Downing Street Years - Margaret Thatcher [76]
As we moved into the winter of 1980 the economic difficulties accumulated and the political pressure built up. It might have been easier to gain support in the battle for tight control of public spending if the second element of the strategy — the money supply — had been behaving predictably. But it had not. On Wednesday 3 September Geoffrey Howe and I met to discuss the monetary position. What did the figures really mean? Measured in terms of £M3, the money supply had been rising much faster than the target we had set in the MTFS at the time of the March budget. It was hard to know how much of this was the result of our removing exchange controls in 1979 and our decision in June to remove the ‘corset’ — a device by which the Bank of England imposed limits on bank lending. Money analysts argued that both of these liberalizations had misleadingly bloated the £M3 figures.* As I put it to Brian Waiden in an interview on Sunday 1 February:
a corset is there to conceal the underlying bulges, not to deal with them, and when you take it off you might see that the bulges are worse.
By contrast, some of the other monetary measures were undershooting their targets. The ‘wets’ found the wayward behaviour of £M3 a suitable subject for mockery at dinner parties. But for Geoffrey and me it was no such diversion. The arguments about which was the most accurate measure of the money supply were highly technical, but they were of great significance.
Of course, we never just looked at monetary figures to gauge what was happening. We also looked at the real world around us. And what we saw told a somewhat different tale from the high £M3 figures. Inflation had slowed down markedly, particularly prices in the shops where competition was intense. Sterling was very strong, averaging just below $2.40 during the second half of 1980. And here the crucial issue was whether the high exchange rate was more or less an independent factor bringing down inflation, or rather a result of the monetary squeeze being tighter than we intended and than the £M3 figures suggested.
Some of my closest advisers thought the latter. Professor Douglas Hague sent me a paper in which he described our policies as ‘lopsided’ in two respects: first, they were bearing down more heavily on the private than the public sector (which I knew to be true), and second, they were putting too much emphasis on controlling the money supply and too little on controlling the PSBR, with the result that interest rates were higher than they should have been. (I also came to share this view over the next year.) In the summer of 1980 I consulted Alan Walters, who was to join me at the beginning of 1981 as my economic policy adviser at No. 10 and upon whose judgement I came more and more to rely. Alan’s view was that the monetary squeeze was too tight and that it was the narrowest definition of ‘money’, known as the monetary base, which was the best, indeed the only reliable, star to steer by. Certainly, during the autumn of 1980 the narrowest definitions of money suggested that we were pursuing a very severe monetary policy.
If there was uncertainty about the monetary position at this time, there was none at all about the trend in public spending, which was inexorably upwards. Public sector pay was one of the worst problems: the bills we received were largely the legacy of Labour’s failed incomes policy, but they had to be paid all the same, and they set a higher base for future settlements as well. The other main culprit for the enormous increase in public spending was, as I have said, the nationalized industries. Looking at the disappointing figures emerging from the public expenditure round, I wrote at the time that they ‘had