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In 1979 Margaret Thatcher entered Downing Street determined to tame out-of-control inflation. Her monetarist orthodoxy held that control of the money supply should have achieved this at little cost. But by the time inflation was finally under control, unemployment had doubled to more than 10 per cent, where it stayed for most of the 1980s. The steepest recession since the 1930s saw manufacturing collapse, losing a quarter of its workforce. The scars affect UK politics to this day.
British economic history is studded with macroeconomic bungles, from the return to the Gold Standard in 1925 up to Liz Truss’s tragicomic 49 days in power in 2022. It is strange that Thatcher’s first two years, when she pursued her monetarist philosophy with the greatest determination, is generally missing from the list. Instead, Conservative mythology sees this as a time of obdurate heroism, and Thatcher’s refusal to heed her critics a blueprint for principled leadership against the wet bleating of the establishment “Blob”. Yes it was painful, but ultimately her refusal to change course reversed decades of unmanaged decline.
Anyone believing this myth should read Inside Thatcher’s Monetarism Experiment by Tim Lankester, who served Thatcher in the economics brief. It is a quietly devastating insider account of the theory and practice of monetarism during this crucial period: a tale of economic mismanagement where the main characters often had no idea what they were doing.
To understand the bungling, Lankester takes us briskly through the easy-sounding theory of monetarism. At its heart is one of the simplest equations in economics: MV = PY, an expression of how the cash value of economic output (P, the price level multiplied by Y, real gross domestic product) is equal to the money in circulation (M) multiplied by how fast it circulates (V).
If prices are out of control then the monetarist prescription is to limit the growth of M, the money supply. Milton Friedman, the Nobel laureate whose influence did the most to inject monetarism into Conservative veins, called for a simple money growth rule. Make it clear that you won’t budge from the rule, and the economy would only have to slow “modestly” for inflation to be tamed.
It appeared so easy, but almost immediately went wrong. Monetary growth soared far above target, even as the economy dove into recession. Obsessed with the money figures, the government determinedly deflated the economy even further through tight budgets and higher interest rates. As one academic put it, it was like “watching a man scalding to death in the bath and running in hotter and hotter water because the thermometer he was reading had the scale upside down”.
This exposed problems with the theory that its Keynesian critics had long predicted. Lankester does a forensic job of teasing out the unknowns hidden within that simple equation. Politicians could not agree on the definition of money, nor grasp how it should be controlled; Thatcher ludicrously resisted the notion of deploying higher rates. Velocity was impossible to measure directly, and declining steadily thanks to other Thatcherite financial reforms. Arguments raged about whether the supply of money drove the economy or vice versa.
Lankester never veers from a posture of calm impartiality. Unlike Thatcher’s more uncompromising critics, he does not question the need for deflationary measures of some sort. The Conservatives took over from a Labour government overpowered by union bosses: one told the prime minister “It’s your job, Jim [Callaghan], to get inflation down to 2 per cent; it’s my job to get 18 per cent for my members”. This kind of mindset needed tough medicine to defeat.
Nor does Lankester fail to acknowledge Thatcher’s beneficial economic reforms. Her government is sometimes portrayed as callously indifferent to the harm caused by the recession, but in his telling they were shocked and distressed. The point is that they thought they had a neat economic formula to conquer inflation painlessly. None of them expected 3mn on the dole.
What emerges most from this account is how central was Thatcher’s own dogmatism to the debacle. Without being remotely qualified, she was determined that money supply drove the economy rather than the other way round, and refused to let the matter be discussed in her presence. She mistook genuine uncertainty for ideological weakness. When she eventually abandoned direct involvement in monetary affairs, the ministers — notably Nigel Lawson, her greatest chancellor — who took over were much more pragmatic.
The operation of monetary policy is no longer a matter for politicians. The brand new Labour government of Sir Keir Starmer is occasionally derided as stolidly institutionalist, too willing to let technocrats take the wheel. Memories of the early 1980s remind us why this is good. Politicians steering blindly can cause untold damage.
Lankester’s ringside seat to the debacle left him anxious that he worked “too diligently” in support of a policy he knew was failing. On the basis of this brilliant account, it is clear where the blame really lies.
Inside Thatcher’s Monetary Experiment: The Promise, the Failure, the Legacy by Tim Lankester Policy Press, £19.99, 228 pages
Giles Wilkes, a former adviser in Downing Street, is now senior fellow at the Institute for Government
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