Economic history · 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.
Britain had spent thirty years holding prices down by agreeing pay with the unions. By 1979 that had failed four times, and the government elected that year had ruled out trying it again.
Was mass unemployment the price of beating inflation, or the way it was beaten?
The government elected in 1979 had ruled out bargaining with the unions over pay. That left one tool it could use without anybody's agreement: raising interest rates until people stopped spending.
It raised that interest rate sharply, published a plan it promised not to abandon, and then watched prices rise for another year while the factories closed.
By March 1981 it had to decide whether to keep going, and this module puts you in that chair on the day.
What this module covers
- The interest rate rise, and how raising interest rates is supposed to slow prices
- Why the cost lands before the benefit does
- The four-year plan, and the target missed in its first year
- The 1981 Budget, and the 364 economists who said it was wrong
Written for every level. Tap any underlined word for what it means, and open the boxes below for the economics behind each decision. If you already know the theory, skip both and the history reads straight through.
- [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
Step 1 of 8
The one lever it could pull alone
When prices rise faster than wages, the difference turns up in a weekly shop, and no household 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, having 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 spend it on. A seller who cannot keep up with the orders raises the price and still sells everything. Raising the interest rate makes borrowing more expensive, so households buy fewer of the things people borrow to buy, and firms put off building and hiring. Higher interest rates also pay more for leaving money in a savings account. Less money reaches the shops while the goods on the shelves stay as they were, and sellers can 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 acts as a floor under the rest, so when it moves, mortgages, loans and savings rates move with it.
- inflation
- The rate at which prices in general are rising, measured over a year. 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.
Take a guess. You are not expected to know the answers, and being wrong is what makes a number stick.
How high was the Bank's interest rate pushed within six months?
For scale. The same interest rate had been 12% six months earlier, and it was back up at 15% in October 1989.
Why that costs jobs
Britain's higher interest rates worked on prices by making people spend less, and an economy where people spend less 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's interest rate, and people who already had one saw their monthly payment rise within weeks, leaving less for everything else. Higher interest rates also pay more for holding money than for spending it, and the purchases people were in two minds about get put off. What goes instead to lenders and savers is money that stays out of the shops, and businesses sell less.
That put people out of work, and the 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 coming in and the same wage bill as before, and it cannot carry that for long. The pay rate per hour is set by agreements running a year or more, and a firm cannot rewrite one. It can cut overtime and move staff to fewer paid days a week, and that goes part of the way. Past that, the only thing left in its hands is how many people it employs. Pay rates themselves settle lower a year later, when the agreements are renewed with people now out of work and competing for the jobs. Firms paying less then undercut each other for the customers left. Jobs go first, prices follow.
An economy where people are spending less needs fewer people to make things, so the price of bringing prices down was paid in work.
- 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. How much of Britain's factory output had gone by early 1981?
For scale. Manufacturing production fell around 15% over the year to late 1980, the largest fall recorded in any twelve months since the war.
The plan, published four years ahead
The government published a plan in the 1980 , with targets for how fast the could grow and for how far would come down.
Pay is agreed a year at a time, and both sides settle on what they expect prices to do over that year. Expecting fast rises, workers ask for big pay rises to keep up. Wages are most firms' biggest cost, so firms raise their prices to cover them, and the expectation makes itself come true. A money target is a price target in disguise: spending cannot outrun the money there is to spend, and capping how fast the money grows caps how fast prices can rise. Publishing four years of figures was meant to break the loop. People who believed them would ask for less.
The government had to show that it knew where this was going, with prices still rising and the factories closing. A published target can be checked against, which is most of the reason for publishing one.
The plan set targets for tax and for spending as well as for money, and tying the two together was new to post-war Britain.
- 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. In Britain the Chancellor delivers it, and it is the main moment at which a government can change tax.
- 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, made up by selling bonds. 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 scale. The last of these targets was dropped in 1987, seven years after the plan was published.
Missed in the first year
The plan missed its first , and 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, and the money supply grew faster over that year than the plan allowed for.
The first target was missed by a wide margin in its first year. There is more than one reason, and they pull in different directions:
- A control on bank lending was removed in mid-1980. Banks had been arranging loans in ways the official count could not see, to get round it. When the control went, that lending was counted again. Part of the jump was borrowing that had been going on all along, counted for the first time.
- The measure the government had chosen to target counted money held in bank accounts, savings accounts included. High interest rates pay more to anyone who saves, so savers moved money into exactly the accounts the measure counted, out of shares and property and everything the measure left out. The tool and the target worked against each other.
- Interest rates work on the count both ways. They draw money in, and they also make new loans more expensive, and a new loan is what creates a new deposit. Slowing the count therefore meant raising interest rates further still, in a recession already the worst since the war. The government had one tool and two things it wanted from it.
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.
The target range topped out at 11%. How fast did the money supply actually grow?
For scale. Allowing for one change in the rules brings the growth nearer 17.5%. Either figure sits well outside the range.
Prices went up before they came down
Going back to June 1979, the government's own first Budget raised 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, and some of the climb was the government's own doing.
Inflation was 10.3% in May 1979, the month the government took office, and it was still climbing a year later.
Raising the tax on spending 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.
Inflation was 10.3% in May 1979. How high did it go before it started falling?
For scale. The 1980 peak was higher than any year of the 1970s except 1975, and it was about ten times what 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 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.
Borrowing has come out at £11.5bn, about 6% of .
- 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. It attaches conditions to what it lends, usually about what the borrowing government may spend.
- 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 it came not from changing a tax rate but from freezing the . The borrowing target was set at £10.5bn, about 4% of national income.
What followedOutput stopped falling within two quarters 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, a research body that argues for free markets, published a volume asking whether the 364 economists who signed the letter against the Budget were all wrong, arguing the Budget was the turning point and the recovery began within months of it.
Stephen Nickell Stephen Nickell, writing for the Bank of England, argued the tightening went further than it needed to and that the cost was carried in jobs for the rest of the decade.
Prices did come down
Inflation went on falling 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.
Put these years in order of inflation, highest first.
For scale. 3.4% 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 went up again, so what the country paid between 1979 and 1983 did not settle the question.
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 scale. In between it had been as low as 3.4%, so this is not a policy that never worked. It is one whose result did not hold.
Module 2 of 13 in Thatcher's Economic Policy
What this module covered
The one lever the government could pull alone, November 1979
17%Why a policy aimed at prices costs jobs, and what it cost the factories
17.4% of outputThe plan, published four years ahead
March 1980How fast the grew against a 7 to 11% target
about 20%at its peak, a year into the policy
21.9%Taxes raised in the worst of the recession
£3.6bnat its low point, 1986
3.4%And where it stood two months before Margaret Thatcher left office, September 1990
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 acts as a floor under the rest, so when it moves, mortgages, loans and savings rates move with it.
- inflation
- The rate at which prices in general are rising, measured over a year. 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.
- 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. In Britain the Chancellor delivers it, and it is the main moment at which a government can change tax.
- 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, made up by selling bonds. 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. Whether the cost in between had to be paid is still argued.
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.
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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