Downing Street Years - Margaret Thatcher [81]
Yet these were essentially secondary issues — and on larger issues there were legitimate disagreements inside the ‘dry’ section of the Government. The main problem was to determine how tight the fiscal stance of the budget should be and the monetary policy which it would be supporting. On this question Alan Walters, who had now joined me at No. 10, had his own strong views. He argued for a larger cut in the PSBR than Geoffrey Howe was proposing. He also believed that the way in which the monetary policy was conducted was defective. But the Treasury were not prepared to move to the system of monetary base control which Alan favoured and to which I was attracted by his clear and persuasive analysis.
And this was much more than a technical disagreement. Alan Walters, John Hoskyns and Alfred Sherman had suggested that Professor Jurg Niehans, a distinguished Swiss monetary economist, should prepare a study on our monetary policy for me. Professor Niehans’s report which I read in early February, though framed in highly technical language, had a clear message. It was that North Sea oil had probably not been a major factor in sterling’s appreciation; rather, tight monetary policy had caused the pound to rise so high, imposing such pressure on British industry and deepening the recession. The report argued that we should use the monetary base rather than £M3 as the main monetary measure and suggested that we should allow it to rise in the first half of 1981. In short, Professor Niehans thought monetary policy was too tight and should quickly be loosened. Alan emphatically agreed with him.
My doubts at this time about the Treasury’s conduct of monetary policy, however, were more than matched by the concern I felt at the steady growth in its estimates of the PSBR — the target by which we steered our fiscal policy. On 10 February 1981 Geoffrey Howe and I met to discuss the budget strategy. Geoffrey now told me that the forecast for the PSBR had been updated and showed not £11 billion but £13 billion. He was now talking about raising income tax allowances by only 6 per cent rather than the 10 per cent he had earlier envisaged — though he still wanted a substantial enterprise package. I told him that our primary concern must be to boost industry and that this meant giving priority to a reduction in interest rates, which would also help get down the exchange rate. If there were to be a choice between cutting the NIS and a lower PSBR I preferred the latter.
I was worried by the prospect of a 2 per cent addition to the RPI as a result of the indirect tax increases which were being proposed. I was sure it would be better to achieve further public expenditure cuts. But I had to agree that the chance of achieving these, given Cabinet attitudes, was very slim indeed.
At this meeting Alan Walters continued to press the view that we should allow the monetary base to grow more quickly. We also discussed the timing of any interest rate cuts which we would be able to make.
The starkness of the choices before us was now becoming clear. Later that day Alan sent me a note which summed up the problem with the PSBR. We were confronted with rapid and huge changes in the figures which made the strategic planning of the budget very difficult. But one thing was clear. The trend of PSBR forecasts was upwards. The likelihood was that we would budget for too low a reduction in the PSBR, as we had in 1980–81. To repeat that mistake would either force us to introduce an additional budget in late summer or autumn, or put great strains on the funding of government borrowing. In the last resort it might lead to a funding crisis, and it would certainly force us to increase interest rates, keeping sterling high and increasing the