 budget was a landmark because, as most people in this room would perhaps suggest, without it, financial and monetary credibility might not have been restored for many years. But others, of course, had a different view. In particular, 364 others signed a letter to The Times, and, tonight, we’re asking the question: “Were 364 economists all wrong?”
Before I hand over to the panel, perhaps I can just mention that at the end of the panel discussion you’ll be able to purchase this IEA monograph, with the same title, half price, and it contains pieces, for £5. It contains pieces by Tim Congdon, David Laws, Patrick Minford, Stephen Nickell, Maurice Peston, Derek Scott, and Geoffrey Wood, and myself, and also contains the full list of signatories and the relevant letters and supporting statements. In fact, it’s the publication of this monograph that I think has sparked some of the flurry of press interest.
We just, we’ve only got, we’ve got literally 90 minutes, so I’m going to start just by mentioning the people and the titles and to some extent their involvement in the 1981 budget and then I’ll just hand over to the panel to speak consecutively, in alphabetical order, without any further interruption from me.
So first of all, we have Andrew Alexander, who’s the columnist on the Daily Mail; followed by Lord Burns, who is Chairman of Abbey National and at the time of the ’81 budget was Chief Economic Adviser to the Treasury; and then David Laws, MP, Liberal Democrat Shadow Secretary for Work and Pensions and at the time, or just after the 1981 budget, he was a student at Cambridge being taught by some of the ringleaders of the 364 [laughter]. Then we have Stephen Nickell, who is a member of the Monetary Policy Committee at the Bank of England and was one of the signatories. And then Professor Michael Oliver, who is an economic historian; and then Derek Scott, who worked for Denis Healey during the 1970s and then as Tony Blair’s economic adviser more recently and is now at Europe Economics; and finally Geoffrey Wood, who is at Sir John Cass Business School.
So, Andrew, would you like to begin? Andrew Alexander:
I should just speak rather generally rather than tackling any technical subjects. For those of us who are, as it were, approaching the tea time of life, the 1981 budget, and the row which followed, was a memorable experience, but for a younger generation all the excitement and the dismay among Tory supporters at that time must seem very puzzling. Surely, the Thatcher strategy was so obviously necessary? Not so in the intellectual deprived and depraved climate of these times, which is what I want to touch on briefly.
Of course, everyone deplored inflation. But unemployment, which was rising, which had risen fast, was still seen as the key measure of economic success and thus a living condemnation of the budgets of 1980 and 1981. It occupied this top space partly because of the vivid memories of the 1930s and the failure to make any serious allowance for the new cushion of the welfare state. And also, this obsession with unemployment was, I’m afraid, due to the media. No one made TV films about inflation, but any number of films were made about unemployment, mainly with the intention of showing what a compassionate chap the filmmaker was.
Of course, real obligatory unemployment was never as high as alleged. While the official jobless totals soared, the hotel and catering trades throughout the country reported tens of thousands of vacancies they couldn’t fill. I recall that Peter Bauer , when he heard people lamenting the high official figures for unemployment, would ask, “so how many valets do you have?” If there really was massive unemployment, you could take advantage of that, surely. And I may say, also, on this question of unemployment, because Philip Booth has mentioned economics without price in this book, of course some shortage or a surplus doesn’t make any sense at all unless you talk about it in terms of price, and the price to the unemployed of being unemployed was so different to what it used to be that this accounts in some way for the rise in the figure.
Curbing inflation is never easy, because of the 18 to 24 month lag between action and results. If inflation could be cured overnight, it would never be allowed to develop. An added curse of inflation is that it is not only itself economically disruptive, but the cure for it is economically destructive. This was the abiding problem in 1981. There were, of course, as we all know, fierce arguments among monetarists about the precise nature of the cure. Though the link between the money supply and inflation was accepted fairly widely, the diverse measures of money supply were proving volatile and unhelpful. As the Goodhart’s law would have it, you had only to settle on one measure of the money supply for it to prove immediately unreliable.
But it was transparent, I think, in 1981 that one thing that had to be done was to reduce the PSBR. There are two reasons for this. The obvious one is it was clearly a cause of inflation, since little of the deficit was funded by real borrowing. The other, scarcely acknowledged at the time, was that government spending was so heavily directed towards the nationalised industries. They were costly, low on productivity, and a regular source of labour dissent. Just think of the National Coal Board or British Steel. The supply side could not be tackled without bearing this in mind. And, inevitably, the subsidised state industries produced powerful vested interests, which were all too well represented in Parliament—and not just on the Labour side.
A good summary of the errors made in the first Howe budget was Douglas Hague’s: “Since June 1979, the balance of macroeconomic policy had been wrong. We cut taxation before we were certain we could restrain public spending.” I also have a quotation from Terry Burns in 1981, early 1980, where he told a meeting of ministers that all the latest forecasts said that public expenditure “was continuing to run away from us, and we can see no end to it.” Margaret Thatcher sagely commented, “We really should have taken some of these measures a year ago.”
I well recall how the 1981 budget went down so badly on the Conservative side, and there were talk about Cabinet resignations, but at least progress has been made, and living standards are actually rising, but I couldn’t help noticing, there was a change in the budget which looked helpful but in some ways was ominous. The age for buying inflation-proof bonds—these you could hold for five years and if you did you got a bonus of 4 per cent, otherwise you got your money back in real terms—the age for permission to buy these bonds was reduced from 65 to 50. Big deal. But it still didn’t alter the fact that a virtual real interest rate of zero was deemed so attractive that it had to be rationed.
As for the 364 economists, we know, there’s a bunch of them here, that many of them wanted to get onto the list but weren’t able to. And all this gives some idea of the scale of resistance which Margaret Thatcher and Geoffrey Howe, and wisely advised by Alan Walters, had to overcome. Mind you, there was a very simple answer to the letter, which included the views of five former Chief Economic Advisers to the Government. You could ask them, how did they have the brass neck to call for a return to policies which had already failed? A very simple question. Only part of the press got round to that point, and that was part of the intellectually deprived climate of the time. [Applause] Lord Burns:
Good evening. What we have seen over the past twenty five years has been described by many people as something of a revolution in macroeconomics, and, of course, as in all revolutions, there is rarely a single day that matters. It’s normally the result of rather a lot of factors coming together. But nevertheless, revolutions often have days which acquire great symbolic attention, and I think probably mainly because of the intervention of the 364 economists, the 1981 budget seems to have taken on that symbolic role, although I have to say, in terms of my own involvement, at the time I didn’t see it as being quite of that scale.
I was closely involved in that budget. I’m therefore conflicted. But I think it’s also probably sensible that I say a few words about that budget rather than examining the letter of the 364 in any detail. It goes without saying that at the time I didn’t agree with it and looking back, it now seems rather out of touch with the characteristics, well … not out of touch, it looks like something of a bygone age. I haven’t read it for many years, but when I saw the book I was caused to read it again.
I would seek to argue that nowadays there is actually something of a consensus about the conduct of macroeconomic policy, and it goes along the following lines: that the main purpose of macroeconomic policy is stability, of both prices and output growth; that monetary policy is the key to the control of inflation; that the conduct of monetary policy is best conducted against the background of a consistent fiscal policy; that there is no longer a trade-off between unemployment and inflation, but that there is a significant short-run trade-off; and that bringing inflation down means going through a period when output is going to be below trend, unemployment will be higher than it otherwise would be. And in the long run I would seek to argue that, if anything, economies with low and stable inflation will perform better than economies with high and unstable inflation, but that in fact long-term growth rates are really about microeconomic policy.
And that is probably a view that is fairly widely shared, maybe not characterised in the same way that I have just done. It’s the way I would say the Monetary Policy Committee, by and large, conducts its affairs. And yet, there is almost none of these ideas that are present in the letter from the 364. Instead, the emphasis is on permanent recession, about the inability to get inflation down, that getting inflation down would not do anything in terms of the recovery of demand, and that really it was going to be depression forevermore.
The element that … of consensus, therefore, as I said, that I think is around, certainly was not present in the letter, and I find it, you know, just slightly odd that there is to some degree, you know, a view that maybe there really isn’t that much of a gap between what is happening now and what it is that was being argued for in that letter.
In practice, of course, doing what of those things that I’ve described, which we, by and large, I think quite a lot of people would sign up to, the practicalities of it are far from straightforward. And there are many very difficult obstacles to the conduct of policy, even if you agreed with the framework. Forecasting the future is always very difficult. Time lags are a very big challenge. The difficulty of framing targets, particularly in an environment removed from a world of controls and deregulation, were all things that were enormously difficult, along with the problem of handing volatile exchange rates and asset prices at the time, of course, in the early 1980s, when we had the huge fluctuations in energy prices.
And, of course, the journey over this period has had some stutters. It’s had some false starts. There have been some mistakes. But my main point would be that the … what I have described as today’s consensus is to me recognisably the same set of policies that Geoffrey Howe, Nigel Lawson, Margaret Thatcher were seeking to put in place in the 1980s. The language was in some ways different. Some of the details of it, of course, were very different. But, in broad … in broad terms, that was what an attempt was being made to do. And I think that it is something that I would argue has basically stood the test of time. And, of course, January … the budget of 1981 in that sense highlights that and what is interesting to me, as I say, is to see the language … and a language that is used in the letter which really is not the sort of language that you really see anywhere today.
The position I took myself in the January of 1981, as we were running up to that budget, was that monetary and fiscal policy had been extremely tight in 1979 and ’80, particularly when you compared it against the sharp increase in inflation. But that those pressures, in fact, were already beginning to ease in the early part of 1981, because inflation had come down by so much. So whether you were looking at real money balances or you were looking at the budget deficit, adjusted for inflation, you already began to see that there were some signs of easing. And, of course, interest rates had become to come down.
There was a very big problem about the exchange rate. There was also - and that led to another very major problem - which was that it was the company sector that was bearing all of the burden of this, the high interest rates, the increase in oil prices, and the high exchange rate. So we had this pattern whereby company sector incomes were falling very heavily, personal incomes were actually in real terms doing pretty well. That was another important aspect of the budget.
That, however, combination of the high exchange rate and tight policies had brought down inflation and, as I say, my own view was that we were already beginning to see through that route some easing of the policy stance.
And, therefore, the main and the key issue of that budget was to have a fiscal and a monetary stance consistent as far as possible with the thrust of the MTFS, that continued to bring down inflation well into single figures and which would do something to try to restore the balance between the punishment the company sector were having compared to the relative positive growth of real incomes that the personal sector as a whole were having.
And that, of course, is essentially in the end, although with quite … you know, a lot of additional things, that became the core of the approach in the ’81 budget.
It was about trying to have a monetary policy that was consistent with the MTFS, despite all the problems with monetary aggregates. It was to try and get the budget deficit back onto some kind of track, having increased very sharply in the second half of 1980. It was designed also, because it brought with it the reduction of interest rates, to try to get some easing of the exchange rate pressure without intervention, and also to improve the position of the company sector. And, of course, the tax increases that we had, apart from those on the banks and the oil companies, were really aimed at the personal sector that had been doing reasonably well.
The problem, of course, for those who see the ’81 budget as in itself as in a sense as the great secret to what happened subsequently is that the reduction in interest rates was actually reversed in the year, in the autumn of that year, in a very difficult episode to do with sterling falling rather fast and the gilt market having some problems, so I don’t think one can put too much weight on that.
But nevertheless, I think the general conclusion, which was that already policy was beginning to ease, recovery … we were reaching the point at which we would begin to see some recovery of output, and inflation was falling faster than expected, and that the real pessimism about that position was hugely overdone in terms of the letter.
I think the … my final point would be that - to stress again the practical difficulties of disinflationary policy - I think getting it right isn’t easy.
In both 1980 and in 1990, policy turned out to be much more severe than was intended by the policy-makers at the time. And on both occasions, it was because of a desire to hang on to a publicly-announced policy that was difficult to change. In both cases, we ended up with a step reduction in inflation that was sharper than intended. And in both occasions, of course, it was followed by a succession of years when the economy was relatively stable, performed rather better than expected, and, indeed, outperformed conventional wisdom.
At the time, my personal view was that I would have rather have seen a more gradual adjustment, rather than this severe step-change that took place. Looking back on it now, twenty five years later, I think it was actually a rather better thing that it was all done and dusted and over with quite quickly both in 1980 and in 1990. I have somewhat moved away from the article of gradualism that I espoused in those days.
I think the most important lesson of all is that we shouldn’t have to go through it again. That is the task of the MPC. They’ve done it terribly well - so far - and I hope that we don’t have to go through the sort of choices which the policy-makers had to make in 1980, and, indeed, again in 1990, for a long time to come. [Applause] David Laws MP:
Philip, thank you very much, indeed, for inviting me along to speak here today.
As a sixteen-year-old in 1981, and as a politician today, I think I am most definitely the least qualified here on your rather distinguished panel to speak on this particular topic, but as you kindly mentioned, and I suppose the reason behind you inviting me, is that I was a student at King’s College [Cambridge] shortly after this letter was written, and many of the Fellows at King’s College, many of the people who taught me at that time, were some of the signatories and, indeed, I think it’s fair to say, the ringleaders in relation to this particular, and famous, letter.
So the first thing I’d like to do, which I think I am well-qualified to do, is to try to set out some of the thinking that was behind the letter that the 364 signed. And I think that there were three things that really drove this letter.
The first - which I think Andrew’s comments at the beginning slightly underplay - was just how dramatic and serious the recession was that we were experiencing at the beginning of the 1980s. The most serious since the 1930s, we’d had, we’d just been through a contraction of output in the economy as a whole of about 4 per cent in the preceding year, the manufacturing sector by itself had seen a contraction of something like 9 per cent - an extraordinary figure - unemployment had more than doubled and was particularly concentrated in some parts of the country and obviously in particular segments of the labour market, not least the young. We’d got interest rates of 17 per cent. We had just had an increase in the trade-weighted exchange rate of something like 20 per cent, which was squeezing not only manufacturing output across the board but obviously particular sectors in a very severe way. And, of course, we had inflation peaking at something like 22 per cent, so for all of us who were around in those days this was a most serious economic crisis. And Terry’s right, that I hope that we don’t see the like of that again. So that was … that was the first part of the context of this letter.
The second part - and I think Tim’s paper [Tim Congdon] paper in the … in the IEA collection is exactly right about this - the second context was that this letter, as Tim puts it, was part of a wider assault on money supply targeting, because there’s no doubt that this was the peak, I suppose, of the obsession with … with the money supply and the view that that should be one of the main targets, or the main target, of economic policy and that it could, by a very rigid focus on monetary targets, bring down inflation and create a context for macroeconomic stability. Today, I think the MPC in this country, and I daresay most monetary authorities, look at monetary aggregates but as part of a whole range of economic and financial indicators they look at in making their decisions about monetary policy. So I think we’re dealing with a slightly different environment today and probably a far more rigid and, what was seen, as being an ideological, environment for monetary policy back in the early eighties.
And the third claim, which is at the centrepoint of both the letter and our discussion today, was that quite clearly these economists, at the time, believed that the decision to tighten fiscal policy in quite a significant way - by greater, I suppose in today’s terms, than £20 billion in tax increases - would deepen the depression. And by that I understand not the more generous interpretation, which I think Steve has given in his paper, of keeping the rate of output growing more slowly than its potential and the potential trend, but actually, I think, what the economists understood was that they believed that this budget would ensure that Britain remained in a depression in which it would be likely for a period of time that output would grow … would be growing negatively, if you like, that output would continue to contract.
In that, therefore, I think that I have to give, in answering the question that we’re invited to answer today, were the 364 economists all wrong?, I think that I have to give the answer that, on the most important part of the letter, they were wrong, because shortly afterwards output turned up and we entered a long upswing, albeit one that continued to see unemployment grow for quite a considerable period of time.
As a politician, however, you’ll expect me to say at this stage that the question I’ve been asked is not the most important one, that the question should have been something entirely different, and perhaps it’s the entirely different questions which are in some ways more interesting, because although it’s clear that the 364 were in the most important way wrong, any economist would want to consider what the counterfactuals would be to the policy decisions that were actually taken and whether just because output moved in the opposite direction to that which the 364 expected, whether they were actually right in believing or implying that monetary and fiscal policy were striking the right balance. And Terry indicated a moment ago that he feared - although he may have changed his mind on this - that actually mistakes were made and that the posture of policy at that time was too contractionary.
So I think that there are a series of other questions that people more qualified than me should be asking, and answering, today.
One of those is clearly, was economic policy prior to the 1981 budget too tight? Was the overshooting of the monetary aggregates, particularly the broad monetary aggregate [£M3], causing decisions to be taken that meant interest rates were higher than they needed to be and therefore the exchange rate much higher than it needed to be as well?
Secondly, was policy eased enough? The assumption that people have made is that the 364 didn’t understand or didn’t realise that going alongside the tightening of fiscal policy there was going to be, and, indeed, there was on budget day, an easing of monetary policy with a 2 per cent cut in interest rates followed later by a very significant easing in the exchange rate over the next twelve months, which perhaps would have, would not have been anticipated by the 364. Was policy eased enough? And if the counterfactual is that there had been a reduction in interest rates with no significant tightening of fiscal policy, what would the profile of output and unemployment have looked like? What would the profile of inflation have looked like? Would that have been a better outturn?
The third question I think that we need to ask ourselves is, was monetary policy, as it was being practiced at that time, overly rigid? Was it leading to excessively tight policy? Was the focus on the broad monetary aggregates, as Kaldor and others at Cambridge claimed, an attempt to focus on the patient’s temperature rather than dealing with some of the … in other words, the symptoms of inflation, of an inflationary problem that was there, rather than dealing with some of the causes? And I think that although the 364 may have lost the primary battle, the … even Tim’s essay acknowledges that monetary policy has come to be administered in a far more ad hoc and discretionary manner in the period since 1981, and, indeed, by 1985-1986 Nigel Lawson himself was considerably moving away from the type of very rigid monetary policy that we were trying to apply in 1981.
And finally, was the Government in any sense lucky in the developments after the 1981 budget? Were they fortunate in particular to have a very large and unanticipated depreciation of the exchange rate that clearly boosted the traded sector and that for a while led, as Terry indicated, to the reduction in interest rates actually having to be reversed for a period of time?
Those, I think, are what I think are the more interesting questions that we have to debate. I think on a substantive issue, in broad terms, it’s clear that the 364 were wrong and that their main claim that the depression would deepen was proved not to be borne out. [Applause] Professor Stephen Nickell:
Am I the only person who signed this damn letter in this room? [Laughter. Then sound of something hitting the floor.] Whoops, oh, I've dropped all my damned papers. They are all incriminating. Okay, so I have to defend myself, clearly.
Lots of things happened between 1979 and 1990. In 1979, in June, inflation was 10.6 per cent, unemployment was 5.3 per cent, interest rates were 14 per cent. Now just remember those numbers. In September 1990, after all that happened in the 1980s, inflation was 10.4 per cent, unemployment was 5.4 per cent, and interest rates were 15 per cent. You could hardly get a bunch of numbers closer than those sets of number. Anyway, a bit of a cheap shot really.
I’m going to talk about the first half of the 1980s because that’s what we’re supposed to be talking about.
Now in 1979, the macro situation was dire, and, quite rightly, after what had gone on in the previous decade, the Government decided that it must construct a coherent structure for macroeconomic policy in general, monetary policy in particular, and, to its very great credit, it stuck to this thankless task in very difficult circumstances. Not only, you see, in 1979, was inflation high, but monetary policy had zero credibility. What that means in practice is that essentially you’ve got the private sector wage and price determination is just shot through with rapid indexation, so that any significant rise in relative prices tends to flood rapidly into general inflation. And the difficulty this causes is just … just immense. I mean, you recall in the third quarter of ’79, because of the .. because of the rise in the relative price of oil and the rise in the relative price of goods subject to VAT, inflation … RPI inflation as measured … rose by 5 per cent in one quarter. What happened is that the next quarter, wages rose by more than 5 per cent, i.e., immediately. And under those circumstances, it’s very difficult to make monetary policy and to get inflation under control.
So by June 1980, inflation was up to 21 per cent. Now in this kind of environment, you don’t … there is no alternative. Tight macroeconomic policy is the only way to get inflation under control. So how tight?
Well, this is … under these circumstances, it’s just fantastically difficult to calibrate the relationship between current macroeconomic policy and where inflation is going to be. I mean, it’s hard enough at the best of times. And this, believe you me, was the worst of times. So, in particular, of course, with endless changes in the structure of the financial markets going on, it makes it kind of doubly difficult.
Anyway, so, why did I sign the letter? Well, my view at the time was that by early 1981 macro policy was too tight. That was my opinion. And what I believed was that you could have had somewhat looser macroeconomic policy and still have created enough of a depression to get inflation down—you needed a depression to get inflation down. That’s more or less inevitable.
So I signed the letter because of one sentence. The key sentence was that present policies would deepen the depression—because I strongly believed this. In signing the letter, which most of my colleagues at LSE didn’t sign because of their distaste for the flawed theoretical analysis contained in some bits of the letter - which I shared - but I thought, stand up and be counted, go for it, and hold your nose. So I signed the letter.
Anyway, David Laws just explained that a worsening depression means negative growth. Well, not in my book it doesn’t. And what is a depression? In geography, it’s a little hole in the ground. So there’s the ground and there’s the hole. That’s a depression, that’s the depression. The economic analogy to that is a depression is a bunch of people, machines, a bunch of resources hanging around in the economy doing nothing. So the depth of the depression is the amount of resources, proportionately, hanging around in the economy doing nothing. Now if growth is below trend, more resources will be hanging around in the economy doing nothing. Because you’re not using the resources in the growth part to the extent that they’re available, so you add to the pool of spare resources, and that means a deeper depression. That’s what a deeper depression is. So basically, a deeper depression means growth below trend. It doesn’t mean negative growth. Otherwise, I mean … if … . Depressions aren’t that unusual. Some of them are shallow. Some of them are deep. Whereas if you have to rely on negative growth for a depression, we hardly have any depressions in the twentieth century, very few indeed. Not even shallow ones. And that’s just not the way it is. Anyway, so that’s my definition, and I believe that to be the correct one.
So what happened? Did the depression deepen? Well, basically, the way I think about it is, what’s the most obvious resource hanging around doing nothing? Well, the answer seems to be people. So, on the standard OECD measure of unemployment, which is pretty consistent over the years, unemployment rose from 1981 to a peak of 12.5 per cent in ’83 and then fell away gradually. Looking at the claimant count it continued to rise until 1986. Now, technically speaking, if a rise in unemployment is to correspond to a deepening depression, the natural rate mustn’t be rising too fast. But over the first period of the 1980s, there are not many reasons why the natural rate should be rising, given that union membership was falling, benefits relative to wages were falling, the relevant tax rates were mostly flat or falling. So there doesn’t seem to be much reason why the natural rate should be rising. And anyway, any measure of the natural rate that I could find didn’t grow as fast as the actual rate of unemployment, at least until towards the end of 1983 and maybe beyond.
So my argument would be that the depression deepened, at least towards the end of 1983. Now some people argued at the time, or indeed since, that unemployment isn’t a good signal of anything much because, with lots of restructuring, de-manning, withdrawing of subsidies from industry, etc, etc, somehow unemployment doesn’t mean the same thing.
Well, there are two points to bear in mind, actually. When unemployment … sorry, when employment fell very sharply in ’78, ’79-80, the proportionate falls in unemployment … sorry, the proportionate falls in employment were almost exactly the same as the proportionate falls in output, which sort of more or less means that the guys who were leaving jobs were, had been producing as much as the guys who were staying. So that kind of de-manning and hidden unemployment thing doesn’t to me make much sense. And the other thing anyway is that industry subsidies and all that sort of stuff doesn’t affect the natural rate of unemployment any more than early retirement affects the natural rate of unemployment.
Basically, it was macro which raised unemployment in the early 1980s just as it was macro that cut unemployment in the late 1980s. And the deviation of unemployment relevant to its natural rate is as good an indicator to me of deepening depressions and growth relative to trend as any, and better than most.
So, to summarise, macro policy in ’80-81 was over-restrictive in the sense that inflation could have been brought down with a less restrictive policy. These macro policy decisions led to below trend growth, deepening depression, and that’s at least one sentence of that letter seems to have been correct. I’m not going to defend the rest. [Applause] Professor Michael Oliver:
My comments on the 1981 budget and the pamphlet “Were 364 economists all wrong?” are delivered from the perspective of an economic historian of the period. And there are many issues surrounding the 1981 budget which economic historians need to disentangle when they actually have access to the official documents, but I want to just focus on three tonight.
The first thing that they will have to understand, which some of the contributors have spoken about tonight, is the context of the budget. Some of the contributors to the volume do actually place the budget within a wider economic framework, but the monetary backdrop, even from Tim’s chapter is largely ignored. The March ’81 budget was the last stage in the easing of money supply policy between 1980-81 and followed hard on the heels of the Niehans report. That easing had actually begun in the autumn of 1980, when it finally appeared to the authorities that monetary policy was growing tight, despite, as we’ve heard, the impression of looseness because of the growth of sterling M3.
But it seems that not everyone in the Treasury and the Bank shared the view that policy was too tight, and several monetarists at the time also argued that policy needed to be tightened further. To be sure, two key monetarists had warned against further tightening: Gordon Pepper, in an article in the Observer in August 1980, and Alan Walters in October 1980. The arguments which then ensued over whether sterling M3 was an appropriate monetary target, or whether a narrow monetary target should be adopted, or the monetary base, are not really covered by the contributors to this volume, but they do form a very important prelude to the ’81 budget, and I think they will need to be considered at length by the historians in due course.
Now while Geoffrey Wood retracts his criticism of the Government’s economic strategy which he made at the time, I think economic historians, whether they’re Keynesians or monetarists or whatever, will see actually some value in probing his original critique. During 1979, there was a big debate between the monetarists, captured beautifully by the Treasury and Civil Service Select Committee on whether the Government’s anti-inflation strategy should be gradualist or sudden shock. Now, as Lord Burns has said tonight, the intention was gradualist, but, in fact, it was cold turkey. And I think that several monetarists then and now still underestimate the damage this did to the Government’s economic strategy, which carried over into subsequent years. I don’t dispute that everyone was on a learning curve then, and these observations are not actually delivered from the perspective of a Keynesian economist, believe me. But there is a sense, I think, in which the naïve monetarism, if we are to call it that, of ’79 to ’80 delivered what it hadn’t intended to do, which was rising unemployment, and failed at what it intended to do, which was hit the money supply targets. And, indeed, the overshooting of those money supply targets, during 1980 to ’81 and ’81 to ’82, coupled to the upward revisions in the target ranges in the budget of March ’82 and March ’83 greatly undermined the credibility of the Government’s monetary strategy, even though inflation was brought under control.
The ’81 budget is seen as a challenge, as we know, to the Keynesian consensus par excellence, but who was really responsible for this budget? This is the second thing which economic historians will be anxious to explore. As it stands, everyone who has been involved in the budget has tried to claim some credit: Margaret Thatcher, Geoffrey Howe, the Treasury, Alan Walters, John Hoskyns. What does become clear, I think, with the passage of time, is that Margaret Thatcher and particularly Geoffrey Howe were very unhappy with the suggestions made by John and then Alan that the PSBR should be cut below ten billion. John’s account, recently published, is by far the most detailed available to historians and it suggests that up until the third week of February 1981 the advisers were deadly serious about resigning because they simply felt that their message to the PM and Chancellor was not getting through. Indeed, the reaction of both the PM and the Chancellor was to argue for the measures of the ’81 budget to actually be delayed until November. They were pressed firmly by John, Alan and David Wolfson and told that unless they acted immediately the Government’s macro strategy was in danger of coming apart.
Currently, economic historians remain very much in the dark about the extent to which the old guard of the Treasury—Douglas Wass and Anthony Rawlinson—battled with those who supported the Government’s economic strategy—chiefly Peter Middleton, Terry Burns, Geoff Littler and others, and perhaps more will be revealed with the release of the official papers.
Finally, as Derek Scott remarks, after ’85 the monetary framework became very confused and changed whenever it seemed convenient for the Chancellor. And it’s really ironic, when you think about it, that after winning this intellectual argument in 1981 policy-makers moved from monetarism to pragmatism with such ease. And once again there were a very small number of economists who spotted precisely where it was all headed, most notably Tim Congdon. Tim’s warnings actually began in 1985 into 1986, and I wonder whether now with hindsight we could suggest that the important changes in policy which occurred in ’85 were the accumulations of many such subtle changes in policy prior to that year. And this is the third area, I think, which economic historians could explore.
Just recall, between ’79 and ’82, the authorities believed they could literally control the stock or supply of money and totally ignore the exchange rate. That was the economic ideology. From ’82 onwards, the money supply figures came to be seen as indicators, which, it was argued, the authorities would seek to influence, to help in interpreting the monetary conditions. In 1983, there was a further shift to pragmatism in the Medium-Term Financial Strategy. This is what it said: “The interpretation of monetary conditions will continue to take account of all the available evidence, including the exchange rate, structural changes in financial markets savings behaviour, and the level and structure of interest rates.” This is very far removed from 1979 and 1980. So even before the end of overfunding in 1985, new money supply targets had been introduced, target rates had been moved, and, of course, Nigel Lawson became very enthusiastic about the Exchange Rate Mechanism. So, in effect, the damage to the monetary strategy was almost complete, and monetarism lost credibility in the financial markets. And in this sense the ’81 budget is an important point between the heady monetarism and then disappointment of ’79-1980 and then the abandonment of monetary targets in ’85, the groundwork for which was laid between ’82 and ’83. Thank you. [Applause.] Derek Scott:
Good evening. I shall be very brief. I think, given the normal jokes about economists, we might have wondered whether 364 actually who signed up to this thing did actually agree. And that Stephen has obviously made clear that they didn’t. But what is, I think, striking is the certainty with which the letter or rather the words it’s couched. And that, I think, is, certainly in my recollection, was much more uncertain about whether it was the right policy or whether it was the wrong policy, and I think even within Government that was true. I guess if you’re writing a letter you have to express certainty. But what I think is more surprising and, again, it’s not something I think we can accuse Stephen of - whose criticisms are much more subtle - but what I think is more surprising is that many of those who signed the letter and predicted a catastrophe are now saying, basically, “we woz right all along”, which is, I think, a slightly bizarre conclusion. And it reminds me a bit of Thomas Beverly, who, no doubt you’ll all recall, in 1697 predicted that the earth would expire. And when he was, 1697, and when he was asked in 1698 about this, he said: “well, it actually did happen, but nobody really noticed it”. [Laughter.] I think there’s an element in that about some of the letters that have been, in some of those who signed the letter.
Now, on the letter itself, there’s no basis in theory. Now, I don’t want to get caught up in the razor fights between superior academic economists that are periodically taking place. And I think to some extent this idea that there was no theory is complicated by the fact that the actual text in the letter is a bit odd when it refers to deflating demand bringing inflation permanently under control. I don’t think that was what actually the Government was really about. But there were clearly perfectly sound theories behind what was happened [happening] in 1990, 1981. It’d be really bizarre if it wasn’t, and Walters, among others, had a pretty clear view of what was … of how an economy works. And I think the reality was that what was in place, or what was confronting them at the time, that fiscal … that public finances were a complete shambles and monetary policy was too tight, so you had to tackle both of them at once. Now it may be that the theory underlying this approach was not the one that the 364 approved of, but to suggest there wasn’t a valid theory behind it just strikes me as being pretty … pretty bizarre.
Now in terms of the deepening recession argument, Stephen obviously makes a very persuasive case. And in some extent, I agree with him, that in the 1979 [sic] there was need for some kind of recession, one way or another, to put things in place, and, in many ways, the tight area of policy was actually ’79 to ’81. After the ’81 budget, monetary policy was eased. Interest rates, we’ve heard, actually had to go up, but if you take into account the currency as well, there was an easing of monetary policy. And it seems to me there are a number of reasons, despite Stephen’s economic wizardry, if I may put it that way around, there does seem to me a number of reasons why the turnaround in output was not reflected in employment, most obviously the clapped-out state of much of industry still and the unreformed trade union movements. I mean, they hadn’t really been broken in 1981. And I think, as David was saying, the motives behind those in the letter was not quite the subtle one Stephen has been putting forward. And the notion that somehow there wasn’t a recovery after 1981 is frankly bizarre. I mean some of you perhaps will remember when Peter Jay could actually stir himself to get on the BBC programme as the economics editor. He used to periodically put up this chart with trend growth and, you know, through the lines, and, basically, month after month, year after year, would say, well, there’s no recovery. Now, strictly speaking that might be true, but it certainly wasn’t the way it looked on the ground and, in my view, was what, not actually what was happening.
Now the letter also said it was going to create, remove or undermine the industrial base and social unrest. The industrial base, much of it needed to be removed, frankly, if anybody had ever been around the previous twenty years. And as to social unrest, what the hell do the people think the Winter of Discontent was? [Laughter.] And the idea that somehow this was provoked by the budget again seems to me to be absurd. And we’ve had lots of instances of social unrest since 1981 which have got absolutely nothing to do with economic policy at all.
And then we come to this, “there were alternatives”. Well, I think that’s complete nonsense. They’d all been tried, in one way or another, the previous couple of decades, whether you go back to Heath or whether you go back to the Wilson and Callaghan Government. Now, nobody … I will surrender to nobody in my admiration for Denis Healey’s grappling with some real political and economic problems, but to pretend that this - and to some extent made some progress - but to pretend that that was offering a long-term solution other than a finger in the dike is just, frankly, I just think it’s crackers. And so, I don’t really buy that afterwards. And I think that, Patrick Minford made a very astute observation about this period. He argued, you have to change everything before you can change anything. And I think that’s the other area where I think fundamentally the 364 were wrong because, in a sense, 1981 begins a process where the whole view of economics, the balance between fiscal and monetary policy, the role for macro against micro policy changes, and, okay, it went badly wrong in the latter part of the 1980s when monetary policy was mismanaged. Nonetheless, that approach is one that actually has given, it seems to me, the period over the last decade or so of prosperity and is broadly accepted by most people and, in a sense, although it wasn’t completed in any real sense in 1981, it was the beginning of a process.
And therefore, by attacking the budget in the way the 364 economists did, it seems to me they are attacking, if you like, the emerging consensus that Terry talked about, which, I think, has proved to be right in defiance of all of the prophets of doom and gloom when they were actually writing this letter.
So, I suppose, to sum up, the 364 economists remind me rather of the two youths who murdered their mother and father and then threw themselves on the mercy of the court on the grounds that they were orphans. [Laughter.] That is to say, that is to say, there was an element of truth in what they were saying, but you feel they actually missed the big picture. [Laughter and applause.] Geoffrey Wood:
When Philip invited us along tonight, it wasn’t altogether clear from his invitation whether he was inviting along a bunch of old codgers to reminisce about battles they had once fought or whether we were invited to appraise the situation since then, so I’d like to do a little of both, if I may.
Michael Oliver said that everyone was rushing to take claim for the 1981 budget. I don’t think that’s altogether true. There are two people, in particular, who haven’t rushed to take claim for that budget who I think deserve it: Terry Burns and, equally important in my view, Alan Budd. Both of them contributed a great deal to the budget and have been important ever since.
Important in two senses, as the budget has been important in two senses. And by far the more important sense was not what it did at the time, although I shall come to that—because I do have some minor differences with Steve Nickell, only minor ones—but what it did, has done since then. Because it brought back to the forefront of policy something that was missing for many years in Britain—and in many other countries: first of all, the notion that money, control of money, was essential to the control of inflation, there is no other way of controlling it; and secondly, the idea that once you have announced a plan for fiscal policy, it is a good idea to stick reasonably close to it or policy loses all credibility and all predictability in its effects. These ideas were brought into economic life in Britain by that budget and they have persisted ever since so long as policy has been successful. When these ideas were deviated from, as they were to some extent as Michael Oliver told us in the 1980s, the policy and the economy drifted off course. The increase in stability we have had since 1992, and stability has increased - the fact that Gordon Brown tells us so doesn’t mean it’s not true [laughter] - stability has increased since 1992. This is in large part due to the stable policy framework that really was in essence inherited since 1981. So in that sense the 364 economists were totally wrong when they wrote the letter. They were wrong about the long-term significance of their budget, of the budget.
What about the short term? Here the issue was more interesting. Some economists claim, you see, that performance hasn’t really improved over all these years. Maurice Peston, in his very thought-provoking little piece in this book, which I’m sure Philip will harass you to buy, in his very thought-provoking contribution, says performance hasn’t really got much better. We have to be careful when we make that kind of comparison because for many years before the 1981 budget we had a fixed exchange rate. We were therefore importing our monetary policy and therefore more or less our inflation policy from the United States. And throughout those years, it was running a pretty stable and reliable monetary policy. We were in a sense importing our monetary policy from them because they did it better just as we used to import our motor cars from Germany because they made them better. The patterns of comparative advantage may now have changed, but again I think that is in part due to the 1981 budget putting a long-term framework in place.
What about the short term? Were these economists right in the short term or were they not? Well, Steve has put up, I think, a pretty compelling case for saying that in his definition the recession was perhaps made worse by the 1981 budget for a short time. But I think there have to be some qualifications. If we look around the entire world, we see the phenomenon of jobless recoveries. A very striking example, I think a useful comparison, is the jobless recovery Finland experienced after it left the Exchange Rate Mechanism, one day after Britain did. The economy grew strongly, but unemployment remained quite high, very much incidentally as happened in Britain after we left the gold standard—unemployment grew strongly, the economy grew strongly, but unemployment remained quite high. This suggests we should look at the microeconomic reasons. Microeconomic reasons certainly have proved that in the Finnish case … unemployment there has started to come down, down, down now that taxes have been lowered. In the 1930s, certainly part of the surprisingly high levels of unemployment given the growth … the very rapid economic growth were due to the behaviour of benefits relative to wages. We should look at these factors.
But we should also consider the effectiveness of fiscal policy in this situation in 1981. Britain had a floating exchange rate in the 1980s, as it has now. There is a very familiar economic theorem … [single word inaudible] Robert Mundell and Marcus Fleming pointing out that an open economy with a floating exchange rate is one in which fiscal policy has essentially no effect because movements in the budget deficit drive interest rates in a way that provoke the exchange rate to offset the effect of the budget deficit. So we should not, I think, really expect all that much from fiscal policy in that setting.
Furthermore, as Geoffrey Howe pointed out at the time and as Terry hinted this evening, with the … a very expansionary fiscal policy, given the monetary control techniques and the attitudes of the authorities, it was going to be difficult to deliver a monetary stringency. Looking back, therefore, in hindsight, I think we can say about the 364 economists, on the long term, they were fundamentally, profoundly wrong, and it’s very fortunate their advice was ignored. Short term, there is a case which Steve Nickell has, I think, argued very eloquently tonight, but is a case to which we have to attach several qualifications, and these qualifications are such that I think on balance Steve might be right, but probably isn’t. [Applause.] Professor Philip Booth:
Well, thank you very much. We’re now open to general discussion, so please, please do keep your points really rather short. I’m sure there are a lot of points, and we obviously have a lot of panellists who are going to try to address as many as possible. Yes, Adam. Sir Adam Ridley:
Adam Ridley. Could I speak as a special adviser who sat not a million miles from Terry during much of these great debates? And my papers are available no doubt whether you still really want to come and see them, Michael, and that’s, by the way, in advance of the normal thirty-year limit.
The first point I want to make is just a technical one about what people were actually saying at the time. I’m always very interested by the interpretations that people offer of what it was feared was going to happen and reminded, and I find it once again, of what Frances Cripps and Wynne Godley said, two of the high priests of the Cambridge view at the time, of which David spoke. It wasn’t just a little mild worsening of the trend of output … the level of output relative to trend. Frances Cripps and Wynne Godley saw this as “a severely disinflationary budget that will cause a hyper slump such as Britain has never seen before.” That was a very good example of what many other people who supported that policy thought. I remember vividly talking to a distinguished economic journalist who said, “Adam, do you realise what you’ve done?” He was looking at me with acid … lightning flashing. He said, “You are plunging the economy into a kind of economic black hole, an endless downward spiral,” and I quote his ipsissima verba. Now, that’s the first one. I didn’t actually think that Steve’s interpretation of what most people meant, whatever he may himself be thinking, it meant anything like what it now means today. [Last nine words difficult to hear.]
Second point: this budget was an enormously important piece of political economy. I am surprised that more people haven’t noticed that at many stages. And I think Steve Nickell put his finger on a very, very important point at one stage when he talked about the rampant indexation.
But what I always felt was that if you looked at what we had to do then, you had to establish the credibility of a declining PSBR and public sector deficit or re-establish it. You had to do something to make the MTFS look good. You had to make credible the longer term commitment to lower interest rates. All this is fairly familiar stuff. You also had to make the Government more credible as a seller of gilts to the City. And you also, in turn, had to make the credibility of the Government’s willingness to draw a line in the sand more vividly meaningful to employers and employees and the unions. And you had to make something credible to the Conservative Party and the TUC.
Now let me just dwell on the Conservative Party. Some of you may remember the Blue Chips. Anybody remember the Blue Chips? The Blue Chips were the most vocal spokesman for those members of the Conservative Party who, like the TUC, believed it was just a matter of time before we had a U-turn. And, all … I mean, “My dear boy, you’ll be able to carry on a little longer. When is the U-turn going to come?” “Have you got the TUC’s telephone number in the back of your diary?” they used to say to you metaphorically.
David Lea, Deputy Secretary-General of the TUC, whom I’ve known for years, used to say just the same thing. We used to bump into each other every three or six months. He’d say, “Adam, you know I’ve looking forward to your call.” So that’s that.
Last point: unemployment levels. If you look at what was happening, and I think Stephen made a very interesting point about the natural rate, you must look at the micro detail. For example, the steel industry. Let’s take the steel industry. The unions went into a completely suicidal strike. The employment of British Steel Corporation was 180,000 at the beginning of the strike. A year after the strike, it had shrunk to 90,000. All of those people who went onto the unemployment pile, almost all of them were in an area which wasn’t going to in any way improve the general labour supply in the country. Professor Philip Booth:
Thanks. I’ll collect two or three before we put them back to the panel. David, yeah. David [Surname unknown]:
My question is addressed mainly to Terry because it was on both occasions, I mean, why is it that the ’92, if you like, revolution, a move towards the money supply target has been so fast, so much more successful? Because, I mean, one the things that was striking in Stephen’s presentation is that by 1992 we were more or less back to where we were in 1979. So to some extent something went wrong, and I wonder, was it all the shadowing of the ERM that caused the fact that the initial benefit had gone?
And, just as a reflection addressed to some of the people … the monetarists, I mean, we are pursuing now monetarist policies, but it’s monetarism without the money supply. I mean, essentially, I mean, yes, I mean, out of politeness, one says that the MPC talks about money supply, but at the moment it’s one of those indicators that the press doesn’t report. We don’t know what the money supply is or certainly most economists that work today in business don’t know. And how is that, what is the rationalisation of this disappearance of the money supply, you know, in a framework which is basically a monetary framework? Professor Philip Booth:
Is there another question? Yeah, David, and then we’ll put it, to two or three to the panel. David Smith:
David Smith . I was actually at Cambridge [inaudible word] working for Cambridge Econometrics, which was the commercial arm of the Growth Project so I was actually… Professor Philip Booth:
Speak up so as people in the room behind you as well… David Smith:
… So I was not directly involved, but I was very close with people that were involved. We are assuming that all 364 economists were voluntarily filling in that letter. [Laughter.] What I can guarantee is immense pressure was being put on people - and these are people on three-year contracts, their average expectancy was 18 months - to sign up. But many people for reasons that Steve Nickell’s LSE colleagues had but also people particularly who came from overseas backgrounds who didn’t want to get involved in UK policies who were very reluctant to sign it. At the end of day they thought it was not such a sensible career move. Now I have no idea what went on [inaudible word] basis, but I think one needs to actually look a little bit at just how much pressure was actually put on the 364. [Laughter. Interjection: “It’s an interesting angle!”] David Smith:
Was it under duress? The other thing I do think is, the historians are [semi-audible words - ?“forgetting that at the same time as the”] steel industry’s strike there was a very big engineering industry strike which lasted about six weeks. That pushed up wage costs of the engineering industry by about 25 per cent, at the time, … manufacturing output fell 25 per cent peak to trough. That to me says that the trade price elasticity of demand for manufactured goods is 0.5. To blame it all on UK policy I think is unfair. A third point is, of course, many City monetarists were warning well before Margaret Thatcher was there, that the demand for money was a skittish beast. I mean, I need only quote Dennis Robertson in 1928 giving the conditions of the demand for money were very aware [sic: semi-audible] that if the real rate of return on holding bank deposits went from minus 15.5 per cent to 7.5 per cent plus you’ll likely get some shift in the demand for money. A final comment is looking back just from what we know today in terms of supply side economics and fiscal stabilisation literature I think our package actually looks rather less clever than we think at the time. I think most supply side economists even at the time said, raising VAT and cutting income tax, which left output [several inaudible words] for the vast majority of people actually did no good as far as the supply side was concerned and [several inaudible words] supply side effect. The fiscal stabilisation literature fairly crudely says you can’t tax your way out of structural budget deficits. You have to control government spending. And the first issue was with Clegg, which was clearly a major , mistake awarding very large pay rises to the public sector and burgeoning unemployment levels [several inaudible words]. But I think with hindsight it is one of these battles which we won possibly more by accident than by design. It would be very nice to have a conference where modern economists and modern [several inaudible words] actually went through that period and looked at it perhaps [several inaudible words] more thought than the way we’re doing it at present. Thank you very much. Professor Philip Booth:
Thanks. Terry, maybe one or two others, would you like to comment on why we’ve had sort of 13 years of stability since 1992 and looks as if it, 14 years, and looks as if it’s going to continue to be stable, whereas we only had six or seven years of stability after 1981 before things started to go wrong again? Lord Burns:
Well, two things, after basically the ’81-82 experience, inflation fell to something like 5 or 6 per cent, I would say, was the underlying rate then for a number of years. And we were struggling throughout that period as has been described quite vividly in terms of trying to get the control mechanism improved.
What happened after … and I think two things then occur after the ’92, the 1992 session, the package was put in place in ’92, was in a sense … it was then the next stage of the … of trying to refine all of that, which of course came up with the inflation target. But what was put in place from ’92 was something that was much more about the … in a sense the administratio, n of that thing. It was about putting in place a process and a system and the way in which individuals were meant to interact and … having the Bank of England publish advice, having minutes of the meetings publicised, and trying to make the whole process a great deal more open. And, of course, by then the underlying inflation rate had come down to 2.5 per cent. In a sense that process of … by 92, had completed the journey in terms of getting inflation down and rather … the emphasis shifted towards trying to design a process for keeping inflation under control. Whereas throughout the ’80s the search was on really to try to find a regime of targets that, you know, in terms of this mixture of things. And you know of course the terrible … . There was a third factor, of course, which is that post ’92 we no longer had the whole business of ERM on the table because from 1985 through we had you know the whole issue about the ERM - whether you were in favour of it or not - it was always there and we went through some of those really quite difficult periods when that debate was stronger, but you know, I think, you know, it was a further ratchet down. I think the process that was put in place after ’92, which learned a great deal from what had happened in the ’80s - I mean, it couldn’t have happened without what had happened in the ’80s - but I think it demonstrated that it was a much more robust system because it was based rather more upon getting the systems and the people, and the way in which they interacted right rather than this rather heavy reliance that had been in the early period just to find the particular control mechanism. Professor Philip Booth:
David? David Laws MP:
Can I just come back on a couple of the points? I mean, firstly, the did they sign under duress point I think is probably slightly generous or misguided. I mean, I, looking at the list, about ten of them were from King’s College, which I was at at Cambridge. I’m pretty confident that the ten who were from King’s not only signed but believed very strongly in the … in the rather broad letter and obviously it was a fairly catchall in terms of what the proposals were for doing something else in policy terms. But I think that they believed, I mean, Steve and others will have to speak for themselves, but I’m pretty sure that the ones that I spoke to believed very strongly that this was the wrong decision and that the Government’s policies, both in the budget and in the wider monetary framework, were completely wrong.
I think that Steve has produced an elegant explanation for some people having signed the letter and has raised an important point about the trajectory of the economy after the budget. I suspect that the people that I met who signed it did believe, as Adam suggested, that the economy would be stuck in a real recession with continuing declines in output every quarter for some considerable period of time and I think that’s what they signed up to.
But I think out of the discussion from the panellists and a couple of the points on the floor, some more interesting questions have come up, which I’ll touch on very briefly. I mean, firstly, was the Government driven to be particularly tough in terms of the fiscal framework of the Government precisely because, as one of the panellists said, the monetary framework was going seriously astray. That’s a point that Nigel Lawson actually makes in his own memoirs, that they were under particular pressure to get the PSBR down precisely because the sterling M3 was so far adrift and the Government’s credibility on the major part of economic policy, i.e., monetary policy, was seriously at stake.
Secondly, a link to that, what is the counterfactual? If some of us are accepting that those economists were wrong in their conclusion, what would have happened to the economic outlook had the budget either been cancelled or had the monetary easing in the budget gone ahead without the fiscal tightening or the same degree of fiscal tightening because that is, in a sense, I think, Steve’s point… Lord Burns:
Can I just respond to that? I mean, this was a very big issue. I mean, this, a lot of this is in the clouds of my memory, but there was a strong feeling that given what was happening to the monetary aggregates more generally it was not possible to have a significant reduction of interest rates without doing something effective on the fiscal side. So the notion that you could have had one without the other was certainly not within the framework that ministers were contemplating, and part … you know, the final clincher in the whole thing, was: What was it that was necessary to be able to have a substantial reduction in interest rates in that budget? David Laws MP:
That clearly … I acknowledge that was your experience at the time, part of that … [inaudible remark by Lord Burns] … But it is a serious part of the debate that you have to ask … if you’re asking not just were the 364 wrong in their terms but also was the macroeconomic policy issue pursued the right one? Professor Philip Booth:
Ok. Stephen. Professor Stephen Nickell:
Yeah, I won’t take very long. I mean, interest rates did go up again shortly afterwards and were higher by the autumn. Anyway, I think that the depression, recession or whatever you want to call it is a bit more than a bit of below trend growth, the second biggest one in the twentieth century pretty much.
Why is it all so easy now? I think this is one of life’s great mysteries actually. It is true that to get some sort of credibility is tough. It’s really helpful to have everything really simple. I mean, 2 per cent or 2.5 per cent. Everyone understands what that is. All that Medium-Term Financial Strategy when you’re explaining it to the man on the street, [Several words inaudible.], it’s fantastically complicated. So transparency and simplicity, I think, goes a long way. But of course you have to start from a place where there’s low inflation, to start at 10 per cent is just hopeless. My guess is if we’d had inflation targeting in 1979, if it’d been introduced in 1979, what happened subsequently wouldn’t have been much different. I can’t think how you could do it very differently.
One thing I will say about the macroeconomic frameworks, however, while the profession more or less everyone agree roughly what the right kind of way to conduct monetary policy is, I don’t think the profession in particular agree about in practice the right way to do fiscal policy. I mean, we all know what we’re trying to aim for, which is some sort of zero average, but to get that into … to get that working, as the ECB Stability and Growth Pact demonstrates, it’s not, the nitty gritty of it’s not easy, and I don’t think they all agree on that. Professor Philip Booth:
Okay, only twelve minutes left, so the lady there and then Gordon. Yes. Female speaker:
Having been born in ’75 and being 6 in ’81, I am quite interested in the panel’s thoughts going forward. It seems strange to me that while I agree that there was certainly an improvement in terms of macroeconomic or the conduct of macroeconomic policy in ’81, and I would say that the 364 were wrong, why do we assume that all of a sudden macreconomic policy has become easy and has achieved a blissful success? It’s quite striking that the major period of stability really appears since ’97 when the Bank of England was made independent but this is also the year when some global phenomenon has appeared as well which is this excess desire to save in a bunch of countries, mostly in Asia but also in Northern Europe, and basically these excess savings have depressed the rate of return everywhere and have turned the central bankers into reactive agents and has led to growth being constantly driven in the borrowing countries by ever more taking up of debt which eventually when these guys decide to save less in the next decade will leave these countries with a lot of debt in exactly the same time when the baby boomers retire, which I think will make it an entirely different setting for monetary policy to be conducted in. Professor Philip Booth:
Geoffrey was shaking his head vigorously, but before Geoffrey, Gordon. Gordon Pepper:
I spent the morning rereading everything I had written in 1979 through ’82 in the realm of monetary policy, and some of it is worth repeating as a lesson. Now Alan Walters, Jurg Niehans and I would all argue, very very definitely, in the autumn and winter of 1980, that monetary policy was far too tight. Because it caused massive distortions, when the exchange controls came off all those distortions unravelled and [Several words inaudible.].
So we started off from that position in about December monetary policy was far too tight. It was then eased a bit. Now the thing that I found very interesting was that, as 1981 progressed and 1982 progressed, monetary policy came almost exactly into line with the gradualist approach - it was about 3 per cent growth in real terms. So [word inaudible] coming down from about 15 to 11. Now what I found extraordinary was that with an 8 billion fall in the central government borrowing requirement, that monetary policy was actually eased. If you look at the counterparts of sterling M3 that lending went up from £8 billion to £18 billion. It more than offset it. Now this raises the question of if the same policy was followed today, would it still work? Now what was happening in 1980 was that because real interest rates were very high, and they’ve already been mentioned, and because the yield curve was falling, the rate of return on bank deposits seemed to be an excellent home for savings for many people, and there was a huge wad of savings in bank deposits. Now what the March ’81 budget did was restore confidence in financial markets, get expectations of the bond and equity market rising, expect a return on those markets that exceeded the ordinary return on bank deposits, and that wad of money moved into asset prices, etc, etc. It was a classic example of the importance of the role of financial markets.
From having enforced policy changes, Healey had to turn around at the airport and go to his party conference in a buyer’s strike and the financial markets were highly negative, suddenly turning into being extremely positive indeed. So that’s part of the story, part of the detail, of why the change in forecast was wrong [several inaudible words] have offset that tightened fiscal policy. Thanks. Professor Philip Booth:
Ok, Geoffrey first and then Andrew Alexander wants to make a point. Geoffrey Wood:
I think it’s important to remember that economic stability did not start in 1997. It was not confined to Britain. Economic stability started to increase in 1992. It has been increasing steadily since then. That’s the period over which we had a stable and predictable and very simple monetary policy framework, a point that both Terry and Stephen emphasised the simplicity and transparency of the framework. This is not unique to the United Kingdom. A fascinating paper by John Taylor in the Federal Reserve Bank of St. Louis Review called “Monetary Policy and The Long Boom,” he explores various explanations for the prolonged period of low inflation growth in the U.S. and eventually eliminates everything except stable monetary policy. So I think that stable monetary policy rather than high savings ratios, if indeed they are high, and have produced the economic stability.
I say if indeed the savings ratios are high because of course these are numbers that are notoriously difficult to measure, it may be, it may be that the export of goods as a consequence of reductions of tariffs have made it easier for central banks to control inflation, but again I emphasise it may be, because if we look back at a period of economic stability, say the 1870s-1890s, the kind of interest rates we had then at the short end of the yield curve are not all that different from the kind of interest rates we have now and the inflation rate is rather similar, so perhaps we’re not living in a different world after all. Professor Philip Booth:
Andrew. Andrew Alexander:
I’m glad Gordon Pepper mentioned the mechanisms, not the straightjacket, what was it called? [Interjection: “The corset”.]
The corset, the corset, yes. This thing which Adam Ridley and Terry Burns are well qualified to comment because we haven’t really dealt with this question of the curiosity to have a monetary policy but ignored money supply figures, and it’s extraordinary when you think that it took so long after 1979 to arrive at the relatively simple thing we do today because I can guess, as a non-technician, there was some attempt to control volume by volumetric means instead of having the sense and the very IDA sense to control it by the price of money. We now control money by the price and in those days using…
And in those days using the corset and so on and other mechanisms, I suspect this was doomed to failure and the only solution … . It’s funny why we didn’t come to it so much earlier. Why didn’t we get round to control by price? Very interesting. Sorry, I’ve tried … Professor Philip Booth:
Terry, do you want to comment, or even Stephen? Lord Burns:
I will, I mean, the corset came off very early in the life of the Conservative Government, and indeed monetary policy throughout has actually been conducted in terms of price rather than in terms of quantities, but it was the attempt to try to use quantitative figures as being the control mechanism which made you decide whether or not the … which direction the price should go. And of course the paradox or not the paradox, the Murphy’s Law aspect of this was that it was, you know, the deregulation that went on in ’79-80, which I think actually has, you know, a great deal to do also with improved government performance over this period, which hasn’t been spoken about this evening, actually itself made the conduct of monetary policy more difficult because it caused so much difficulty with the indicators. And so, one of, we have two things which I think have actually been very important. One has been the acceptance that inflation had to be controlled by monetary policy which is not necessarily the monetary aggregates . And the second has been the improved supply side through deregulation, etc.. And the second of those actually made the conduct of the first of the policies [sic - cost of the conduct of the first of these policies?] much greater than had been anticipated. Professor Philip Booth:
Derek, are you trying to come in? Derek Scott:
No, not at all. Professor Philip Booth:
Last three questions we’ll take together in fact. On my left and then the two at the back. [Male speaker]:
[Inaudible word] the question of why monetary policy, the question of why monetary policy seems easier today, it is because the political conditions are in place in this country and in a lot of other countries of the world in which it’s possible to have stable monetary policy. Why was that?
Well, in large part because of the 1981 budget. The state of the British economy in 1979 was the result of everything that had happened in British politics, in British society, between 1939 and 1979. The 1981 budget was a very important part of saying, things are different, it’s not like that anymore, it’s got to be different, it’s going to be different. And when Mrs Thatcher said, “You turn if you want to, the lady’s not for turning,” that is why it is now possible for monetary policy to appear easy, in the same way that in the United States when Reagan sacked the air traffic controllers, that was a hugely important development in the renaissance of the United States economy.
Inflation in 1979 - the result of 40 years of social and political developments. Inflation in 1990, which Steve Nickell referred to, the result of 5 years of obsession with the ERM. That’s the big difference. But in political terms, why is it now possible to have a stable monetary policy? In large part it is because of the 1981 budget. Professor Philip Booth:
Don, very briefly, and then just in front of Don.
Don [Surname unknown]: At the time of the letter, I was involved in manufacturing in computing and electronics and I was also in a small way involved in property. I didn’t suffer from strikes or difficulties in the computing industry, but I’m no longer in that. And all of my associates have now got out of it. We’re all in property, for the simple reason that despite very, very poor productivity in property, we have experienced massive, massive capital gains whether from selling our factories or speculating. What additional weapon do you think you needed in this armoury of yours, over and above interest rates, which have tamed, I don’t know, the wretched remnants of the public sector, what additional weapon do you think you needed in your armoury in order to tame property inflation, which so bedevils everybody in this country? All the youngsters here will need three incomes in order to get on the property ladder. But once other… [Professor Philip Booth]
The number of households since that letter, the number of households formed in the UK has grown by only 20 per cent, but I read in a book the asset structure of the private property was about 300 billion at that time. It’s now supposed to be 3 trillion and yet we’ve only added 20 per cent additional households. Professor Philip Booth:
Ok. Bernard Connolly:
I was going to make a very similar point, so I’ll make a different one and that is to ask, how has the supply of money increased in comparison to inflation over the last ten years? Does the quantity theory of money actually really apply? Professor Philip Booth:
Could we have perhaps Derek on the political conditions and the political conditions being easier in 1997 partly because of the 1981 budget? Maybe Stephen on the issue of property prices? Would you like to? Stephen Nickell:
Yes, I would like ten words. Professor Philip Booth:
And Michael on the. Andrew’s got a one word answer as well. And Michael, would you like to take the quantity theory of money? [laughter at this rapid sharing out] Maybe you’d like to touch on that as well. Okay, so Derek first. Derek Scott:
No, I mean I agree with what Bernard said and I think one of the problems following the point that the lady made earlier on was that, one of the difficulties is that politicians underestimate the time it takes for policies to take effect for ill or good, and the trouble is when things are going reasonably well, as we saw in Germany in the 1950s and 1960s, the politicians start taking it for granted, they start increasing taxes, they start moving spending, and that is what is happening here. So, far from suggesting we can be complacent, I think the worrying sign is that they have actually forgotten, if you like, the lessons as said were set in place in the 1980s, in that period, and we are slowly burning things up, just like Germany after Ludwig Erhard, people forgot what had actually created it and you will have a period when, if we are not very careful, we shall end up managing decline in the way that we were in the business of doing in the 1960s and 70s. Professor Philip Booth:
Stephen? Professor Stephen Nickell:
Well, there are two things you can do about property prices. One is, persuade everyone in the world to stop their saving so that long-term real interest rates go up. But the other one is to put me in charge of all planning decisions. I would certainly manage to reduce the price of most properties. [Loud laughter.] But it would take ten years. [More laughter and interjection: “Including your own?”] Including my own? Absolutely! Professor Philip Booth:
Andrew? One word. Andrew Alexander:
Population! The population pressure. It only needs a quite small increase in population when the supply of land and houses is very limited to send the price shooting up. And you only have to look at the immigration and population figures and there is your explanation. Professor Stephen Nickell:
But there is plenty of room you see, so with me in charge of planning law, the places would get built and you wouldn't have this problem. David Laws MP:
Both of us in charge of planning, because I agree with Steve - I mean, there is just a simple economic mismatch between supply and demand. If you look at the housebuilding vs the household formation [sic], it is not difficult to understand why house prices in this country have gone up such a lot.
But the other thing I just wanted to very briefly comment on is not the quantity theory of money, but the political question: is the current stable framework traceable back to the 1981 budget. I am not actually convinced that it is. I think that, firstly, the global conditions today are totally different to what they were 25 years ago. And when we try to create … try to take the credit for our monetary regime in this country and trace it back to a political decision, we need to relate it also to the fact that right throughout the world the trend is towards greater stability, greater policy stability, greater stability of inflation … have changed completely over 25 years. And therefore our success should be measured against the success that there is in virtually every other country. Professor Philip Booth:
Doesn’t that make the 1981 budget an even great achievement? David Laws MP:
No. The 81 budget came at a time of world economic chaos, and our success now comes at a time of world economic stability, and we are a tiny element of that stability. We shouldn't be trying to take too much credit.
And I think the other point is, if the 1981 budget was the forerunner of the stability that we now have, it was an awful … awful long way forerunner [sic], because we went through a lot of instability in the meantime, and it took us a long time to get to the situation we did after the ERM and after 97, when we actually put in place the regime we have got now, which is the basis of that stability. So I wouldn't overplay the 1981 budget's role in delivering what Steve and others [on the Bank of England's Monetary Policy Committee] are delivering today. Professor Philip Booth:
Terry? Lord Burns:
I was completely intrigued by Steve’s question, if we had an inflation target regime in 1979 would have required broadly speaking the same policies that were followed in order to produce the results? And I suspect that it would have required something that was really rather similar to that.
We looked at … I was involved in discussions for many years as to whether or not an inflation target should be introduced. We looked at it in 1983, we looked … you know, each time we were having problems we looked at it. And one of the real fears at that stage was that people still couldn’t… that if you have an inflation target, people would still think that that meant prices and incomes policies, and [word inaudible] controls and intervention of one kind or another. And part of the desire was to shift the emphasis from those things onto monetary policy as the process. And the fear that until … Peter Middleton was very keen on this notion. If you start talking about inflation targets, you will be back with prices and incomes policies before you knew where you were. And therefore it was much easier to do it when the battle had been won about what were the real instruments that you needed to control inflation. Professor Stephen Nickell:
Absolutely. If you had had an inflation target like two, you would not have hit it any time soon and it would have lost credibility before you started. Professor Philip Booth:
Ok. Michael? Michael Oliver:
If you start talking about the quantity theory of money, you have to talk about velocity. Monetarists believe that velocity is stable in the long run. In the 1980s, as Terry has said, it wasn’t initially. Read Geoffrey's 1994 book that argues that in the long run it is. So, to answer the question about money supply growth since 1980 onwards, please buy a copy of my book with Gordon Pepper [laughter] The Liquidity Theory of Asset Prices, which will outline exactly what has happened since the early 1990s, late 1980s. Professor Philip Booth:
Available through the IEA website! [Laughter.]
Geoffrey, do you want a final word? Or has it all been said? Geoffrey Wood:
If you give me the chance, for a final word on David Law’s concluding remarks, that we have achieved monetary stability, low inflation in a period when this is true worldwide - absolutely correct and totally irrelevant, because we have a floating exchange rate. What happens in the rest of the world perhaps makes it marginally easier for the Bank of England to conduct monetary policy, but with a floating exchange rate we have monetary independence that depends on nobody but ourselves for the monetary [word inaudible] we are having now. Professor Philip Booth:
Thank you. Well, for the last two weeks my wife has been very puzzled as to how I could possibly get so excited about 364 economists writing a letter to The Times and a budget that happened when I was 16 or 17 years old. But if she were here tonight she would know the answer, because our panellists have given us an excellent insight into the issues and some very clear and incisive arguments. And I would like to thank them very much for that and I would like you to them a service, if you are willing, and buy the book for only £5 and amaze your friends in the pub by showing them the actual list of the people who signed the letter … Derek Scott:
Let’s be clear, it doesn’t do us a service, we don’t get a penny out of it.[loud laughter] Professor Philip Booth:
… and, um, please do join us, not only for bookbuying but a drink and something to eat in the room across the way. But let us thank our panellists. [applause]