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Impact of the monetarist policies Essay

When Margaret Thatcher was elected into power in 1979 she labelled herself as a ‘conviction’ PM with her election success attributed partly to her strong character and divided opposition but mainly on her economic pledges. In the 10 years spanning Thatcher’s leadership a variety of approaches were adopted towards the economy, some successful and some not so successful. The best way of evaluating the economic policies undertaken is to divide the era into three sections – the early Thatcher period of 1979-1982, the transitional stage of 1983-1986 and the boom and bust uncertainty of 1986-1990.

The first period of 1979 to 1982 was known by many as the ‘Monetary Experiment’ due to the beliefs of the Conservative government and its approach to economics. When Thatcher became prime minister she inherited an economy where inflation was the cause of instability. Not only were ‘shoe-leather’ and ‘menu costs’ of inflation inhibiting to business but high levels of fluctuation discouraged long term investment vital to whole economies. In 1978 inflation was 8. 2 %, in 1979 it was 13. 4 % and in 1980 it was 18 % 1 reinforcing why the government was placing emphasis on its reduction, above everything else, including unemployment.

This also represented a major shift in economic thought, due to the discovery that the Philips curve was in fact only a short run trade off between unemployment and inflation. Instead, this belief was centred around the Friedman influenced expectations-augmented Philips curve in which the long run unemployment always reverts back to the ‘natural state’ and only supply side factors can shift the NRU lower. Hence there is no long run trade off between inflation and unemployment and measures to lower unemployment below the NRU will create inflationary pressures, currently experienced, and vice versa with inflation.

Following this notion the Thatcher government introduced the Medium Term Financial Strategy (MTFS) based around targets for the growth of money supply in order to curb inflation. This was to be measured using the i?? M3 definition (current and deposit accounts of banks + currency) and was to be observed over 4 years. The result of the MTFS was to push interest rates up to record levels causing wider implications yet despite this the government was still unable to achieve their desired targets for the growth of money supply, missing all of its targets during the 1980-1982/83 period by considerable amounts.

It did, however, manage to reduce inflation to the manageable level of 5 % in 1983 at the expense of unemployment, which rose from around 6 % in 1979 to 12 % in 19832. However, this level of inflation should have been achieved at a much lower level of unemployment according to the Philips curve. Reasons for the rise in unemployment could be the downturn in the world economy but evidence suggests UK world trade grew slightly with manufacturing exports stabilizing between 1977-1980 and only experiencing a small decline of 4% in 1981.

The main reason given was the fall in domestic aggregate demand with a movement away from the consumption of domestic goods to foreign, imported goods. Thus UK manufacturing experienced a serious fall in output by around 20 %. 4 This could be due to closer integration with the EU, but mainly down to favourable exchange rates promoting imports. Consequently, there was a negative impact on exports causing a large negative increase on the Balance of Payments.

The high interest rates also encouraged foreign investors to place deposits in UK banks thus creating further appreciation of sterling. An additional factor in this was the increase in the UK savings ratio encouraged by the high interest rates. Between 1979 and 1982 the savings ratio grew from 10 % to 15 %5; this is common in recessions as with fear of unemployment consumption is cut and a greater proportion is placed in savings. This was accentuated by the financial innovations and de-regulation experienced in the UK in the early 1980’s.

In times of low incomes the relatively cheap foreign products compared to domestic ones could also of had an effect in the choice of imported goods inflamed by cultural changes and the impact of travel. The aggregation of these policies and the economic climate forced the government into conflict. Attempting to hit money supply targets required high interest rates to curb consumption within the economy whilst promoting foreign investments in UK banks, thus causing the value of the pound (combined with North Sea Oil) to rocket making UK businesses internationally unviable.

The 1982 to 1985 period offered vastly different problems to that of 1979 to 1982. In some ways the ‘Monetary Experiment’ can be considered a success as it did fulfil its role in producing lower inflation. However, the measures arguably deepened the recession as it strangled output and doubled unemployment to around 3 million from 1979. 6 These side effects meant the policies were heavily disliked by the population and criticised by analysts, deeming them failures.

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