The Monetarism Trap snares the second Wilson Labour Government

This blog provides another excerpt in the unfolding story about Britain and the IMF. As I noted in this blog – The British Monetarist infestation – I am currently working to pin down the historical turning points, which allowed neo-liberalism to take a dominant position in the policy debate. In doing so, I want to demonstrate why the ‘Social Democrat’ or ‘Left’ political parties, who still have pretensions to representing the progressive position (but have, in fact, become ‘austerity-lite’ merchants), were wrong to surrender to the neo-liberal macroeconomic Groupthink. This is a further instalment of my next book on globalisation and the capacities of the nation-state, which I am working on with Italian journalist Thomas Fazi. We expect to finalise the manuscript in May 2016. In the last instalment, I traced back and demonstrated that Britain was engulfed in Monetarist thinking long before Margaret Thatcher took over. She really just put the ‘(rancid) cream on the top of the (inedible) cake’. I showed that the British Labour Party were infested with the Monetarist virus in the late 1960s and James Callaghan’s famous 1976 Black Speech to tge Labour Party Conference was just a formal recognition of that disease. It really just consolidated what had been happening over the prior decade. This historical journey also helps us understand that it was not the OPEC oil crisis in the early 1970s that provided the open door for governments to reject Keynesian policy. In Britain, the Treasury and Bank of England had fallen prey to Monetarist ideas following the elevation of Milton Friedman onto the world stage. These subsequent events just helped keep the insurgency moving until total dominance in the contest of ideas was won. Today, we start with the Bank of England’s so-called Competition and Credit Control (CCC), which was introduced in September 1971. This formalised the growing emphasis among the banking sector and economists that the central bank had to ‘control’ the money supply. It failed – but empirical failure doesn’t matter when people are becoming swamped with propaganda that says otherwise.

Monetarism failed early in Britain

In June 1970, a Conservative government under Edward Heath replaced the Wilson Labour Government in Britain. However, the work on banking deregulation and more market-based methods to control credit (and the money supply) had already started under the guidance of the Labour Chancellor Roy Jenkins, who had succeeded James Callaghan after the November 1967 devaluation crisis.

He was a motivating force behind the establishment of a joint Treasury and Bank of England discussion group in November 1969 to study more effective ways for the monetary authorities to control the money supply and replace the quantititative ceiling controls that were in place at the time. It was chaired by Douglas Allen, the Permanent Treasury Secretary.

The Monetarist policy takeover was well underway.

Following the advice of that group, which reported to Jenkins in March 1970, the Chancellor started to make changes by abandoning the formal credit control ceilings (‘quantitative limits’) but, then the election loomed, and no further changes were introduced.

The discussion group continued to work and in a series of papers it became clear that they were captive to the growing Monetarist literature coming out of the academy.

They released a further discussion paper in January 1971 (‘Monetary policy: Economic Section interest; new approach to credit control’, The National Archives, Record T338/39) which claimed among other things that there was a stable demand for money, an essential part of the behavioural structure necessary to support the Monetarist assertions that a central bank could control the money supply

The paper concluded that:

… a monetary policy directed towards the establishment of some selected growth for the money supply seems to offer a more effective option than a policy designed to maintain a particular structure of nominal interest rates.

History tells us that the inflation of the mid-1970s exposed these demand for money ‘equations’ as being inherently unstable and that the research that had concluded otherwise was deeply flawed.

The Monetarist experiment that the Bank of England was to introduce in 1971, however, was driven by ideology and a developing Groupthink, and was oblivious to these details.

Duncan Needham relates in a 2012 study (p.9) of this period in British monetary history that the Bank of England pressured the then Chancellor, Anthony Barber in early 1971 to adopt a Monetarist approach to credit control, which involved using the market (interest rates) and doing away with direct quantitative limits.

[Reference: Needham, D. (2012) ‘Britain’s money supply experiment, 1971-73’, CWPESH No. 10, University of Cambridge.]

As discussions proceeded and became more ‘practical’ it was resolved to set “numerical targets” for the rate of money supply growth each year (see ‘New approach to credit control and the banking system: preparation of the consultative document ‘Competition and Credit Control”, The National Archives, Record T326/1261).

On March 30, 1971, the Chancellor told the House of Commons that the bank lending “Guidelines for 1971-72” should embrace a money supply growth of around 12 per cent per annum. Otherwise:

Given the current growth of incomes, there would be dangers for liquidity and employment if we sought immediately to reduce the growth of money supply to much below 3 per cent. per quarter. (see House of Commons Hansard – HC Deb 30 March 1971 vol 814 cc1373-4)

He also indicated that the government wanted “to slow down the growth of the money supply” to reign in the inflation rate and that there would be “no question of relaxing our grip on the growth of money supply in relation to the growth of expenditure”.

The 3 per cent per quarter target had been recommended by the discussion group earlier and reflected a growing consensus across the major economic policy making areas (Treasury and Bank of England) that the Monetarist conception that inflation was due to the money supply growing too quickly had become entrenched in the minds of the policy makers.

The intent to control the money supply became more coherent on May 14, 1971, when the Bank of England published what they called a ‘consultative document’ – Competition and Credit Control (CCC) – which outlined how the Bank was going to respond to the calls from the British Chancellor in his ‘Budget’ speech to “achieve more flexible but still effective arrangements basically by operating on the banks’ resources rather than by directly guiding their lending”.

The document was to form the basis of discussions between the Bank and the commercial banks among other interested parties.

Up to that point in time, the central bank had used direct quantitative limits to control bank lending (and the money supply). These included overdraft limits and the application of so-called ‘ratio controls’ on liquidity (reserves to deposits etc).

In keeping with the Monetarist agenda to create free markets with as little regulation as possible, the Chancellor and the Bank claimed that these quantitative limits had (p.189):

… impeded competition and innovation so that the efficient have been prevented from growing and the less efficient have been helped to maintain the level of their business.

The proposed Competition and Credit Control (CCC) policy would replace the plethora of direct controls and work principally through a ‘uniform reserve ratio’, Special Deposit facilities at the central bank,

free up the banking system and control planned to operationalise the basic Monetarist principles -that is, controlling the money supply as a means of controlling the inflation rate – and free up the banking market,

The CCC policy was introduced in September 1971 and the fanfare was loud and the claims ambitious to say the least. The policy abandoned interest rate controls and promoted the money supply target as the priority.

The Bank of England were confident that they could succeed in controlling the money supply. In 1972, it published a paper – The demand for money in the United Kingdom: a further investigation – which concluded that (p.46):

… equations ef the types described provide a sufficiently accurate statis­tical explanation ef past movements in the stock of money to be a useful guide for monetary policy. It is already well recognised that the authorities cannot pursue independent objectives for monetary aggregates and for interest rates at the same time; possible policy options must satisfy the private sector’s demand fer money, and so estimates of demand-for-money equations provide a schedule of the com­binations of monetary aggregates and interest rates which the authorities can reasonably pursue at any time – given the current, and recent levels of incomes.

[Reference: Price, L.D.D. (1972) ‘The demand for money in the United Kingdom: a further investigation’, Bank of England Quarterly Bulletin, March 1972, 43-55.]

By this time, Monetarism was parading as a near-exact science and combined with the arrogance of the economics profession it became a dangerous mix, soon to fail.

CCC ended in the Northern Autumn of 1973 – a failure, which demonstrated that the basic principles of Milton Friedman’s Monetarism were erroneous.

Initially, the problem was that Britain had not followed the US in abandoning the fixed exchange rate system (Bretton Woods) in August 1971. The US floated immediately President Nixon abandoned gold convertibility, but Britain continued to believe that a fixed parity was defensible.

Of course, trying to control the money supply while at the same time using liquidity management to maintain the exchange parity was impossible, all other considerations which would also render control of the money supply impossible, aside.

This is because to manage the exchange rate, the Bank of England would also have to place limits on capital inflow and outflows, which largely responded to international interest rate differentials.

The ‘dash for growth’

But worse was to come with the so-called ‘Barber Boom’, which referred to the expansion under Edward Heath’s “Dash for Growth” strategy in the fiscal year 1971-72.

After Heath took over government in 1970, economic growth was moderate to say the least. It grew by around 2.5 per cent in 1971 and there was persistent unused productive capacity available. Unemployment had risen consistently throughout 1971 to 4 per cent, which was considered a major problem.

Further, the inflation rate, which had been running at 11 per cent in early 1971, moderated back to 5.5 per cent by the end of the year, giving an average of 8 per cent for the year.

The Bank of England had also cut interest rates in an effort to stimulate economic activity and these were supplemented by tax cuts and increased government spending, all of which was designed to reduce the politically unpopular unemployment.

In his March 21, 1972 ‘Budget’ Speech, Anthony Barber told the Commons that he had “come to the conclusion that a further boost to demand is required”, in recognition of the slowing economy and rising unemployment (see The Economic Outlook, British House of Commons Hansard HC Deb 21 March 1972 vol 833 cc1350-5).

He said in his introductory remarks that (see Recent Economic Developments, British House of Commons Hansard HC Deb 21 March 1972 vol 833 cc1345-8):

There is universal agreement that the present high level of unemployment is on every ground – economic and social – one which no government could tolerate.

He aimed to use fiscal policy to stimulate spending by around 2 per cent of GDP “to ensure a growth of output at an annual rate of 5 per cent” (HC vol 833 cc1353).

In overseeing the ‘dash for growth’, Barber said that (HC vol 833 cc1353):

I do not believe that a stimulus to demand of the order I propose will be inimical to the fight against inflation. On the contrary, the business community has repeatedly said that the increase in productivity and profitability resulting from a faster growth of output is one of the most effective means of restraining price increases.

British economic policy was, at this point, caught betwixt – the old Keynesian view that fiscal policy should be used to provide counter-stabilisation against the non-government spending cycle and the emerging Monetarist view that only monetary policy should be used and, then, only to control the money supply.

The Heath government was still a more traditional Conservative outfit – blaming trade unions for excessive wages growth and the resulting rise in inflation and unemployment.

The Bank of England was clearly become a centre of Monetarist thought.

Aled Davies quotes a financial market player at the time (p.9)

In October 1972 Pepper noted that the Governor had stated:

‘I accept, as most central bankers would, the control of the money supply is my principal, if not my most important, concern.’22

[Reference: Davies, A. (2012) ‘The Evolution of British Monetarism: 1968-1979’, Discussion Papers in Economic and Social History, Number 104, University of Oxford, October.]

The Monetarists that were gathering strength in the economic bureaucracy and the Bank of England were aghast at the “dash for growth”, and the government was warned that the result would be a burst of inflation.

There was further fiscal expansion in the 1973 ‘Budget’ strategy and by the end of that year, real GDP growth had exceeded 7 per cent and unemployment had nearly been halved.

In terms of the CCC though, the “dash for growth” presented problems. Given Britain was locked into a mentality that it had to sell debt to match its fiscal deficits (which was unnecessary once it floated on June 23, 1972).

This meant it had to sell increased volumes of British government ‘gilts’ (bonds) and to ensure the public took up the offer they would have to push up interest rates. The Heath government refused to allow that option and instead the Bank of England sold short-term debt to the banks (Treasury Bills), which the banks then used as qualifying reserve assets under the CCC.

This allowed them to increase loans and the money supply rose accordingly – beyond anything the Monetarists thought would be reasonable.

In 1972, the money supply (measured by the M3 aggregate) rose by 27 per cent and in 1973, it rose by 28 per cent.

It was clear that the Bank of England could not control commercial bank lending and hence could not control the broad monetary aggregate (M3). But the Monetarists did not see this as a failure of their approach – quite the opposite. They shed the blame and pointed it all at the “dash for growth” and the alleged irresponsible fiscal policy that had spawned the ‘Barber Boom’.

The simultaneous increases in the fiscal deficit, the ‘out of control’ money supply, and the rising inflation rate after 1973 were a serendipitous conjunction of events for those interested in promoting monetarist thinking.

It was very easy to conflate these events into a causal model that validated everything that Milton Friedman had said in his 1968 Speech to the American Economic Association.

Please read my blog – The British Monetarist infestation – for more discussion on this point.

Aled Davies writes (2012: 11) that:

In a speech dramatically entitled ‘An Economic Threat to Democracy’ given to the Conservative Bow Group in March 1974, Pepper chastised the Heath Government for its ‘growth at all costs’ policy, informing the Conservative ‘House of Commons Finance Committee’ later that year that ‘the economic record of the last Conservative Government was almost unbelievably bad.’

He also notes that (p.12) that “As inflation soared throughout 1974 and 1975 (and PSBR growth continued apace), this broad ‘monetarist’ interpretation of events gained a strong impetus. The modest cadre of British monetarist economists became particularly vocal, expressing their concerns in increasingly pessimistic terms.”

The Labour Party falls into the Monetarism trap

While Anthony Barber was being attacked by Monetarist academics and practitioners in the financial markets, it was his Labour counterpart (Denis Healey) “who did most to further the ‘monetarist’ cause in British public discourse” once the Wilson government was re-elected in February 1974 (Davies, 2012: 12).

A reading of the British Hansard in this period reveals that Healey regularly berated the Conservative party over the rising inflation that had emerged in the last year of the Heath incumbency.

In one memorable Commons session, Healey was asked whether there was a need to “curb the vast wage increases now being sought in the nationalised industries” (see British House of Commons Hansard, HC Deb 27 March 1975 vol 889 cc667-73 – specifically cc671).

Healey responded (cc671-72):

I have set those out in detail in various statements … I must, however, remind the hon. Gentleman of one fact, which, since his right hon. and learned Friend referred yesterday to my speech at the Mansion House, may be worth stating again. I think that there is now general agreement on both sides of the House that the major cause of the inflation now racking Britain is the excessive increase in the money supply which took place in the last year of the previous Conservative Government … I am sure that the Leader of the Opposition will now concur, although she was a member of the Government who were responsible for that large increase in the money supply.

Another turning point was about to be reached but as we will see it was without foundation and British Labour had fallen right into the trap.


We are nearly to 1975 and James Callaghan’s Speech.

The next instalment will cover the oil crisis and how the Monetarists duped people into believing their story.

The series so far

This is a further part of a series I am writing as background to my next book on globalisation and the capacities of the nation-state. More instalments will come as the research process unfolds.

The series so far:

1. Friday lay day – The Stability Pact didn’t mean much anyway, did it?

2. European Left face a Dystopia of their own making

3. The Eurozone Groupthink and Denial continues …

4. Mitterrand’s turn to austerity was an ideological choice not an inevitability

5. The origins of the ‘leftist’ failure to oppose austerity

6. The European Project is dead

7. The Italian left should hang their heads in shame

8. On the trail of inflation and the fears of the same ….

9. Globalisation and currency arrangements

10. The co-option of government by transnational organisations

11. The Modigliani controversy – the break with Keynesian thinking

12. The capacity of the state and the open economy – Part 1

13. Is exchange rate depreciation inflationary?

14. Balance of payments constraints

15. Ultimately, real resource availability constrains prosperity

16. The impossibility theorem that beguiles the Left.

17. The British Monetarist infestation.

The blogs in these series should be considered working notes rather than self-contained topics. Ultimately, they will be edited into the final manuscript of my next book due later in 2016.

That is enough for today!

(c) Copyright 2016 William Mitchell. All Rights Reserved

This Post Has 13 Comments

  1. “We are nearly to 1975 and James Callaghan’s Speech”

    Looking forward to that.

    How much of all this though is to do with people unable to make the mental shift that the switch to floating exchange rates in the early 1970s required. Whenever I read the historical articles – and to be honest most modern articles – the assumption of convertibility always seems to be there. At best you get an assumption of infinite liquidity.

    ‘Strong currency’ is a disease of the same class as ‘export led growth’ – but I can never work out how those two can be reconciled.

  2. @ Neil Wilson
    “Strong currency’ is a disease of the same class as ‘export led growth’- but I can never work out how those two can be reconciled.”
    Me too. But I think Germany figured out how to prolong that disease for a long time. Create a currency union where you mostly control the currency, and export away.

  3. Hi,

    I´m interested in Bill´s blog-post “Deficit spending 101 – Part 3” but I can´t find it(here) on his blog.
    Help wanted!

  4. @ Neil Wilson, @ Jerry Brown

    Strong currency and export-led growth only works under imperialism and the ability to control the colonies.

    Neo-imperialism works similarly.

    The EZ is now the “neo” German empire that has “colonized” the periphery by setting the monetary rules.

    The US is colonizing Ukraine, e.g., by installing an American as finance minister, and there is now talk of her becoming prime minster since the colony is not operating as the US wishes even though its handpicked man, “Yats,” is now PM.

    This is “political economy,” with an emphasis on “political,” which is about distribution of power and control.

  5. I think most economists are deliberately ambiguous on this. For example here:

    “Say the Central Bank, which had been following a policy of increasing the quantity of money by 0%, announces a policy of raising the quantity of money by 20%, and everyone anticipates that this will raise prices by 20%. Won’t this 20% higher expected inflation lead to nominal interest rates being 20 percentage points higher than before. So the Central Bank has raised both the quantity of money and the interest rate. ”

    W. Lewis does not link in reply to anything correcting this mistake.

  6. a bit confused here:
    “Bank of England sold short-term debt to the banks (Treasury Bills), which the banks then used as qualifying reserve assets under the CCC.

    This allowed them to increase loans and the money supply rose accordingly – beyond anything the Monetarists thought would be reasonable.”

    this blog is pretty clear that lending isn’t reserve dependent.whether there are requirements or none.

    “The proposed Competition and Credit Control (CCC) policy would replace the plethora of direct controls and work principally through a ‘uniform reserve ratio’, Special Deposit facilities at the central bank”

    i wonder how those direct controls worked

  7. I am in despair. Can you send your deficit spending parts 1-3 to John McDonnell? He has just come out tonight to tell the BBC that he intends to balance every day spending with taxes. But that he will spend to invest in infrastructure. Labour has committed to “economic credibility.”
    Link –
    From my understanding, this means further shrinkage of the economy, as the UK has a large trade deficit.
    With the present precarious employment, unemployment cuts to local councils, I cannot see how this can improve the economy.
    Do you think he understands what he is doing?
    He says that “We must be a party that thinks first about how we earn money, not only how we spend money.”
    He states that Labour will however borrow to fund investment.
    He does not seem to understand that government spending funds tax payments and purchases of government bonds.

    I cannot see a huge difference between his statements and the one that Thatcher made in 1983 in terms of a lack of understanding of sovereign currency issue, when she said that the “State has no source of money other than money which people earn themselves. If the State wishes to spend more it can do so only by borrowing your savings or by taxing you more. It is no good thinking that someone else will pay-that “someone else” is you. There is no such thing as public money; there is only taxpayers’ money.

    John is using the same terms. Household terms. Borrowing, taxing to balance the books etc. He says “We must be a party that thinks first about how we earn money, not only how we spend money.”

    He has had many economists to talk to, Anne Pettifor, Stiglitz, Yanis Vakoufaris, Ja Hoon Chang Wren Lewis.
    What are they telling him? Or id he not really listening?

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