Philip Pilkington: The New Monetarism Part I – The British Experience

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By Philip Pilkington, a writer and journalist based in Dublin, Ireland. You can follow him on Twitter at @pilkingtonphil

While there are pret­ty stark dis­sim­i­lar­i­ties between the cur­rent quan­ti­ta­tive eas­ing (QE) poli­cies of many gov­ern­ments and the old mon­e­tarism that pre­vailed in the late-70s and ear­ly-80s, the rea­son that these both poli­cies were inef­fec­tive is because they were based on the same flawed ideas. The key dif­fer­ence between the two is that where mon­e­tarism was imple­ment­ed as a defla­tion­ary and con­trac­tionary pol­i­cy, QE is cur­rent­ly being imple­ment­ed as an infla­tion­ary and expan­sion­ary pol­i­cy. As a result, exam­in­ing the fail­ure of mon­e­tarist poli­cies thir­ty years ago pro­vides impor­tant lessons con­sid­er­ing QE and its off­shoots.

Before look­ing at the sim­i­lar­i­ties between these two doc­trines, we will explore the actu­al his­tor­i­cal tri­al of mon­e­tarism. We will focus on the British expe­ri­ence since the doc­trine was applied there with far more zeal than in the Unit­ed States. Indeed, Paul Vol­ck­er – Fed chair­man at the time of the mon­e­tarist exper­i­ment in the US – has recent­ly stat­ed that he nev­er believed in the doc­trine and sim­ply used the mon­e­tarist ‘fad’ of the day to push for unpop­u­lar inter­est rate hikes. By con­trast, those work­ing in the Bank of Eng­land at the time were true fol­low­ers of the mon­e­tarist faith.

Mag­gie Thatcher’s Lega­cy: Mon­e­tarism in Britain

Mar­garet Thatch­er was elect­ed as Prime Min­is­ter in Britain in 1979. She was vot­ed into office at a time when the British econ­o­my was under­go­ing an infla­tion­ary cri­sis that was main­ly due to oil price hikes by the Saud­is in response to polit­i­cal insta­bil­i­ty in the Mid­dle East cou­pled with unions demand­ing that their wages keep pace with infla­tion. How­ev­er, to paint this in such drab terms would be to illus­trate the era poor­ly. The wage-bar­gain­ing process had become deeply inflex­i­ble and entrenched in Britain at this time. Unions were com­ing to be seen by many as a can­cer­ous growth on British soci­ety and on British indus­try.

In 1978, one year before Thatch­er was elect­ed, Antho­ny Burgess wrote a short nov­el enti­tled ‘1985’. It was a poor piece of writ­ing, as so much of Burgess’ out­put was – ‘A Clock­work Orange’ being a notable excep­tion. Burgess grew up in a work­ing class fam­i­ly and much of his work reflects his hatred of his ori­gins. In his books the work­ing class are usu­al­ly por­trayed either as hope­less dullards con­di­tioned by the social sys­tem in which they live or as vio­lent anti-social rebels who wreak hav­oc upon soci­ety. How­ev­er, poor though it was Burgess’ ‘1985’ – which was sup­pos­ed­ly an ‘update’ of Orwell’s excel­lent ‘1984’ – artic­u­lat­ed what many in Britain had come to feel toward the trade union move­ment.

The sto­ry fol­lows Bev, a man who had recent­ly lost his wife to the cal­lous­ness of the unionised staff at the state-run hos­pi­tal ser­vice who were strik­ing for a pay increase and neglect­ed to treat her. In a moment of out­rage that was soon to get him fired due to its anti-union tone Bev indicts the sys­tem of unionised work as a tremen­dous evil:

My rage,” said Bev, “as you right­ly term it, is the mere emo­tion­al cul­mi­na­tion of a long-grow­ing belief that the closed shop is evil, that it’s unjust to force men into being mere cells in a gross fat body that com­bines the tor­pid and the preda­to­ry, that a man has a right to work if he wants to work with­out hav­ing to jump at the shop steward’s whis­tle, and that, giv­en cer­tain cir­cum­stances, a man has a duty to work. A duty to put out a fire, if that’s his trade. A duty to –” He was going to say: drop nuts on choco­late creams, but he saw the absur­di­ty of it. And then he did not see the absur­di­ty of it. A child dying and want­i­ng only one thing: a box of Penn’s Assort­ed. And every­body on strike and not a box left in the world, and the defi­ant work­er, brav­ing the threats and the blows, going to the machine–

Burgess’ ‘argu­ment’ – if we dare use that term – is rather weak. Its strik­ing work­ers that deny a dying woman health­care is lit­tle beyond the car­i­ca­ture found in some of the more vul­gar tabloid news­pa­pers. (It, of course, being infi­nite­ly more like­ly in today’s world that a per­son will go untreat­ed due to an inad­e­quate­ly fund­ed health­care sys­tem). How­ev­er, due to the trou­bles tak­ing place in Britain at this time such a view of unions res­onat­ed with much of the British pub­lic who could not see that the infla­tion­ary push under­ly­ing much of the strikes and the dis­con­tent were par­tial­ly due to cir­cum­stances out­side of the British government’s con­trol. It is in this con­text that we must under­stand why the dis­as­trous mon­e­tarist exper­i­ment was allowed to be car­ried out by the British pub­lic.

The aim of Thatcher’s mon­e­tarist poli­cies was to attempt to con­trol the rate at which the over­all mon­ey sup­ply grew. Thatch­er and her advis­ers – rely­ing on the work of Mil­ton Fried­man which will be con­sid­ered in what fol­lows – believed that it was the expan­sion of the mon­ey sup­ply pure and sim­ple that caused infla­tion. This was appeal­ing to the Thatch­er gov­ern­ment for a num­ber of dif­fer­ent rea­sons. It pro­vid­ed them with an osten­si­bly sci­en­tif­ic the­o­ry that told them that despite the fact they had no influ­ence on the OPEC oil price and lit­tle direct influ­ence over the unions and their wage bar­gain­ing, they could nev­er­the­less sim­ply order the Bank of Eng­land to tar­get the amount of mon­ey allowed to be cre­at­ed and this would bring down infla­tion. The mon­e­tarists essen­tial­ly allowed the Thatch­er gov­ern­ment to pre­tend that the infla­tion Britain was fac­ing had noth­ing to do with either inter­na­tion­al or class pol­i­tics and was sim­ply a tech­no­crat­ic prob­lem with a tech­no­crat­ic solu­tion.

Tra­di­tion­al­ly cen­tral banks use inter­est rate pol­i­cy to reg­u­late the lev­el of demand and hence infla­tion in the econ­o­my. How­ev­er, in the post war years the use of inter­est rate pol­i­cy as an effec­tive means to reg­u­late the econ­o­my had fall­en into dis­favour – espe­cial­ly after the British gov­ern­ment had launched a detailed inves­ti­ga­tion into mon­e­tary pol­i­cy in the ear­ly 1950s named the Rad­cliffe Com­mit­tee (to be dis­cussed in more detail when we con­sid­er the the­o­ry as opposed to the prac­tice of mon­e­tarism). The mon­e­tarists claimed that the British gov­ern­ment need no longer use straight­for­ward inter­est rate tar­get­ing to get infla­tion under con­trol. Instead they would sim­ply tar­get the sup­ply of mon­ey and let inter­est rates fall where they may.

But in Prac­tice…

The mon­e­tarist exper­i­ment proved dis­as­trous. The Bank of Eng­land failed com­plete­ly to con­trol the mon­ey sup­ply and suc­ceed­ed only in caus­ing inter­est rates to spi­ral out of con­trol. This threw the econ­o­my into a deep reces­sion. Between the last quar­ter of 1978 and the last quar­ter of 1980 the M3 mea­sure of the mon­ey sup­ply – the tar­get of the mon­e­tarists – rose by some 32.8%; this was sig­nif­i­cant­ly faster than in the years before the tar­gets had been ini­ti­at­ed. Mean­while unem­ploy­ment sky­rock­et­ed and busi­ness­es shut their doors.

The British film­mak­er Adam Cur­tis made an excel­lent film enti­tled ‘The League of Gen­tle­men’ [] as part of his series ‘Pandora’s Box’ [] which dealt exten­sive­ly with Britain dur­ing the mon­e­tarist years. Here is a clip from that film describ­ing the sit­u­a­tion in Britain as the mon­e­tarists tried to tar­get their mon­e­tary aggre­gates:

Nev­er­the­less, despite the fact that the exper­i­ment was a com­plete fail­ure, the Thatch­er gov­ern­ment clung onto the pol­i­cy with a deter­mi­na­tion that bor­dered on zeal­ous­ness. Thatch­er and oth­ers had put so much stock in the mon­e­tarist doc­trine and its sup­posed sci­en­tifici­ty that to aban­don it would have been an enor­mous embar­rass­ment to the gov­ern­ment and its cham­pi­ons.

Note the resem­blance to today’s QE pro­gram. Many in the mar­kets and the media have suc­cumbed to a sort of ‘QE fatigue’ as it is obvi­ous that the pol­i­cy has not pro­duced the desired effect. Nev­er­the­less, QE con­tin­ues to live on as a sort of undead pol­i­cy tool. A great deal of the rea­son for this is that those engaged in the mar­kets can still trade on QE. For exam­ple, if anoth­er round of QE is announced by a cen­tral bank an investor can short the cur­ren­cy of that coun­try, buy their gov­ern­ment bond or throw mon­ey at the stock mar­ket. The brief increase or decrease, gen­er­at­ed most­ly by self-ful­fill­ing expec­ta­tions, can then give their port­fo­lios a boost. Econ­o­mists and com­men­ta­tors also cling to QE because it gives them some­thing to talk about which they can use to enhance their pres­tige – this even though QE, stripped of its aura, is a straight­for­ward asset swap pro­gram that a child could under­stand.

Back to the ear­ly 1980s. Some­thing even­tu­al­ly had to give. And, not sur­pris­ing­ly giv­en the absur­di­ty of the mon­e­tarist poli­cies, the Thatch­er gov­ern­ment even­tu­al­ly fold­ed. How­ev­er, Mrs. Thatch­er nev­er admit­ted that she had been wrong. Instead she pre­tend­ed that her gov­ern­ment had nev­er sub­scribed to the pol­i­cy. Here is a won­der­ful inter­view with Thatch­er tak­en from Cur­tis’ doc­u­men­tary where she flat out denies that she was ever an enthu­si­ast of mon­e­tarist.

Scorched Earth

By the mid-1980s the infla­tion in Britain was com­ing down. One of the main rea­sons for this was the fall in oil prices as the OPEC car­tel drew back their price ris­es. But anoth­er rea­son was that Thatcher’s poli­cies had, through the mas­sive reces­sion that the mon­e­tarist poli­cies had induced, hol­lowed out the British trade union move­ment – and with it a good por­tion of British indus­try.

The reces­sion was brought about main­ly through the chaot­i­cal­ly high inter­est rates of the peri­od – which remained at dou­ble dig­its through most of the mon­e­tarist era – togeth­er with tax ris­es and cuts to gov­ern­ment spend­ing that were osten­si­bly tak­en to meet the mon­e­tary tar­gets. The chan­nel through which this affect­ed the econ­o­my was main­ly that pro­duc­ers became extreme­ly ner­vous about the future as they saw sales fall – a good deal of the effec­tive­ness of this pol­i­cy was due to self-rein­forc­ing expec­ta­tions. The high inter­est rates also strength­ened the British pound which led to exports falling and domes­tic goods being out­com­pet­ed by the now cheap­er for­eign goods. All this, cou­pled with the high and unsta­ble rates of inter­est they had to pay on loans, led British busi­ness­es to cut invest­ment rapid­ly. As invest­ment fell so too did employ­ment and a depres­sion­ary spi­ral ensued. Much of British indus­try crum­bled and went bank­rupt; those indus­tries that did sur­vive were much small­er than they had pre­vi­ous­ly been.

This is a point lost on many who look back on the era. These poli­cies did not have the effect of redis­trib­ut­ing income from the work­ers of the fac­to­ries to the own­ers, but rather they sim­ply destroyed large seg­ments of British indus­try. As the British econ­o­mist Nicholas Kaldor wrote in his book ‘The Scourge of Mon­e­tarism’:

[Mon­e­tarism] is not, there­fore, a viable method of restor­ing a ‘broad bal­ance of pow­er in a frame­work of col­lec­tive bar­gain­ing’ [as the Thatch­er gov­ern­ment had claimed]. It is a method of ruin­ing both sides of indus­try at the same time, and not of strength­en­ing one side at the expense of the oth­er.

Some of the more reflec­tive civ­il ser­vants who took part in the mon­e­tarist exper­i­ments lat­er became dim­ly aware of what they had engaged in. Here is yet anoth­er short clip from Cur­tis’ doc­u­men­tary in which a gov­ern­ment banker reflects on what had tak­en place in the dur­ing the reign of mon­e­tarism.

Whether the gov­ern­ment or seg­ments of the gov­ern­ment were con­scious of what they were doing is unclear. Kaldor, for one, thought that they real­ly did believe in the mon­e­tarist doc­trine. How­ev­er, Paul Volcker’s admis­sion that he effec­tive­ly used mon­e­tarism as a smoke­screen cit­ed at the begin­ning of this piece casts some doubt on this. Regard­less, the effects of mon­e­tarism are now crys­tal clear.

One more of these effects should briefly be con­sid­ered before in the next part of this series we move on. Mon­e­tarist poli­cies, as Cur­tis allud­ed to in his doc­u­men­tary, great­ly ben­e­fit­ed the finance com­mu­ni­ty in the City of Lon­don. Again this was not due to mon­e­tarist mys­ti­cism or mon­ey sup­ply tar­gets, but sim­ply that the objec­tive effect of the pol­i­cy was to great­ly strength­en the val­ue of the British pound through per­sis­tent­ly high inter­est rates. This attract­ed much for­eign cap­i­tal to the City of Lon­don – includ­ing the cap­i­tal that was being paid out to the oil sheiks as they price-gouged British con­sumers. This, togeth­er with the light-touch reg­u­la­tion that the Thatch­er gov­ern­ment favoured, led to finan­cial ser­vicesbecom­ing a main­stay of the British econ­o­my. No longer would the inter­ests of British man­u­fac­tur­ing dom­i­nate debates over eco­nom­ic pol­i­cy in Britain. Mon­e­tarism was, in a very real sense, the har­bin­ger of a new dawn for Big Finance in Britain.


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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.