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fabian tract 462 
the politics of monetarism 

chapter 1 
2 
introduction 
the Labour Government 
1 
4 
3 what is monetarism ? 6 
4 
5 
monetarism and growthinternational monetarism 
10 
13 
6 
7 
the international monetary fund 
and Labour's policy 
an old song 
16 
18 

the authors : 
Bryan Gould, a New Zealander by birth, was educated in New 
Zealand and at Oxford where he was a Rhodes scholar. He 
worked in the diplomatic service for four years before being 
elected Fellow and Tutor in Law at Worcester College Oxford. 
He was Member of Parliament for Southampton Test until May1979. 

John Mills is an economist who has wide practical experience 
in both manufacturing and international trade. 'He is very much 
involved with local government, mainly in housing and is deputy 
leader of Camden ·Council. He is prospective candidate for Greater 
Manchester South in the European elections. 

Shaun Stewart took a degree in economics at the London School 
of Economics and served for 26 years at the Board of Trade 
including two years as Counsellor (Commercial) in Ottawa. 
He also spent 14 months as a Harkness Fellow studying importcompetition in the United States. 

this pamphlet, like all publications of the Fabian Society, 
represents not the collective view of the Society but only the 
views of the individuals who prepared it. The responsibility of 
the Society is limited to approving publications it issues 
as worthy of consideration within the Labour movement. 
Fabian Society, 11 Dartmouth Street, London SW1 H 9BN. 
May 1979 I'SSN 0307 7535 fSBN 7163 0462 7 


1. introduction 
The -most significant development in 
economic policy over the last two or 
three years ha·s been the conversion of 
almost everyone concerned with the management 
of the Br~tish economy to the 
doctrines of monetarism. Th·is development 
has had the full support of the 
financial establishment and of the Conservative 
Party, as well as that of most of 
the leading !figures in the last Labour 
Government. The result of the General 
Election is therefore unlikely to make any 
major difference to this vital a1>pect of 
the way our affairs are run. The monetarist 
consensus, underpinned by the 
Governor of the Bank of England and 
by the financial institutions, seems likely 
to continue to prevail. 

a superficial and 
erroneous theory 

This is an exceedingly unfortunate tum 
of events. Monetarism, far from providing 
a solution to any of our perennial 
problems, is only compounding them. It 
is based on a superficial and erroneous 
view of the way •in which the economy 
works. Its policy implications, especially 
·in terms of growth and unemployment, 
run clean contrary to everything the 
Labour Party stands for. The efficacy of 
monetary policies in dealing w'ith inflation 
has been grossly exaggerated, but the 
deflationary consequences of a tight 
monetary policy are inflicting real and 

•lasting dama-ge to our already weak and 
uncompetitive economy. The prospectsfor prosperity and full employment in 
Britain, based as they must be on an 
expa!nding and secure manufacturing base, 
rare desperately gloomy unless there ]s a 
fundamental change of course. 
The fatal flaw in monetarism js that it 
sees everything in terms of the money 
economy to the total exclusion of the 
real economy. Our current economic 
position illustrates this well. The last 
Labour Government, over the past two 
years, did much that the monetarists 
would ask of it. It prevented the money 
~upply from expanding to the level required 
to maintain output and employment. 
It pushed up interest rates to astronomic 
levels to enable the public sector 

borrowing requirement to be financed 
by the sale of long terms debt on terms 
dictated by the b,<tnks, !finance · houses 
and other bodies known as the City 
" institutions ". It deliberately pricedBritish goods out of home and overseas 
markets :by raising the exchange:rate, despite our relatively high rate of 

•inflation. Tills display of monetarist virtue 
bas earned the Chancellor plaudits in the 
City and financial press, but bas had a 
predictably disastrous effect on the real 
economy. Manufacturing output in the 
fourth quarter of 1978 was nearly 2 per 
cent less than during the three day week 
of 1974 and shows no sign of climbing 
even slowly above its present dismal level. 
If monetarism fails the practical test by 
a very wide margin its theoretical basis 
is no more convincing. Monetarist theory 
postulates a cons·istent and predetermined 
causal relationship between the growth 
in the money supply and the rate of 
•inflation. This relationship has never lbeen 
shown to exist. The causal mechanism 
has never been established. The measurements 
of money supply used are both 
arbitrary and misleading, and real factors 
in the economy, such as commodityprices and wage levels, are totally ·ignored.
Despite the preten1>ions of its theoreticians 
the truth about monetarism is that it is 
simply old fashioned deflation dressed 
up 'in newly fashionable jar-gon. 
the attractions of monetarism 

Adherence to deflationary policies as the 
way to solve the chronic problems of the 
British economy is, unfortunately, nothing 
new. The City, the financial press and the 
mo-neyed establishment in this countryhave always advocated the bankers' 
policies of retrenchment and restraint 
as the way to improve our poor economic 
performance. The reason why those in 
firranc1ally po>werful positions should so 
consistently favour remedies which manifestly 
do not work is not diffi~ult to 
explain. It is the political attractiveness 
of these policies which explaim why they 
a·re held in such e~teem. 

First. monetarism is 1deologJcallv very 
congenial to tho e whose philosophy and 


interests are completely at odds with 
those in the Labour Party, because it 
reduces the ·ability of any Government 
to intervene decisively in the managementof the economy. The role of a Government 
pursuing monetarist policies is 
limited to the management of the moneysupply ; beyond .that the achievement of 
economic targets must be •left Ito others. If 
monetarism is in principle profoundlyanti-interventionist and anti-socialist, its 
main practical manifestation is in tying 
public expenditure into an ·ever tightening 
strait-jacket In both practice and theory,
therefore, it is not surprisirrg that monetarism 
accords well with the politicalprejudices of those who a-re apposed to 
Labour's aspirations. 

Second, monetarism places the Cityand the money markets in an extremely 
powerful position. If the Government's 
sole functions is to manage the moneySUipply, which in turn determines the level 
of the exchange rate, then it follows that 
the money markets and the exchange rate 
markets have ·a weapon of great power. 
It is they who are in effect daily passing 
judgment on the Govemnment's economic 
policies. If that judgment is unfavourable, 
as it is l'ikely to be in the case of anyGovernment with ever vaguely socialist 
aspirations, then it is the Government 
which must give way and so adjust its 
policies as to produce a favourable 
verdict from the ma-rkets. 

Government policy is therefore placed 
upon a familiar treadmilL The myth has 
been established that ·the success or 
failure of monetary policy is to be 
measured in terms af the monthly M3 
figures. "M3 " is shorthand for a measure 
for the volume of deposits held by the 
ba·nking sector, which in turn determines 
the amount of money avaiilable .fo·r them 
to lend, and hence the total volume of 
money in circulation. This figure is determined 
by the willingness or otherwise of 
the institutions to hold Government debt 
it is the money market which effectively 
determines monetary policy and thus the 
country's economic strategy. A goodexample of this can be seen followingthe I 978 budget. The Chancellor, with 
almost un·iversal approval, had introduced 

a mildly reflationary set of measures but 
was forced to reverse direction when the 
money markets, in a typically conservative 
reaction, decided that interest rates 
were too low for comfort and that 
deflation rather than .reflation was called 
for. •By the simple expedient of refusingto buy gilts for two or three weeks they 
produced a sudden increase in the M3 
figure. The Chancellor was then hoist Ofl 
his own petard. Because he had himself 
stressed the importance of M3, he was 
forced to respond when 'it appeared to be 
going out of control. Yet all that had 
happened was that the money markets 
had expressed a judgment unfavourable 
to his budget. 

The position is similar when one looks 
at the foreign exchange market The 
Chancellor again gave a hostage to fortune 
by announcing that the maintenance 
of a stable (not to say overvalued) exchange 
rate was central to his economic 
strategy This allowed the exchange markets 
to exercise a veto over anythingwhich the Chancellor might do of which 
they might take an unfavourable view. 
As has been the case so often •in the 
past, a LaJbour Chancellor was thus effectively 
inhibited from doing anythingwhich might destroy " confidence " in 
the pound. 

The third reason for the near unanimous 
support for monet<l!rism in the City is 
that it is of course a doctrine which 
operates very much .in the interest of 
bankers and others who hold and deal 
in money. From a short tenn and practical 
viewpoint, it ]s worth noting that 
when the money markets manipulate the 
money supply and the sale of Government 
securities or gilts on which it is 
based, they are able ·to force up interest 
rates as they did in February 1979. 

The scramble which subsequently followed 
for gilts showed just how successful 
the financial institutions were in 
creating a buyers' market. In the long 
term, monetarism is a useful reinforcement 
for the traditional principle of 
British economic management which IS 
that the interests of those who hold and 
deal in money are to be preferred to th.: 


interests of those who actually make and 
sell things. Jt is the holders of money who 
want stability at whatever cost to the real 
economy. lt is those who make and sell 
·things who need the prospect of growthwhich is, however, destroyed by a monetarist 
pol'icy. Monetarism means quitesimply that the Government has chosen 
once ·again to put the City and its interests 

ahead of manufacturing industry. 

Finally, monetarism is wjdely supported 
because it ·is .a matter of fashion. Mone-
tari·SIIU is not a new or sophisticateddoctrine; indeed 'in many ways it is 
essentially primitive jn nature. It has the 
great advantage, however, that it offers, 
in an uncertain world, a feeling of certainty 
and simplicity which makes a 
.powerful appeal to those who have no 
opportun'ity or incentive to appreciatethe true complexity of our problems. This 
is rparticularly so when that simplicityand certainty are a-ttractive politicallyas well as economically. ' 

labour and monetarism 

The daims of the monetarists ought ·to 
have been resisted by the Labour Party. 
The problems af the British economy do 
not lie in the growth of trade union 
power, or the rise of expenditure, or 
any of the other politically inspiredexplanations. The real problem lies in the 
perennial attachment of a conservative 
financial establishment to the doctrines 
of financial orthodoxy which have meant 
a constant recourse ·to deflation as a means 
of trying to ·escape from our difficulties. 
MonetariSIIU is simply the latest mani· 
festation of this theme, which has run so 
strongly and dama_~gingly throughoutBritish economic policy for the better par-t 
of a century. 

We bel'ieve that policies for growth are 
not a reward to be gained after we have 
solved our problems, 'but are in fact the 
only essential means by which these prob· 
lems can he solved. Only by abandoning 
our preoccupation with deflation and 
financial orthodoxy can we begin to growand thereby obtain the improved productivity 
which we need to be able to com


pete internationally. The lesson to be 
learnt from our own and others' exper· 
'ience is that groWth is ·tbe precondition 
of improved productivity and not the 
other way round. Only if we give priority 
to the needs of the real economy and 
free it from the constraints imposed byfinancial orthodoxy can we hope to break 
out of ·the vicious circle which threatens 
to destroy :British industry and the Br'itish 
economy. 


2. the Labour government 
It would be churlish not to acknowledge 
the achievements of the last two or three 
years of the last Labour Government. 
The rate of inflation was substantiallyreduced. Unemployment was a:t least not 
getting much worse. Investment in new 
plant and machinery was higher during 
the first part of 1979 than it had been a 
couple of years previously and livingstandards were ris'ing over the last months 
-before the General Election. 

None of this should obscure, however, 
the fact that all our basic problems remain 
unresolved. The fall in inflation 
owes a great deal to the success of a 
pay policy which •is now in tatters, and to 
the stability of world commodity priceswhich are now likely to rise shanply.
Unemployment, while not as high as 
some might have feared, has nevertheless 
been held down by a variety of 
costly and essentially short term '(though 
none the less socially valuable) govern· 
ment subsidies. Output, investment and 
l'iving standards have risen recently, but 
only back to the levels which were 
achieved four or five years ago. Importsof manufactured ·goods continue to rise 
two and a half times as fast as exports 
of manufactures, and every week 
thousands of jobs are lost as countless 
factories in one sector after another in 
British industry are closed down byforeign competition at home and abroad. 

The result of the General Election has of 
course made the immediate prospects 
bleaker still. The Conservative approach 
to our economic problems is not onlymuch less sympathetic to those who are 
vulnerable but also just as blinkered about 
the efficacy of deflation as a solution to 
our difficulties as the .last Labour administration. 
It is now clear that in 1979, 
even on the basis of some heroically 
optimistic assumptions; inflation will rise 
again, unemployment will grow, and our 
manufacturing industry will become even 
more vulnerable to foreign competition. 
In other words, having gone through the 
whole gamut of monetarist policies, and 
having endured all the political, social 
and financial difficulties associated with 
them, we are faced again in 1979 with 
all our familiar problems. In the wake of 

yet another debilitating twist of the deflationary 
screw, we are even less able 
to deal with them. 

North Sea oil 

All of this would have been made much 
clearer to us if it were not that our 
difficulties have been masked by the 
fortuitous advent of North Sea oil. It is 
North Sea oil which has allowed us, together 
with the restoration through tax 
cuts of money which need never have 
been taken out of the economy in the 
first place, to push up living standards 
once again thO'Ugh only to 1973 levels. 
It is North Sea oil which makes our 
national income figures anything like 
respectable and which allows us to conceal 
the fact that our manufacturing output 
is still more than 5 per cent lower 
than it was s'ix years ago. 

It is North Sea oil, in particular which 
has enabled us to pay for our swollen 
imports. If it were not for the £3.2 billion 
benefit which North Sea oil brought to 
our current trade account in 1·978-to 
say nothing of North Sea ga·s-we should 
have been in deficit by a terrifying 
amount. North Sea oil, being finite, 
should be regarded as a capital asset. 
It is one measure of the failure of 
the economic orthodoxy that, despite all 
the brave words about not wasting the 
opportunity it provides, current policieshave inevitably meant that North Sea 
wealth is being squandered in 'buying consumer 
goods. Goods which 'Would have 
been supplied by British industry if the 
appreciation of sterling as a result of the 
saving on North Sea oil had not made 
them uncompetitive. 

If North Sea oil is one huge opportun·itywhich has been totally wasted by current 
economic policies, the other is paypolicy. The first two rounds of pay policy 
played a major part in reducing inflation. 
However, because it was accompanied bymassive deflation which reduced hvingstandards and effiiployment, trade union 
leaders and their members became disillusioned 
with it. The policy was " sold " 
to them in 1976 on the basis that re



sources had to be transferred from consumption 
to exports and capital investment, 
'but the balance of trade in manufactured 
goods has actually deteriorated 
and investment in productive indust·ry is 
not much higher now than it was in 1976. 

There can be little prospect of sustaining 
a pay policy which is seen by those subjected 
to it simply as a means of holding 
down their purchasing power without any 
corre~ponding advantage in terms of 
employment prospects and possibilities of 
·growth. Nor can they be expected to take 
seriously the Government's warningsabout pricing themselves out of jobswhen this is 'being done very effectively 
by the Government's own policies. 

There is of course an important role for 
pay policy; but a pay policy can only be 
successful and sustainable if it is used 
as a platform for growth rather than as 
a means of deflation. The tragedy is that 
each abuse of the trade unions' willingness 
to embrace a pay policy makes it 
that much less likely that they will cooperate 
when a pay policy could 
genuinely be used to their advantage. It 
is ironic that when a pay policy breaks 
down it is the trade unions, rather than 
the Government's policies, which take the 
blame. 


3. what is monetarism? 
Monetarism, which ha both a dome ttc 
and an international Vltriant, has become 
fashionable over the past few years because 
it offer an apparently simple solution 
to an increasingly important and 
intractable problem-the control of inflation. 
The essence of the monetarists' position 
is that increases in prices and wages 
can be held in check by nothing more 
complicated than control•ling the amount 
of money in circulation. Ideally, a condition 
of nil inflation is achieved when the 
increase in the money supply equals the 
increase in real output in the economy,
and prices are stable. Since both wageand price increases require extra money 
to finance them, if no more money is 
made availltble increases will not take 
place. If attempts are made by firms or 
wage earners to gain an advantage by 
putting up the costs of their goods and 
services on the one hand, or labour rates 
on the other, then with a constant moneysupply the ·result for the firm will be 
unsold goods and services and; for labour; 
pricing itself out of a job. Thus as long 
as the Government is prepared to keepthe money supply down everyone will 
see it as being in his interest to exercise 
restraint, and inflation will be reduced 

to whatever level is deemed acceptable. 

domestic monetarism 

The crude version of this theory was first 
given popula·r expression in this countryby an article in The Times of 13 July1976 in which the editor, M r William 
Rees-Mogg, argued that an increase of 

9.4 per cent in the "excess" moneysupply in the nine years 1965/73 had 
re ulted in an average increa e of 9.4 per 
cent in price in the nine years 1967 f75. 
He concluded from this, a Profesmr 
Milton Friedman had done before him. 
that there i a two year time lag between 
an increa e in the money upply and a 
corresponding mcrea e in the level of 
prices. 
A careful reader would immedtately havt! 
been truck by the su pi iously neat fit 
between the two set of figure producedby Mr Ree -Mogg. Only a little further 
re earch would have heen needed to 

demonstrate that the exact match whtch 
he produced between money upplyfigures and inflation rate could only be 
achieved by a careful definition of 
" excess money supply", and by concentrating 
attention on the particular nine 
year period selected by Mr Rees-Moggrather than on a different nine year period 
or indeed on a shorter or longer period. 
In other words, Mr Rees-Mogg's calculation, 
accurate to a decimal point and with 
a neat two year time lag, bear all the 
hallmarks of a statistical fluke. 

what is money ? 

The first doubt which must be raised 
concerns the definition of money itself. 
There are few questions which have 
caused economists greater difficulty than 
that of deciding what should fall within 
the definition of money. It is therefore 
inherently implausible that any one of 
several generally accepted definitions 
could be used as a consistently reliable 
barometer of inflation regardless of 
changes in the economic climate. The 
Government nevertheles pinned its 
colour to a particular definition of 
money, M3, which is not u ed by manyother countries and which may have 
emerged simply because it included the 
kind of money which the Bank of England 
is concerned with in the management 
of the Government's debt. 

lt is equally unlikely that, even tf a definition 
were useful at any given moment, 
It would remain o for very long ; new 
form of money have alway been Introduced 
precisely in order to circumvent 
attempts to control the money upply, 
and this was particularly so under the 
gold standard, which Mr Rees-Moggthinks wa the epitome of monetari t 
virtue. Over recent month even the high 
prie ts of monetarism have begun to 
expres doubt about the reliability of 

M.3 as a definitatiOn of money. Gordon 
Pepper, a partner tn a firm of ity lock-
broker . has. for example, hown how 
the banking ystem can arrange Its books 
so as to e cape the full rigours of the 
Bank of ngland' attempts to enforce 
monetary targets again t the ~ tshes f 

the market. This has had the incidental 
effect of limiting the damage which those 
targets might have inflicted on the real 
economy, but Gordon Pepper's point reinforces 
the doubts which must accompanythe use of any single moneta·ry measure. 

the demand for money 

Even--veveryone could agree, however, 
on a comprehensive and universallyappropriate definition o{ money and on 
the accuracy of the means we use to 
measure it, there remains the fundamental 
question of whether such a measurement 
is or can be relevant and meaningful ·in 
isolation from other factors. The mere 
adding up of the quantity of money tells 
us very little unless we know to what 
use the money is put, or in other words, 
how much demand there is for it. This 
is not a new point. The principle elements 
in this ar-gument are all to be found in 
the report of the Select Committee of 
the House of Commons on The HighPrice of Bullion, written as long ago as 
J 810. The Committee pointed out that 
" the mere numerical return of the 
amount o1 bank notes in circulation cannot 
be considered as at all deciding the 
question whether such paper is or is not 
excessive . . . the quantity of currencybears no fixed relation to the quantityof commodities . .. and any inferences 
proceeding on such a supposition would 
be entirely erroneous ". They concluded 
that "the effective currency of a countrydepends on the quickness of circulation 
... as well as on the numerical account" 
and that " all the circumstances which 
have a tendency to quicken or to retard 

the rate of circulation render the same 
amount of currency more or less adequate 
to the wants of trade". 

The force of this important point can 
best be seen 'by looking ·at the changeswhich have taken place recently in the 
ratio between the national income and 
the money supply over the last few years. 
This ratio is a measure of the rate or 
"velocity" o.f circulation. From the third 
4.uarter of 1971 until the first quarter of 
1974, the velocity fell quarter by quarter 
from 3.111 times per annum to 2.345, 

as the supply of money increased. When 
the Labour Government came to office 
and the increase 'in money supply slowed 
down, the velocity of circulation increased 
quarter by quarter to 3.094 in 
the third quarter of 1977. 

1n other words the demand for moneydid not increase or fall by as much as 
the change in its Slllpply. When the supply 
was increas'ing rapidly the velocity fell, 
but as soon as the supply fell short of 
the "wants of t·rade" the velocity increased 
as traders accommodated themselves 
to the change in circumstances. No 
cons·ideration of the efficacy of monetarypolicy could possibly be complete without 
taking account of this point. Yet 
those who are currently applauding the 
application of strict monetary targets do 
so in terms of the simple measure of 
quantity, a practice which was condemned 
as naive as long Cl'go as 1810. 
Their problem is that they dare not 
admit that the demand for money moves 
independently of the supply because that 
would concent·rate attention on the 
demand side of the equation, and lead 
to the conclusion that a restrictive monetary 
policy is only appropriate in the case 
where " too much money is chasing too 
few goods". This is plainly not the case 
at the present time with vast unused 
capacity in industry and a million and 
a half unemployed. 

This conclusion is reinforced by the 
realisation by even leading monetarists, 
among them Professor 1Milton Friedman 
of the University of Chi·cago, that 
the connection which they postulatebetween money supply and inflation rates 
is subject to time lags which are both 
variable and unpredictable, and by the 
failure of monetarists to demonstrate convincingly 
just how 'increases in the moneysupply actually caus-e an increase in the 
rate of inflation. A number of possibletransmission mechanisms have been considered 
and propounded by monetarist 
economists. The candidate advanced bythe international as opposed to the 
domestic monetarist school is the . exchange 
rate and this will be considered 
later. Another major contender i~ the 
notion that an increase in the money 


supply increases the real demand for 
goods which in ;turn affects rprices. However, 
as Tarling and Wilkinson have 
demonstrated (" Inflation and the MoneySupply", Cambridge Review No. 56, 1978)
the connections between money supplyand real demand, and between real 
demand and prices, cannot ibe made to 
stand up. There is therefore a gaping 
hole in the theor·etical basis of monetarism 
and mone'ta·rists are reduced to 
simple assertions that there must be a 
connection between money supply and 
the rate of inflation. 

It may well be that there is such a connection 
but the monetarists' difficulty in 
showing how the transmission mechanism 
works sugge~ts that the connection maynot be the causal one which they assert. 
When other .factors in the real economy 
cause prices to rise, the money supply 
may rise in order to accommodate those 
factors. The relationship would then. 
however, no longer be one in which 
increases in the money supply caused 
inflation, but rather the other way round. 

the real economy 

Monetarists are easily led into mistakes 
in matters such as this because of their 
preoccupation with money and their 
refusal to acknowledge that other factors 
may also play a part. We can take two 
examples. According to monetari·sts the 
very high inflation rates of 1973/75 were 
entirely the result of the substantial increase 
in the money supply which had 
been allowed under the ·notorious 
" Heath/Barber boom". A more rigorous 
inteDpretation of events would, however, 
reveal that there was an explosion in 
world commodity prices in 1973, of which 
the fourfold increase in oil prices was 
only the most obvious and dramatic : 
that we <began to feel the first impact of 
the increase in food prices as a result of 
our joining the EEC; that the exchange 
rate was at a relatively low real level 
which increased demand for goods and 
services; and that Mr Heath ·introduced, 
unluckily for him, a wage indexation 
scheme at the very moment when it was 
most likely to transmit these externally 

produced cost increases directly through 
into ·domestic prices. 

None of these factors can he realisticallyignored in trying to assess the reasons 
for the inflation rate of 1973-75, but as 
soon as they are admitted to consideration, 
the monetarist case falls to the 
ground. The increase in the money supply 
is then seen as only one amongst a number 
of contributory factors and by no 
means the sole determinant of events. 

A similar approach can be adopted in 
respect of the fall in inflation rate from 
1976-78. Again, according to monetarist 
orthodoxy, the 'inflation rate fell because 
the Chancellor had introduced a tightcontrol over the money supply. However, 
other and more plausible explanations 
include the comparative success of the 
first two rounds of pay policy ; the 
dramatic fall in interest rates from the 
high levels of 1976 which did much to 
restore confidence in the future; the reduction 
of as much as 5 per cent in the 
price of fuel and materials suprplied to 
manufacturing industry; and the continuous 
·increase in the real value of the 
pound which kept prices down, albeit 
at the cost of encouraging imports and 
discouraging exports. 

IJ'hat monetarists recognise the potency 
of these real factors is well demonstrated 
by our current situation. If the inflation 
Tate were determined solely by the rate 
·of growth in the money supply we should 
have little to fear from the breakdown 
of an incomes policy or from the renewed 
rise in world commodity rprices. 
tin practice, however, monetarists are now 
Tunning .for cover because they know 
that these factors are likely to override 
the supposed Influence of the moneysupply on the rate of inflation. 

Another, and at first sight pa·radoxical, 
aspect of the monetarists' preoccupation 
with the financial as opposed to the real 
economy, is their belief that the real 
economy is in the end largely beyond the 
control of government. They postulate,
for examrple, for each economy a "minimum 
sustainable level of unemployment··. 
They argue that any attempt based on 


Keynesian principles to increase the 
money supply so as to reduce the rate 
of unemployment below this .[eve! will 
be counter productive. This is so because 
it would ·raise the rate of inflation to a 
level which would inevitably result in 
corrective measures which would be far 
more damaging to output and employment 
than if nothing had been done in 
the first place. What is not explained is 
why thP. trade-off between unemp,loyment 

a:J.d inflation cannot be changed within 
any particular country, for example by 
pay policy as clearly was the case in 
Britain over the last few years. 
Nor do international comparisons give 
any credence to the monetarist case. The 
GePman experience, for example, certainly 
shows that a rapidly increasing 
money supply does not necessarily lead 
to more 'inflation. As IMF statistics show, 
in the five year period 197·4-1978 prices 
in Britain rose on average 11.5 per cent 
more ·each year than in Germany, but 
the money supply in Germany grew on 
average 3.3 per cent more each year than 
in Britain. Some part of the difference 
is of course accounted for by the much 
higher rate of growth in Germany, but 
there is no doubt that the supply of 
money in Germany exceeds the demand 
and this has of course pushed interest 
rates down to a level which has greatly 
facilitated the recovery there which is 
now well underway. 


'4. monetarism and growth 


There is one point on which politicians 
and economists of almost every view are 
agreed and that is that there is a "virtuous 
circle" of productivity and growthwhich we must break into if we are to 
resolve our problems. The nature af this 
"virtuous circle" was well described ·bythe Treasury in the Economic Progress 
Report of December 1977. They said 
there that "productivity is a key element 
in what is often described as the ' virtuous 
circle ' of high growth ; increased 
productivity-briefly and in summary, a 
reduction in the labour cost of producing 
any .given amount of goods-providescheaper products; increased demand for 
these cheaper products increases employment 
and is an incentive for investment 
1n expansion, at the same time providing 
the funds for this investment ; expansion 
enables higher levels of output and 
employment to 'be sustained while additional 
investment enables .further improvements 
in productivity. And so the ' circle ' 
hegins again at a higher level of output

and employment: economic growth becomes 
self sustaining"


productivity 

Although there is this wide agreement 
on the nature af the virtuous circle. it 
seems to be a peculiarly British assumption 
that the way to break into it is 
through increased productivity, and that 
only after productivity has been increased 
will growth be achieved. This assumption 
has been central to British economic 
management for the past century or 
more; one Chancellor after another has 
felt obhged to defer policies for growth 
until productivity has improved. The difficulty 
is that we have never discovered 
the means to improve productivity in the 
absence of growth. It is not that we have 
been unaware of our deficiencies in productivity 
; we have been making speechesof an exhoratatory nature about it for 
the past 100 years. An endless succession 
of meetings, conferences and plans has 
been organised with the object of talking 
our way into increased productivity (the 
industrial strategy is in many ways simply 
the latest manifestation of this approach) 
but the improvement in productivity 

which we are assured is the necessarypre-condition of growth still continues 
to elude us. Despite a century of hand 
wringing, ·we are no nearer than we ever 
were to breaking into the " virtuous 
circle" ; indeed that prospect is becoming 
more remote. 

The truth is that productivity is a function 
of growth and not the other wayround. This is the unm·istakable message 
to be derived from the available evidence. 
The following table compares the average 
annual increase in output per worker in 
the principal industrial countries between 
1965/73 and 1973 / 77. 

ANNUAL AVERAGE 'lNCR'BASE IN 
OUDPUT PER WORKER 


1965-73 1973-77 
Japan 9.0 2.7 
Italy 5.5 -0.3 
France 4.9 2.3 
Germany 4.5 3.2 
UK 2.9 0.1 
USA 1.4 0.3 

Source: OECD 

The difference between the two periods. 
for every country, is strikingly clear. 
The point to be noted is that even 
in countries with enviable records of 
productivity <growth, and where the 
docility of the labour unions is legendary,
productivity fell quickly as the growth 
rate felL 

The point is also well illustrated from 
our own recent experience. During the 
much maligned "Barber boom", output 
per head 'in manufacturing industryincreased by almost 1·8 per cent in the 
period from the 'first quarter of 1971 to 
the third quarter of 1'973, compared to 
an increase of little more than 2 per cent 
for the rest of ·the economy. The deflation 
which followed reduced output per head 
in manufacturing by nearly 7 per cent 
in the 21 months to the second quarter of 
1975 ,even though productivity in the 
rest of the economy continued to increase 
at a;,bout the same rate as before. 

The ·difficulty with a restrictive monetary 
pol icy designed to keep price rises in 


check, when applied to an economy which 
is already very understretched, is that it 
cannot restrain a rise in the inflation 
rate ·without dest-roying the possibility of 
economic growth. In our case, with a 
small growth rate and a substantial infla· 
tion rate, we are likely to have completely 
extinguished growth long before 
we have eliminated inflation. Monetarists 
counter th.is by arguing that a tight money 
policy will 'indeed extinguish growth in 
the short term , but that once inflation 
has been conquered and monetarystability restored, the conditions for a 
h.igh and sustained rate of economic 
growth will have 'been established. 

The problem with this a,pproach is that 
there is no transmission mechan'ism be· 
tween monetary stability and economic 
growth. All depends on the nature of 
the conditions which are stabilised. If 
stability can be achieved in conditions 
of increasing compefitiveness and pro·
ductivity, well and good. Otherwise, however, 
stability can rapidly become the 
stability of the morgue. There are manyexamples from our own experi·ence in the 
1920s and 1960s, and that of other 
countries (compare the 30 years of 
stability and stagnation of Salazar's 
Portugal with the high inflat'ion accompa-
nied by high growth rate in Brazil) to 
show that monetary stability is not of 
itself either a necessary or a sufficient precondition 
of economic growth. 

In the end, a tight monetary policy suffers 
from exactly the same logical defect as 
destroys every attempt to deflate our way 
out of our problems. It is a necessaryprecondition for the success of defla tionary 
policy that a certain proportionof resources should be kept out of use. 
However, 'in these circumstances, growth 
can never be achieved, because as soon 
as the underutilised resources are drawn 
into use the necessary precondition for 
success has been destroyed. Those 
managing the economy will be compelled 
by the logic of their own theories to intervene 
to restrict growth-or, to use the 
currently fashionable terminology, the 
money supply-to prevent what theydescribe as "crowding out". This is the 
fam'iliar recipe for "stop go ... The 

damaging.-increases. jg the. MinimHm 
Lending Rate (MLR). on basic interest 
rate during 1978 and the early months of 
1979 are a:n example of the price wh.ich 
has to 'be paid ·for the kind of stabilityto which monetarist rpDiicymakers aspire. 

The most ironic aspect of monetarist 
policies is that ·they are not even particulal1ly 
effective as ·counter-inflationary 
measures. Recent reductions in the rate 
of inflation have had much more to do 
with other factors such as the stability 
of world commodity prices and the 
comparative success of the pay policy.
Furthermore, the contribution ·of monetarist 
policies to the battle against inflation 
has been a mixed one to say the 
least. Trade Unions are hardly likely to 
moderate wage demands at a time when 
the Government is itself pushing up the 
cost of living through increased taxes 
and interest rates. Indeed it is preciselyin the conditions of nil or slow growth 
engendered by deflationary policies that 
a rpay policy is most difficult to sustain. 
Since there is no rocm for a real increase 
in wages the pressure for a moneyincrease is so much greater. When outputis static or falling unit costs are unlikely 
to be reduced and every small increase 
in costs becomes inflationary. Hence the 
failure of the Government's 5 per cent 
pay norm during the 1978/79 pay round. 

The rigid application of monetarist 
policies therefore produces the worst of 
all possible worlds. The economy will 
simultaneously be delibitated 'by the 
cancer of unemployment and inflamed 
by inflation. Wage costs rise rapidly in 
the non-traded sector where trade unions, 
spurred on by Government-imposed increases 
in taxes and interest rates, have 
the muscle to obtain large wage increases, 
while the traded sector grinds to a halt 
under >the impact of the Government's 
own deflationary policies. 

The conclusion must be therefore that 
monetarist policies can be supported only 
by those who suffer from tunnel vision 
in looking at the panorama of our economic 
situation. The whole doctrine is 
based on an arbitrary de'finition of money 
and pay~ no attention to the demand (or 


money. Even if these difficulties could be 
ignored, the consequences of applyingmonetarist policies in isolation from 
other objectives is simply to deflate the 
economy to a dctngerous degree and to 
bring about not stability but paralysis. 


5. international monetarism 
Recent economic policy in Britain appears 
to have been heavily influenced not just 
by conventional monetarist dectrines, 
but also by the international monetarist 
theories propounded by the London 
Business School. This version of monetarism 
atta,ches great importance to the 
impossibil-ity of improving our economic 
performance by lowering the exchange 
rate_ What is asserted is that the effect 
of exchange rate depreciation is to create 
a surplus on the balance of payments 
which will increase the money supply 
as more money comes into the countryin payment for e~ports than goes out in 
payment for imports_ This in turn will 
have the effect of raising all prices, both 
in the traded and non-traded sectors of 
the economy, so as to nullify in a short 
period of time any competitive advantage 
that devalution may have produced_ It 
follows from this that no improvementin the competitive position of British 
industry can 'be achieved by exchange 
rate depreciation, even if continuing loss 
of share in world trade indicates that the 
prices of British exports are too high.
This is so since it is claimed that anyprice advantage will inevitably and veryquickly be washed away 'by the higherdomestic rates of inflation which better 
foreign trade performance itself induces. 
The supposed inability of the Government 
of any country to ·improve its 
foreign trade performance by exchange 
rate policy for these reasons is called 

the "'Law of One Price". 

the exchange rate 

The last Government, unfortunately, was 
apparently persuaded that these international 
monetarist theories as well as the 
domestic variety are correct. As far as 
one can tell, it still believed during the 
course of 1976 that the fall in the v~lue 
of sterling, 'Which it went to extreme 
lengths to resist, would provide a substantial 
benefit to competitiveness and 
that we could therefore look forward to 
export led growth. Indeed, the Chancellor 
made h a r d 1 y a statement over a 
period of six months or more in which 
the phrase "export led growth " did not 
figure prominently. Our share of world 

trade in manufactures did increase in 
1977, but the Chancellor seems to have 
lost faith in currency depreciation as a 
means of obtaining a price advantage 
as he was clearly increasingly ·impressedby the supposedly immediate and overwhelming 
inflationary consequences of 
devaluation. He increasingly took the view 
that a currency depreciation works its 
way through far more quickly into 
domestic prices than used to be the case 
and therefore the benefits to competitiveness 
are indeed marginal and short-lived. 

There are two points to be made 
against this interpretation of events. First, 
the fall in the value of sterling in the 
last three quarters of 1976 did in fact 
produce a 'benefit to our competitiveness, 
and is undoubtedly the explanation for 
our relatively good showing in terms of 
our share of world trade in manufactures 
in the first nine months of 1977. This was 
one of the rare periods over the whole 
of this century in which we managed to 
retain, and indeed slightly increase, our 
share of trade in manufactures. Unfortunately, 
by pushing up the exchange 
rate at the first opportunity, the Bank 
of England guaranteed that this could 
not last. 

Secondly, the fall in the value of sterling 
was not the cause of our high inflation 
rate hut was in fact its consequence. In 
the fourth quarter of 1973 the exchange 
rate had fallen to 90.7 per cent of the 
1970 level, but the Bank of England took 
advantage of the change of Government 
in 1974 to raise the rate each quarteruntil it reached 99.3 per cent in the first 
quarter of 1976. This was made possibleby the inflow of Arab oil money into 
London. When this was withdrawn duringthe course of 1976, it was inevitable that 
the exchange rate would fall to reflect 
our substantially worsened competitiveposition. 

More recently the situation has become 
worse still as the value of sterling has 
risen against other currencies even though 
our in:fl.ation rate has been higher than 
theirs. Taking the whole rperiod from 
February 1974 we estimate that our export 
prices have gone up by 24 per cent 


more than those of our main competiton 
on average. Taking individual countrie 
the figures are 13 per cent against France. 
19 per cent against Germany and Italy, 
21 per cent against the USA and a staggering 
40 per cent against Japan. No wonder 
that our exporters are in desperate strait . 
while our ·import bill is oaring. 

The truth is that Government policy 
totally failed a a result of money illusion 
to distinguish between a:n effective and a 
nominal devaluation. A devaluation is 
purely nominal when it represents no 
more than an adjustment to an alreadyexisting loss of competitiveness. A de· 
valuation is effective, on the other hand, 
when it has the effect in real terms of 
making our exports cheaper and our 
imports more expensive. 

The Labour Government eemed neverthele 
s 'to have been persuaded that 
change in the exchange rate were ineffective. 
It presumably -reached thi conclusion 
.because ·it accepted the essence 
of the international monetarist case which 
i expres ed in the so called ·• Law of 
One Price ". If, as they claim, it is true 
that devaluation automatically generates 
increases in the money supply sufficient 
to finance price rise caused by higherimport costs spreading through the 
economy on a cale which completelyoff ets the competitive advantage which 
depreciation bring about, then clearly 
no long term improvement will be 
achieved. After these price adjustments 
have all taken place our goods would be 
just as competitive or uncompetitive in 

price a they were before. 

What evidence, apart from as enion. have 
international monetarist advanced to 
~upport their ca e? The fir t attempt in 
thi country appear to have been made 
by Mes r Ball, Burns and Laury of the 
London Bu ine School in an article in 
The Economic Journal in March 1977. 

ven they were forced to admit. however. 
that their apparently ophisticated 
model could not e plain why, in the case 
of the K, there was a per i lent tendencyunder a ~y tern of fixed exchange rate\ 
lor our pnce~ to n\e fa\ter than tho'e 
uf our pnnc1pal compt:l!lor The; could 

only suggest, contrary to all evidence and 
reason, that the devaluation of sterlingin 1949 was excessive and had to be compensated 
for by a higher rate of inflation 
lasting until the mid sixties in order to 
wipe out the competitive advantage we 
had thereby gained. 

A rather better attempt to measure the 
influence of exchange rate changes in 
prices has been made by Messrs Robinson, 
Webb and Townsend in a study("The Difference of Exchange Rate 
Changes-a Study of 18 Industrial 
Countries", Economica, 1979) financed 
by the EEC. The authors concluded from 
an analysis of the effects of exchange 
rate changes of various countries that 
relative domestic prices were stable under 
fixed exchange rates. They also found 
that export prices did not change in 
foreign currency terms, except in the 
short term, when there was a change in 
parity. They admitted, however, that the 
evidence did not show the link 'between 
export prices and domestic pr·ices which 
is postulated by i·nternational monetarist . 

Indeed. in the case of countries such a 
France, which had succeeded in changing 
their relative prices by deva.luing, the 
evidence suggested that whole ale prices 
were not determined by wonld prices but 
could be affected by exchange rate 
changes. Recent studies by both the Bank 
of England and the National Institute 
of Economic and Social Research have 
also failed to confirm the "Law of One 
Price ". 

This inability to e tablish the automatic 
connection between export and domestic 
price , which i the essence of the international 
monetarist ca e, uggests that 
the exchange rate i not the elusive tran mission 
mechanism which monetari t~ 
believe translates changes in the moneyupply to dome tic price . Our own interpretation 
of the evidence is even les 
charitable to international monetari m. 
rn the fir t place, we do not accept that 
a change in relative export pnce of up 
to 5 per cent over a five year period(which the \ludy by Robin,on ,., al 
found d1d occur under a reg1me ol lixul 
e\change rate~) can be di~regarded a 


insignificant. lt undoubtedly represents a 
significant departure from any so-called 
" world price ". 

International monetarists are also in difficulties 
when it comes to the causal link 
between domestic money supply and the 
exchange rate. Their problems arise from 
the fact that, as we have seen, the rate of 
increase in the money supply in countries 
which have had the lowest rates of inflatiOn 
and the most steadily appreciating 
currencies has sometimes been higherboth than international monetarist theory 
would normally predict, and higher than 
has been the case in countries with rather 
less fortunate experiences of inflation 
and currency movements. They have 
circumvented this problem through the 
simple expedient of attaching a label to 
the phenomenon whi·ch contradicts their 
theory. They say that countries such as 
Germany have a natural propensity to 
require a higher money supply increase 
for a given rate of inflation than 
countries such as the United Kingdom.
They therefore postulate for each country 
a "warranted " rate of monetary growth. 

This is no more than an admission that, 
in order to finance growth and productivity 
on the German scale, a higher 
degree of monetary expansion is required 
than is currently permitted 'by monetarist 
doctrines in this country, and that it does 
not necessarily lead to hi•gher inflation 
rates. This seems to be an excelrlent 
reason for abandoning a doctrine which 
is so deficient in theory and so lackingin practical evidence to support it. The 
notion of " warra·nted " growth in the 
money supply is not so much a theory as 
a description of the awkward fact (awkward 
that is for the international monetarist) 
that in some countries a high rate 
of increase in money supply means not 
a fall in the exchange rate and a rise in 
inflation, but the reverse. International 
monetarists are forced to explain this 
away by treating trends in productivity 
as though they are entirely independent 
on economic growth, a view which is 
contradicted by all the available evidence. 

lt is probably true to say that, as the 
thenretical and practical defects of 

international monetarism become more 
apparent, the heyday of its popularity is 
passing. Its significance lies in the fact 
that it is still widely accepted 'by the 
financial institutions which, by acting in 
accordance with its predictions, make its 
prophecies self-fulfilling, at least in the 
short term. If the ·exchange markets 
·believe that the money supply determines 
the value of the currency, they will act 
accordingly and their belief and actions 
will appear to validate the theory. This 
is a classic case of an emperor without 
clothes. The nakedness of the doctrine 
will quickly become apparent thoughwhen the influence of real factors on the 
exchange rate (factors like the trade 
barlance and comparative inflation) can 
no longer be resisted. In the short term·, 
however, the views of international monetarists 
seem likely to be lent a spurious 
validity (at least so far as the exchange 
rate and its relationship with the moneysupply are concerned) by the impact of 
North Sea oil on the value of sterling-
a striking example of the way in which 
monetarist theorists prefer a convoluted 
monetary explanation for a phenomenon 
which is more easily explained byreference to real economic factors. 


6. the International 
Monetary Fund and Labour's 
policy

It is one of the great triumphs of prejudice 
over reason that most people, even 
those professionally involved in such 
matters, believe that the last Labour 
Government's monetarist policies are 
those which were imposed upon us as 
the price of obtaining the loan from the 
IMP in 1976. The truth is very different. 

Lf the Government had indeed pursued 
the policies recommended 'by the J MP 
and which the Chancellor undertook that 
he woUJld pursue, we should by now have 
found ourselves in a very different and 
much more favourable position. Instead, 
the Government turned its back on two 
of the major recommendations of the 
IMF, with all too predictably eriou 
consequences for the economy. 

The first issue on which the undertakings 
given to the IMP were reversed concerned 
the exchange rate. The IMF, which believes 
in the effectiveness of changes in 
the real exchange rate, required the 
Government a was stated in the Chancellor's 
Letter of Intent, to " manage the 
exchange rate so as to preserve the 
competitiveness of British manufacturing 
industry". This was a crucial undertaking. 
The fall in the value of sterling during 
the course of 1976, it shoUJld be recalled. 
had done no more than reflect the enormous 
deterioration in our competitive 
position brought about by our high rate 

of inflation in 1974/5. 

The IMP' insistence, therefore, that we 
should preserve the competitiveness we 
enjoyed at that moment was of vital 
importance. However, the Bank of England, 
reversing !this undertaking. The 
nominal exchange rate was pushed up at 
the beginning of 1977 and was then held 
stable for nine month , at a time when 
our costs were ri ing much faster than 
those of our competitors. Throughoutthis period our competitiveness con equently 
declined. Even o, because of the 
lagged effect of the fall in the real exchange 
rate in 1976, we managed to 
perform 'better over that nine month 
period in terms of our share of world 
trade than is normaHy the case. This 
prov.ides a small insight into what could 
have been achieved if the real exchange 
rate had been kept at its autumn 1976 

level. In the autumn of 1977, however, 
the Chancellor " uncapped" sterling and 
the rate has since risen substantiallyunder the influence of North Sea oil. Our 
prices relative to those of our principalcompetitors are now neanly 20 per cent 
higher than they were in 1974, and when 
the IMP were her·e in 1976. There is now 
no pretence that we are complying with 
the IMP requirement or that there is any 
prospect of export-led growth. 

One of the major reasons for the reversal 
of this ·ex·change rate undertaking related 
to the interpretation put on the second 
major IMF requirement concerning the 
money supply. The IMF, it is true, insisted 
upon the adoption of strict money supplytargets and it is this which has attracted 
~o much attention from the commentators. 
What ha escaped their attention. 
however, i that the targets were specified 
in terms of Domestic Credit Expansion 
(ocE) and not M3. The significance of 
this is that, provided any improvement in 
economic activity and any increase ·in 
the money supply had been broughtabout by a surplus on our balance of 
trade, no restriction on either need have 
been imposed. ·In other words, the export 
led growth which the IMP exchange rate 
policy was designed to bring about would 
have 'been accompanied by the monetary 
policy which they specified. 

The Chancellor's decision to pur ue a 
money supply policy 'based on M3 was 
therefore crucial to his decision to 
" uncap., ~terling in the middle of 1977. 

The Chancellor apparently feared that 
unless sterling were allowed to float upwards, 
the inflow of foreign moneywould continue and would increase the 
money supply defined in tenms of M3 . 
There were several peculiarities about this 
decision. Firstly, the 'Bank did everything 
possible to encourage the inflow by intervening 
in the market to put a floor under 
sterling. Secondly, no one paid any attention 
to the example of other countrie . 
such as Germany, Switzerland and Japan, 
which have experienced very substantial 
inflow of capital and accretions to their 
reserves without apparently suffering any 
ill effects on their Jnfl.ation rate. 


Thirdly, at times when sterling has been 
under pressure, the Chancellor and his 
Bank of England advisors paid lit:tle 
heed to the argument that if an inflow 
of capital increases the money supply, 
an outflow of capital ought to reduce it 
and should therefore, ~ccording to monetarist 
theory, offset any inflationary effects 
of a falling exchange rate. Fourthly, and 
most importantly for the present context, 
the Chancellor seemed unaware of the 
fact that if he had adhered to the 
Domestic Credit Expansion 'basis of monetary 
policy, as recommended by the IMF, 
the movements in foreign capital would 
have had little effect on the figmes and 
could safely have been ignored. To the 
extent that capital inflows found their 
way into the private sector, the effects 
would have been identical to those of a 
current account surplus, and to the extent 
that the effect was felt in the publicsector, the increased demand for public 
sector debt wourld probably have reduced 
M3 rather than the reverse (R. Lomax 
and C. Mow!, "Balanced Payment Flows 
and the Monetary Aggregates .jn the UK, 
Working Paper No 5, HM Treasury, 1978). 

None of this seems to have shaken 
the belief of most commentators that 
what they were seeing was a Government 
pursuing policies imposed on them 
by the IMF. A good deal of this seH 
delusion was of course rooted in political 
prejudice. Many commentators, including 
the then Chancellor's politica:l 
opponents in the Conservative Party,
wholeheartedly approved of the rigourof his monetarist approach hut they were 
faced with the dilemma that while they 
approved of the policies they did not 
wish to give any credit to a Labour Chancellor. 
They therefore propagated the 
myth (which some seem themselves to 
believe) that the origin of these policies 
was the IMF, despite the fact that the 
IMF insisted on a quite different strategy. 
The economic iMiteracy of the Conservative 
front bench is nowhere better 
illustrated than by their loud approvalboth of the IMF's intervention in our 
affairs and of the policies subsequently 
pursued which ran directly counter to 

the IMF's recommendations. 


7. an old song 
Monetarist poiJcies, like their predecessors, 
are entirely conventional in the 
~ense that they command the fuJi-hearted 
support of the establishment. However. 
the monetarists appear to 'believe that 
they have discovered a new solution to 
our problems. They believe that their 
theories provide them with a ·new too! of 
analysis, a new theoretical basis for 
action and a new range of policy options. 

How true is this ? The first point to make 
is of course that monetarism is not a new 
doctr·ine hut ra:ther the revival of an old 
one. The only novel feature of the 
present versions of monetary policies is 
that they are even more rigidly and 
arbitrarily applied than were their predecessors. 
An excessive preoccupationwith financial orthodoxy, to the detri ment 
of the real economy, has been the 
recurring motif of Hr·itish eco-nomic 
management for well over a century. We 
are sadly deluding ourselves if we believe 
that current policies differ in any essential 
respect from the policies which have been 
tried and which have failed in the past. 
The point can best be made by comparing 
the current policies with those which were 
pursued in two earlier eras-1924/ 31 and 
1964/67. 1In January 1921, when whole-

ale prices had risen to 251 per cent of 
their 1913 level, it was decided that we 
should return to •the Gold Standard at 
the pre-war parity and for four yearsthe whole of the Bank of England's resources 
were devoted to getting wagesand prices down to enable this to be 
done. They succeeded, but the effect on 
the economy was disastrous and of all 
industria~! nations, we were the only one 
which did not share a high rate of growthin the 1920s with the rest of the world 
before the depression which began at 
the end of the decade. We were also 
the only country with a very high rate 
of unemployment and thi , combined 
with the reduction in both money and 
real wages which the policy required, was 
re ponsible for the social . tresses and 
~trains which led a surely to the General 
Strike of 1926 as similar policies a century 
earlier had ·led to the Peterloo 
massacre. 

The return to the Gold Standard and the 

policies which accompanied it were of 
course no more than the familiar attempt, 
~till With us today, to deflate our way out 
of the problems created by an over 
valued exchange rate. There are ominous 
parallels between the position of the 
last Labour Government and that of 
Ramsay MacDonald's in 1929/31. 
MacDonald's Government fell. havinginflicted great damage on the Labour 
movement, when the trade unions finll!lly 
·refused to cooperate with policies which 
would have meant cuts in real livingstandards, and in the i·nterests of a 
financial orthodoxy to which it was 
thought that there was no alternative. 
Then, as now, it was the collective 
ignorance of a whole administration 
which led to the betrayal of the interests 
of the people they claimed to represent. 
As J H Thomas is said to have plaintively 
remarked when the National 
Government took office and left the Gold 
Standard, " Nobody told us we could do 
that". One can well imagine a member 
of the 1974/79 Labour administration 
making a simila·r remark in relation to 

monetarist policy. 

The second instructive comparison is with 
the policies rpursued in the 1960s. The 
Labour Government, then as now, was 
reluctant to do anything which ran 
counter to the views of the money markkets. 
By advertising its readiness to die 
in the last ditch in order to preserve a 
particular parity. the Government found 
itself obliged to pursue the most severe 
deflationary policies in order to protectan over valued exchange rate. The theorythen was that the exchange rate ·could be 
preserved, and the balance of paymentskept in equilibrium, if only excess 
demand could be syphoned out of the 
economy. Tn pursuance of thi view. 
~everely deflationary policies were imposed 
in an attempt to hold costs down 
and prevent the balance of paymentsdeficit from worsening. 

We no longer talk about excess demand 
but instead policies are framed in term~ 
of restraining the money supply. Despite 
this different theoretical basi . however. 
the practical effect of the currently 
favoured policie is indistingui~hable from 


the deflation impo~ed in the past.
Adhering to monetary targets has the 
same ·effect on the economy as that of 
simple deflation. There is in effect no 
difference except that whereas Jim 
Callaghan as Chancellor in the 1960's was 
himself decidin<g on the level of deflation 
required, Denis Healey handed this 
decision over to the money markets. 

The truth then is that the ·current ortho~
oxy is simply a re-run, dressed up in 
fashionable language of 'the policieswhich have disfigured British economic 
performance for so long. We have been 
..lver this course so many times before, 
and always with such disastrous results, 
that it is oruly to be marvelled at that 
we are prepared to try it again. 

conclusion 

The conclusion drawn is 'that the presently 
accepted monetarist policies, which 
are no more than a continuation of the 
policies which have failed us so often in 
the .past, have once again •led us into an 
even more disastrous cul-de-sac. We can 
only hope to reverse direction by runningthe economy at full speed and securing 
improvements ·in competitiveness and 
productivity as a consequence of the full 
utilisation of all the resources available. 
This means that we must abandon an 
arid and sterile adherence to monetary 
targets, as though they were the so-le 
determinators of the economy's health, 
and concentrate instead on policies which 
will lea·d to real growth. 

To the extent that w.e pay attention at 
all to monetary policies, they should he 
designed to accommodate, not constrain 
economic growth as has indeed 
been done in all the rapidly growing 
economies. We should be prepared for 
and positively welcome •low interest rates 
and a fall in the value of sterling as a 
means of stimulating growth. Growth 
itself would then do a great deal to raise 
living standards, moderate inflation, increase 
employment and balance our ·trade. 
North Sea oil would then 'be simply a 
valuable and welcome bonus which would 
enable us to overcome any short term 

problems which might arise in the pursuit 
of this strategy. If it is argued by faint 
hearts thM this strategy might involve 
risks, the only answer is that the prospects 
of its success must surely outweigh 
the certainty of failure if we continue as 
we are at present. 


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the politics of monetarism 
This pamphlet discusses the conversion to monetarist theory and doctrine 
during recent years of not only the financial establishment and the Conservntive 
Party but also the last !Labour Government. In the view of the authors 
this has been a major disaster. The attractions of monetarism for the right 
are understan:::lable because of the power it gives markets rather than governments. 
It can also be appreciated that those who make a living out of finance 
rather than manufactur~ng can have good reasons for prefering the interests 
of money to those of the _real economy. But the authors believe that a tabour 
Government should have resisted far more strongly the pressures to adopt 
such a doctrine. 

The authors argue that the·· tne'oretical basis of monetarism is much weaker 
than is usually recognised ·.a~ that the practical efficacy of tight money 
policies in restr~it:ain~ irdl<!tion,has been greatly exagerated. The cost however 
in terms of une!!'ploy~~nt and low investment have ben all too evident. 

fabian society 
The Fabian Society exists to further socialist education and research. It is 
affiliated to the labour Party, both nationally and locally and embraces all 
shades of socialist opinion within its ranks -left right and centre. Since 
1884 the Fabian Society has enrolled thoughtful socialists who are prepared 
to discuss the essential questions of democratic socialism and relate them 
to practical plans for building socialism in a changing world. Beyond this 
t:-:e Society has no collective policy. It puts forward no resolutions of a 
political character. The Society's members are active in their 'labour parties, 
trade unions and co-operatives. They are representative of the labour 
movement practical people concerned to study and discuss problems 
that matter. 

The Society is organised nationally and locally. The national Society, 
directed by an elected Executive Committee, publishes pamphlets and holds 
schools and conferences of many kinds. local Societies-there are one 
hundred of them-are self governing and are lively centres of discussion 
and often undertake research. 

Enquiries about memJership should be sent to the General Secretary, 
Fabian Society, 11 Dartmouth Street london SW1 H 9B'N : telephone 
01 222 8877. 

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