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Thatcher's Economic Policy
Thatcher's War on Inflation
Eight steps, about twelve minutes, a question at each. You need no economics and no preparation, only a willingness to guess before you are told.
- 12 min
- 8 steps
- 7 questions
- 1 decision
Step 1 of 8
For thirty years, British governments held prices down by agreeing pay rises with the unions. By 1979 that approach had failed four times. The government elected that year ruled out trying it again.
The question
Was mass unemployment a side effect of beating inflation, or the method that beat it?
The government elected in 1979 had ruled out bargaining with the unions over pay. It had one tool left that it could use without anybody's agreement: raising interest rates until people stopped spending.
What you'll be able to answer
- How did raising interest rates bring prices down?
- Why did prices rise for a year before they fell?
- Why was the March 1981 Budget so disputed?
- Did inflation stay down?
Where this sits in the series
Thatcher's Economic Policy · this module is lit
- Jan 1979Public service strikes: the winter of discontent
- May 1979Margaret Thatcher's government takes office
- Oct 1979Exchange controls scrapped
- 1980Council tenants given the Right to Buy
- Mar 1981A Budget raises taxes in the recession
- Mar 1984The miners' strike begins
- Nov 1984British Telecom shares go on sale
- Oct 1986The Big Bang in the City of London
- Oct 1989Nigel Lawson resigns as Chancellor
- Apr 1990The poll tax reaches England and Wales
Why it matters and what it covers
The government raised the Bank of England's interest rate sharply. It published a four-year plan and promised not to abandon it. Prices still rose for another year, and factories closed.
By March 1981 the government had to decide whether to keep going with the plan. In this module, you make that decision.
- [1] ONS series CZBH, Retail Prices Index, all items, twelve-month rate
- Inflation. 10.3% in May 1979, 21.9% in May 1980, 18.0% in 1980, 4.6% in 1983, 3.4% in 1986, 10.9% in September 1990. Open the source
- [2] House of Lords Library, The UK economy in the 1980s
- The decade in outline. The Bank's main interest rate raised to 17% in November 1979. Inflation 24.2% in 1975, 18.0% in 1980, 4.6% in 1983, the lowest since 1967. Open the source
- [3] Bank of England, Stephen Nickell, The Budget of 1981 was over the top
- The 1981 Budget assessed. Policy rate reaching 17% in November 1979, from 12% when the government took office. Argues the tightening went further than it needed to, and that the cost was carried in jobs for the rest of the decade. Open the source
- [4] Margaret Thatcher Foundation, the 1981 Budget, background and documents
- The Budgets of 1979 and 1981. The 1981 Budget raised about £3.6bn in taxes and set a borrowing target of £10.5bn, about 4% of national income, against an actual £11.5bn and 6% the year before. VAT was unified at 15% in June 1979, adding about 3.75 points to the index. Open the source
- [5] Bank of England Quarterly Bulletin, 1981 Q1, economic commentary
- The money supply and the recession. The growth of sterling M3 over the year to February 1981 considerably exceeded the target range of 7 to 11 per cent, at about 20%, or about 17.5% adjusted for the ending of the supplementary special deposits scheme. Unemployment excluding school leavers 2.38 million, 9.9%. Open the source
- [6] Bank of England Quarterly Bulletin, March 1982, economic commentary
- The recession. The fall of around 15% in manufacturing production in the year to the fourth quarter of 1980 is the largest recorded in any twelve-month period since the war. Open the source
- [7] Bank of England Quarterly Bulletin, 1994, Monetary policy instruments: the UK experience
- How the targets were set and abandoned. Broad money targets were set out for four years ahead in 1980 and were later dropped, the last of them in 1987. Open the source
- [8] Fiscal Studies, The medium term financial strategy: an experiment in co-ordinating monetary and fiscal policy
- What the plan was. As much a fiscal strategy as a financial one: it tied targets for the money supply to a declining path for government borrowing, four years ahead, and published both. Open the source
- [9] ONS series K22A, index of production, manufacturing, chained volume measure
- Manufacturing output. Manufacturing output fell about 17.4% from its 1979 peak to the first quarter of 1981, and manufacturing employment never returned to its 1979 level. Open the source
- [10] ONS series IHYP, gross domestic product, year on year
- Output. The economy shrank in 1980 and again in 1981, and grew from 1982. Open the source
- [11] ONS series MGSX, unemployment rate, aged 16 and over, seasonally adjusted
- Unemployment. 5.4% in 1979, 9.9% in 1981, 7.1% in 1990. Open the source
- [12] Were 364 Economists All Wrong?, Institute of Economic Affairs, 2006
- The 364 economists. The letter was published in The Times on 30 March 1981, three weeks after the Budget. Five signatories were former chief economic advisers to the government. The volume carries both cases. Open the source
- [13] The National Archives, Geoffrey Howe private office papers 1979 to 1983, T 639/66
- The Chancellor's own papers. Howe's stated aim was to re-establish confidence by bringing in a rather tough Budget. Open the source
- [14] ONS series CZBH, RPI all items, percentage change over 12 months, monthly
- The episode chart. Open Government Licence v3.0. Retrieved 30 September 2026. Monthly rates; the module's figures for whole years (for example 4.6% in 1983) are annual averages of the same series. Open the source
The one tool the government could use alone
Take a guess
How high was the Bank's interest rate pushed within six months?
When prices rise faster than wages, people can buy less with their pay. Each household sees it in the weekly shop, and none can do anything about it alone. A government has to decide what to try.
The government elected in May 1979 raised the to bring down. It had already ruled out bargaining with the unions over pay.
Every government since the war had held prices down by agreeing pay with the unions. A government that will not do that has one tool left that it can use on its own.
Prices rise fastest when there is more money being spent than there are goods to buy. A seller who cannot keep up with the orders raises the price and still sells everything. Raising the interest rate makes borrowing more expensive. Households buy fewer of the things people borrow to buy, and firms put off building and hiring. Higher interest rates also pay savers more for leaving money in the bank. Less money reaches the shops, while the goods on the shelves stay the same. Sellers can then no longer raise their prices as freely.
The Bank of England's interest rate stood at 12% when the government arrived in May 1979.
- interest rate
- The price of borrowing money, given as a percentage of the amount borrowed each year. The Bank of England sets one rate that the rest are priced from, so when it moves, mortgages, loans and savings rates usually move with it.
- inflation
- The rate at which prices in general are rising. It is not the level of prices but the speed they are climbing, so falling inflation still means things are getting dearer, only more slowly. It is usually quoted for a year, but it can be measured over any stretch of time, and in the fastest episodes the figure that matters is the one for a month.
For scaleThe rate had been 12% in May 1979. Ten years later, in October 1989, the same rate was raised to 15%.
Why higher interest rates cost jobs
Higher interest rates were meant to slow prices by making people spend less. When people spend less, the economy shrinks.
Households cut back on what they bought and firms cut back on what they built, within months of the interest rate going up.
A new loan costs more, so fewer people take one. Most British mortgages moved with the Bank of England's interest rate. People who already had a mortgage saw their monthly payment rise within weeks, which left less for everything else. Higher interest rates also pay savers more, so people put off the purchases they were unsure about. The extra interest goes to lenders and savers instead of the shops, and businesses sell less.
Less spending put people out of work. Factories lost the most . The economy as a whole was about 4% smaller by early 1981 than it had been in 1979.
A business selling less has less money coming in but the same wage bill as before. Pay rates are fixed by agreements that run for a year or more, and a firm cannot rewrite them. The firm can cut overtime and move staff to fewer paid days a week, but that saves only part of the cost. After that, the only thing left in its control is how many people it employs. A year later the pay agreements are renewed. By then many people are out of work and competing for jobs, so pay rates settle lower. With lower wage costs, firms cut prices to win the customers who are left. Jobs go first, and slower price rises come later.
When people spend less, firms need fewer workers to make things. Bringing prices down therefore cost people their jobs.
- output
- How much an economy actually produces, in goods and in services. It is the thing growth measures the change in, and the thing a recession is a fall in.
The economy as a whole shrank about 4% from its 1979 level. By early 1981, by how much had Britain's factory output fallen?
For scaleManufacturing production fell around 15% over the year to late 1980, the largest fall recorded in any twelve months since the war.
A plan set four years ahead
In its 1980 , the yearly statement of taxes and spending, the government published a plan. It set targets for how fast the , the amount of money in the economy, could grow. It also set targets for how far government would come down.
Pay is agreed a year at a time. Workers and employers each settle on what they expect prices to do. If they expect fast price rises, workers ask for big pay rises. Firms raise prices to cover the higher wages, and the expected price rises really happen. The government's target limited how fast the money supply, the amount of money in the economy, could grow. People can only spend money that exists, so capping the money caps how fast prices can rise. Publishing four years of targets was meant to break the chain from expected prices to pay rises to price rises. Workers who believed the targets would expect slower price rises and ask for less.
Prices were still rising and factories were closing. The government had to show that it had a plan and would stick to it. A published target lets anyone check whether the government kept to it.
The plan set targets for tax and spending as well as for money. No post-war British government had linked money targets and borrowing targets in one plan before.
- Budget
- The annual statement in which a government sets tax rates and spending plans for the year ahead and reports how the last year turned out. It is the main moment at which a government can change tax. Who delivers it differs by country: in Britain the Chancellor, in Germany the finance minister.
- money supply
- The total of notes, coins and bank deposits held by households and firms. It grows two ways: when banks lend, because a new loan creates a new deposit, and when a central bank creates money directly, either to buy assets or to pay for what a government has not raised in tax.
- government borrowing
- What the state spends in a year beyond what it raises in tax, and has to fund from somewhere other than tax. It rises on its own in a downturn, because tax receipts fall as incomes fall and benefit payments rise as people lose work.
How far ahead did the plan set its targets?
For scaleThe last of the plan's money targets was dropped in 1987, seven years after the plan was published.
The first target missed
Take a guess
The money supply grew far faster than the plan allowed in its first year. What was one reason?
The plan missed its first . The Chancellor, the minister who sets tax and spending, had to say so in the March 1981 Budget.
The first year of the plan ran to February 1981. Over that year the money supply grew faster than the plan allowed.
The first target was missed by a wide margin in its first year. There were several reasons, and some of them worked against each other:
- In mid-1980 a control that limited bank lending was removed. While the control was in place, banks had arranged some loans in ways the official count of money did not include, to get round it. When the control ended, that lending appeared in the count. Part of the jump in the money supply was borrowing that had been going on all along, now counted for the first time.
- The government's chosen measure of money counted money held in bank accounts, including savings accounts. High interest rates pay savers more. So savers moved money into the bank accounts the measure counted. They moved it out of shares, property and other things the measure left out. Raising interest rates, the government's tool, pushed up the figure it was trying to hold down.
- Higher interest rates affect the money count in two opposite ways. They draw savings into bank accounts, which pushes the count up. They also make new loans more expensive. When a bank makes a loan, it adds new money to the borrower's account. Fewer loans mean less new money, and the count grows more slowly. To slow the count by cutting lending, the government would have had to raise interest rates higher still. The economy was already in its worst recession since the war, and higher rates would have made it worse.
The target had been for the money supply to grow by between 7% and 11% over that year.
- money supply target
- A published limit on how fast the amount of money in the economy will be allowed to grow, announced in advance so that people setting pay and prices know what to expect.
For scaleGrowth over the year was about 20%. Leaving out the effect of removing the lending control, it was about 17.5%. Both figures are far above the 7% to 11% range.
Prices went up before they came down
Take a guess
Inflation was 10.3% in May 1979. How high did it go before it started falling?
Going back to June 1979, the government's first Budget raised , the tax added to the price of most goods, to a single rate of 15%. That rise alone put prices up by nearly 4 per cent.
Higher interest rates were meant to start slowing prices from 1979. Prices went on climbing for a year anyway. Part of the climb came from the government's own VAT rise.
Inflation was 10.3% in May 1979, the month the government took office, and it was still climbing a year later.
Raising VAT put prices up in the same year the government was trying to bring them down.
- VAT
- A tax added to the price of most things people buy, collected by the shop and passed to the government. Because it sits inside the price on the shelf, raising it raises the cost of living straight away.
Source: ONS, RPI all items, percentage change over 12 months (CZBH)
For scaleThe 1980 peak was higher than any year of the 1970s except 1975. It was about ten times the 2% the Bank of England aims for now.
You are the Chancellor
It is February 1981. Government borrowing was meant to be falling by now and it is not, and the Budget is in three weeks.
Output has been falling for five quarters, which is fifteen months, and the factories are closing. A Chancellor who misses a published target has to choose: change the plan, or hold to it through a bad year.
Government borrowing has come out at £11.5bn, about 6% of , the total the country earns in a year.
- national income
- The total value of everything a country produces in a year. Government figures are usually given as a share of it, because that is what makes a sum comparable between one decade and another.
- government bonds
- Promises to repay, sold by the government to raise money it has not collected in tax. The buyer lends now and is paid interest until the promise falls due.
- International Monetary Fund
- A body funded by its member governments that lends to countries which cannot borrow enough elsewhere.
- public spending
- Everything the state pays for: health, schools, defence, benefits, pensions and the interest on what it has already borrowed.
You are the Chancellor. What do you put in the Budget?
The Budget of 10 March 1981 raised taxes by about £3.6bn in the middle of the worst since the war. Most of the money came from freezing the , the amount people can earn before they pay . With the allowance frozen, more of people's pay was taxed. The new borrowing target was set at £10.5bn.
What followedOutput stopped falling within six months and rose from there, but went on rising for four more years.
Whether the Budget caused the recovery is still open to debate.
The Institute of Economic Affairs The Institute of Economic Affairs is a research body that argues for free markets. It published a book asking whether the 364 economists who signed the letter were all wrong. It argued that the Budget was the turning point, and that the recovery began within months of it.
Stephen Nickell Stephen Nickell, writing for the Bank of England, argued that the government's tax rises and high interest rates went further than they needed to. He said the cost was carried in lost jobs for the rest of the decade.
Prices did come down
Take a guess
Interest rates went up in 1979, but inflation did not reach its low point until 1986. Why did the fall take so long?
Inflation fell through 1982 and kept falling for four more years.
Interest rates high enough to stop people spending eventually stop firms putting their prices up as well. The gap between spending slowing and prices slowing is measured in years rather than months.
By 1983 prices were rising at 4.6% a year, the lowest inflation rate since 1967.
For scale3.4% in 1986 is close to the 2% the Bank of England aims for now, and it was the lowest for twenty years.
It did not stay down
The Bank's interest rate was back at 15% in October 1989, raised to that level to stop inflation climbing again.
Inflation was rising again from 1986 onwards, and the government's answer to inflation was still the interest rate.
Prices had been rising at 3.4% a year in 1986. They were rising faster every year after that.
Prices came down and then rose again. So the jobs and output lost between 1979 and 1983 did not settle whether the policy was worth it.
Inflation in the month the government took office, against September 1990, shortly before Margaret Thatcher left. Which was higher?
A tie counts as correct either way.
For scaleIn between, inflation fell as low as 3.4%, so the policy did work for a time. The lower inflation did not last.
Thatcher's Economic Policy
The key questions
Can you answer each one now? Tap to check.
How did raising interest rates bring prices down?
Reveal
Dearer borrowing made households and firms spend less. Firms sold less at prices they had not yet cut, so they made less and employed fewer people. The lost output and jobs were how the policy worked.Why did prices rise for a year before they fell?
Reveal
The government's first Budget raised VAT, which put prices up at once, and prices take time to respond when spending slows.Why was the March 1981 Budget so disputed?
Reveal
It raised taxes in the worst recession since the war. The aim was to cut government borrowing so that interest rates could come down. Hundreds of university economists wrote publicly against it, and whether it worked is still argued.Did inflation stay down?
Reveal
No. It fell for several years after 1980, then rose again from 1986. In September 1990 prices were rising slightly faster than in May 1979.The numbers
Can you remember each figure? Tap to check.
The one tool the government could use alone, November 1979
Reveal
17%Why a policy aimed at prices costs jobs, and what it cost the factories
Reveal
17.4% of factory outputThe plan, with targets set four years ahead
Reveal
March 1980How fast the grew against a 7 to 11% target
Reveal
about 20%at its peak, a year into the policy
Reveal
21.9%Taxes raised in the worst of the recession
Reveal
£3.6bnat its low point, 1986
Reveal
3.4%And where it stood two months before Margaret Thatcher left office, September 1990
Reveal
10.9%You met nine terms in this module
, , , , , , , ,
- interest rate
- The price of borrowing money, given as a percentage of the amount borrowed each year. The Bank of England sets one rate that the rest are priced from, so when it moves, mortgages, loans and savings rates usually move with it.
- inflation
- The rate at which prices in general are rising. It is not the level of prices but the speed they are climbing, so falling inflation still means things are getting dearer, only more slowly. It is usually quoted for a year, but it can be measured over any stretch of time, and in the fastest episodes the figure that matters is the one for a month.
- output
- How much an economy actually produces, in goods and in services. It is the thing growth measures the change in, and the thing a recession is a fall in.
- Budget
- The annual statement in which a government sets tax rates and spending plans for the year ahead and reports how the last year turned out. It is the main moment at which a government can change tax. Who delivers it differs by country: in Britain the Chancellor, in Germany the finance minister.
- money supply
- The total of notes, coins and bank deposits held by households and firms. It grows two ways: when banks lend, because a new loan creates a new deposit, and when a central bank creates money directly, either to buy assets or to pay for what a government has not raised in tax.
- government borrowing
- What the state spends in a year beyond what it raises in tax, and has to fund from somewhere other than tax. It rises on its own in a downturn, because tax receipts fall as incomes fall and benefit payments rise as people lose work.
- money supply target
- A published limit on how fast the amount of money in the economy will be allowed to grow, announced in advance so that people setting pay and prices know what to expect.
- VAT
- A tax added to the price of most things people buy, collected by the shop and passed to the government. Because it sits inside the price on the shelf, raising it raises the cost of living straight away.
- national income
- The total value of everything a country produces in a year. Government figures are usually given as a share of it, because that is what makes a sum comparable between one decade and another.
Inflation was 4.6% by 1983 and back near 10% by 1990. People still argue over whether the lost jobs in between had to happen.
Take it further
Where every figure came from
[1] Inflation: ONS series CZBH, Retail Prices Index, all items, twelve-month rate. 10.3% in May 1979, 21.9% in May 1980, 18.0% in 1980, 4.6% in 1983, 3.4% in 1986, 10.9% in September 1990.
[2] The decade in outline: House of Lords Library, The UK economy in the 1980s. The Bank's main interest rate raised to 17% in November 1979. Inflation 24.2% in 1975, 18.0% in 1980, 4.6% in 1983, the lowest since 1967.
[3] The 1981 Budget assessed: Bank of England, Stephen Nickell, The Budget of 1981 was over the top. Policy rate reaching 17% in November 1979, from 12% when the government took office. Argues the tightening went further than it needed to, and that the cost was carried in jobs for the rest of the decade.
[4] The Budgets of 1979 and 1981: Margaret Thatcher Foundation, the 1981 Budget, background and documents. The 1981 Budget raised about £3.6bn in taxes and set a borrowing target of £10.5bn, about 4% of national income, against an actual £11.5bn and 6% the year before. VAT was unified at 15% in June 1979, adding about 3.75 points to the index.
[5] The money supply and the recession: Bank of England Quarterly Bulletin, 1981 Q1, economic commentary. The growth of sterling M3 over the year to February 1981 considerably exceeded the target range of 7 to 11 per cent, at about 20%, or about 17.5% adjusted for the ending of the supplementary special deposits scheme. Unemployment excluding school leavers 2.38 million, 9.9%.
[6] The recession: Bank of England Quarterly Bulletin, March 1982, economic commentary. The fall of around 15% in manufacturing production in the year to the fourth quarter of 1980 is the largest recorded in any twelve-month period since the war.
[7] How the targets were set and abandoned: Bank of England Quarterly Bulletin, 1994, Monetary policy instruments: the UK experience. Broad money targets were set out for four years ahead in 1980 and were later dropped, the last of them in 1987.
[8] What the plan was: Fiscal Studies, The medium term financial strategy: an experiment in co-ordinating monetary and fiscal policy. As much a fiscal strategy as a financial one: it tied targets for the money supply to a declining path for government borrowing, four years ahead, and published both.
[9] Manufacturing output: ONS series K22A, index of production, manufacturing, chained volume measure. Manufacturing output fell about 17.4% from its 1979 peak to the first quarter of 1981, and manufacturing employment never returned to its 1979 level.
[10] Output: ONS series IHYP, gross domestic product, year on year. The economy shrank in 1980 and again in 1981, and grew from 1982.
[11] Unemployment: ONS series MGSX, unemployment rate, aged 16 and over, seasonally adjusted. 5.4% in 1979, 9.9% in 1981, 7.1% in 1990.
[12] The 364 economists: Were 364 Economists All Wrong?, Institute of Economic Affairs, 2006. The letter was published in The Times on 30 March 1981, three weeks after the Budget. Five signatories were former chief economic advisers to the government. The volume carries both cases.
[13] The Chancellor's own papers: The National Archives, Geoffrey Howe private office papers 1979 to 1983, T 639/66. Howe's stated aim was to re-establish confidence by bringing in a rather tough Budget.
[14] The episode chart: ONS series CZBH, RPI all items, percentage change over 12 months, monthly. Open Government Licence v3.0. Retrieved 30 September 2026. Monthly rates; the module's figures for whole years (for example 4.6% in 1983) are annual averages of the same series.
Country data from the World Bank (CC BY 4.0) and the UNDP Human Development Report (CC BY 3.0 IGO)
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