Economic Viewpoint Bringing Counter‐Inflation Policy Back on Course

Abstract

There is no doubt that the monetary limit for the first year of the Government's Medium‐Term Financial Strategy will be grossly exceeded, The reported figure for sterling M3 is likely to show a growth of 16 per cent to 18 per cent for the financial year compared with the upper limit of 11 per cent. This is a setback for the government's counter‐inflationary policy but not a disaster. The likely overshoot can be largely (but not completely) explained by the removal of the Bank of England's Supplementary Special Deposits Scheme (the corset). Its significance is best understood if we re‐examine monetary history since June 1978. (when the corset was imposed). A reasonable interpretation is that the money supply has effectively been growing at an annual rate of 15 to 16 per cent for the past three years (Details are shown in Table 4 on p. 12.) In retrospect it can be said that last year's monetary policy (but not that of the previous two years) was defensible in the light of the shock to prices caused by the oil price rise and the increase in VAT. We did in fact argue in Economic Outlook of June/July 1979 (“Price Shocks and the Economy”) that if the UK'S past record of monetary control had been better we would advocate a relaxation of monetary policy to accommodate these shocks. In the event monetary policy was relaxed (albeit unintentionally) and the squeeze on the real money supply was less severe than appeared at the time.However, there must be a steady reduction in monetary growth from now onwards if the government is to maintain its current progress in reducing inflation. We believe that such a policy is feasible and will be successful However the government must stick to the fiscal policy set out in the Medium Term Financial Strategy (MTFS). Our preliminary estimates suggest that, if Current public expenditure plans are fulfilled, there may be little or no scope for a reduction in personal taxation in 1981‐82. Further ahead, the danger point, on past experience, will be 1983 when the economy should be on a strong path of recovery and inflation should be well below current rates. That is the point at which upward pressures on the money supply are likely to reappear and will have to be resisted