Economic history · Thatcher's Economic Policy
Six steps, about nine minutes, a question at each. You need no economics and no preparation, only a willingness to guess before you are told.
Interest rates had been raised to bring prices down, and British manufacturing had shrunk more than the rest of the economy. North Sea oil was coming ashore at the same time.
Nigel Lawson resigned as Chancellor on 26 October 1989, after six years in the job, and the reason was the pound. He wanted it tied to the German mark. Margaret Thatcher did not, and she would not dismiss the adviser Lawson wanted removed.
Britain had struck oil by then. The North Sea took the country from buying its oil abroad to selling it, the pound rose about 21% against Britain's trading partners between the election in May 1979 and January 1981, and factory jobs fell by about 22% between 1979 and 1983.
This module is about a currency the government could not decide what to do with: the money that arrived and went, the year a Chancellor held the pound at a level the Prime Minister denied existed, the resignation, and joining the European system in 1990.
What this module covers
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.
Step 1 of 6
Finding oil under your own sea sounds like nothing but good news. It was not.
Britain became self-sufficient in oil in 1980, for the first time. The North Sea produced nothing in 1974 and was 7.2 per cent of everything the country made by 1984.
Britain's oil was sold abroad and paid for in pounds, so the buyers of the oil became buyers of the currency. High s were raising it too, because money left in a British bank now paid more than money left elsewhere.
Oil is sold abroad and paid for in pounds, so a country that starts selling it has more buyers of its currency than before. A country that used to buy oil from abroad also stops selling pounds to pay for it. Both push the same way.
In May 1979, the month of the election, a pound bought 3.94 German marks. Over the twenty-one months that followed, oil came ashore faster and the interest rate went higher.
A German customer buying a British machine listed at 10,000 pounds paid 39,450 marks for it in May 1979. The exchange rate decided that bill, and the firm in Britain had no say in it.
A British firm selling abroad is paid in somebody else's money. When the pound rises, the same foreign price converts into fewer pounds at home, so the firm either takes less for each sale or raises its foreign price and sells fewer. A firm selling only at home never faces that choice.
Take a guess. You are not expected to know the answers, and being wrong is what makes a number stick.
The same machine, still listed at 10,000 pounds, on 28 January 1981. How many German marks did the customer pay for it?
For scale. A pound bought about four German marks when the decade opened and about three when it closed.
Two things pushed the pound up in the early 1980s and the oil was only one of them. High interest rates were the other, and the two were happening at the same time.
The 1980s cannot be run twice, so there is no way to watch what the pound would have done with no North Sea. Economists get round that by building a model and running it both ways.
You cannot watch the same years twice, so the only way is to build a model of the economy and run it in two versions. One has the oil in it. The other does not. Everything else is held the same, and the gap between the two runs is what the oil did.
The economist Charles Bean built one. By 1983 the oil had raised the pound by 12 per cent, and had moved workers out of making things and into services.
Factory jobs fell by about 22 per cent between the middle of 1979 and the end of 1983. Bean's model puts a figure on how much of that fall the North Sea accounts for.
Of that 22 per cent fall in factory jobs, how much does the oil account for on Bean's estimate?
For scale. The Bank of England put no number on this at all. It said the claim that the oil closed the factories could not be proved without knowing what would have happened had there been no oil.
North Sea oil provided 10.1 per cent of all the tax the government collected in 1985. A tenth of the government's income came from one industry.
That money came in three ways: a royalty paid to the government on every barrel taken out, ordinary company tax, and a tax charged on North Sea profits alone.
The peak was the tax year 1984-85, when the North Sea paid 12.0 billion pounds. No year before it had raised as much.
North Sea tax raised 12.0 billion pounds in 1984-85. How much did it raise seven years later, in 1991-92?
For scale. The North Sea was 10.1 per cent of the tax take in 1985 and 6.3 per cent of everything the country made. It was taxed harder than the rest of the economy.
It is November 1987, and the government has spent the year keeping the pound at a set level against the German mark. No law requires it to and no minister has announced it.
The government cannot raise the interest rate while it holds the pound at this level. A higher interest rate brings money into Britain from abroad. Whoever brings that money in must buy pounds, and the buying would take the pound above the level.
Two ways, and it usually uses both. It can buy its own currency when the price falls and sell it when the price rises, the way any large owner can move a market. And it can set interest rates to make holding the currency more or less attractive to people abroad.
The government is holding the pound just under three marks. It cut the interest rate again on 4 November, to 9 per cent, with prices rising at 4.1 per cent a year.
The Prime Minister denies that the government is holding the pound at any level. Asked in public this month, she said there is no specific range and that Britain is free to let the pound move.
You are the government. Buyers keep pushing the pound above the level you are holding it at, and you have never admitted to holding it. What do you do?
The government went on holding the pound at just under three German marks, and kept interest rates low enough to do it. The pound sat at around 2.98 marks for the first three weeks of January 1988.
What followedThe government gave up holding the level on 7 March 1988. Keeping the pound down had become too difficult to go on with, so the pound was allowed to rise, and it reached 3.10 marks by 17 March. Interest rates were cut again that day.
Whether that year of low interest rates caused the that followed is still argued, and both sides use the same figures.
One reading One reading blames the level. Holding the pound there kept interest rates lower than Britain needed for a year. Households and companies borrowed heavily at those interest rates. Prices rose from 4.1 per cent in November 1987 to 10.9 per cent by the autumn of 1990 as a result.
The other reading The other reading is that taxes were cut in 1988, and banks and building societies were freed to lend more, so borrowing and prices would have risen anyway. The level the pound was held at changed the timing rather than the outcome.
Nigel Lawson resigned as Chancellor on 26 October 1989, after a public row with the Prime Minister about the pound.
Lawson wanted the pound tied to the German mark, and told Parliament that a steady exchange rate was an essential part of holding prices down. Margaret Thatcher wanted the interest rate to hold prices down and the pound left alone.
Sir Alan Walters was her personal economic adviser, and he had written about the exchange rate mechanism. On 24 October the House of Commons, the elected house of Parliament, was told his article called the mechanism half-baked. Walters resigned on the same day as Lawson.
Lawson had been Chancellor for six years and had cut the top rate of from 60 to 40 per cent. Prices were rising at about 7.6 per cent when he went, against 4.1 per cent two years earlier.
Lawson's resignation letter gave one reason. What was it?
For scale. Lawson had held the job for six years. The Prime Minister's reply to his letter opened, “It is with the most profound regret that I received your letter”.
Britain set the pound's official level at 2.95 German marks on 8 October 1990, by joining the European exchange rate mechanism.
Britain agreed to hold the pound within six per cent of that level. The pound had risen against the German mark through the summer, so on the day Britain joined it was already close to 2.95.
Prices were 10.9 per cent higher than a year earlier on the day Britain joined, and pay was rising about ten per cent a year. The Bank of England's interest rate had stood at 15 per cent for the twelve months before Britain joined.
The Bank of England's interest rate. Which was higher, the day before Britain fixed the pound or the day after?
A tie counts as correct either way.
For scale. The pound had bought over five marks at the 1981 peak. It was fixed at 2.95.
Module 4 of 13 in Thatcher's Economic Policy
The pound at its 1981 peak, in German marks, and where it was fixed in 1990
5.01 in 1981, 2.95 in 1990What Bean's estimate gives the oil, of a 22% fall in factory jobs
about 1.5%North Sea tax in 1984-85, and seven years later
12.0bn, then 1.0bnWhere the pound was held through 1987, and when that broke
under DM 3, until 7 March 1988Why the Chancellor said he was resigning, in October 1989
one adviser, Sir Alan WaltersThe level Britain fixed the pound at, and what interest rates did that day
DM 2.95, and a cut to 14%You met two terms in this module
,
Britain left the mechanism on 16 September 1992, two years after joining. The Treasury later put the cost at 3.3 billion pounds.
[1] What the pound was worth: Bank of England, A millennium of macroeconomic data, sheet D3, daily sterling effective rate index. On the 1975 = 100 method: 82.02 on 2 January 1979, 87.08 on 3 May 1979, 101.41 on 24 October 1980 and 105.63 on 28 January 1981, which is the highest daily value of the period. Yearly averages 81.5 in 1978, 87.3 in 1979, 96.0 in 1980, 94.9 in 1981, 72.8 in 1986.
[2] The Bank on the peak: Bank of England Quarterly Bulletin, September 1981, Sterling and inflation. Footnote 1: sterling reached its recent peak against the US dollar, 2.4650, on 24 October 1980, and in effective terms, 105.6, on 28 January 1981. The note itself is about the other side of a high pound, which is that it brought the rate prices were rising at down.
[3] Marks to the pound: Bank of England, A millennium of macroeconomic data, sheet D2, daily bilateral exchange rates. Marks to the pound: 3.9450 on 3 May 1979, 5.0127 on 28 January 1981, 2.9782 on 15 January 1988, 3.0987 on 17 March 1988, 2.9482 on 5 October 1990 and 3.0253 on 8 October 1990.
[4] What the oil paid for: Office for Budget Responsibility, The evolution of North Sea oil and gas receipts. Receipts reached a then record high of 12.0 billion pounds in 1984-85, and between 1984/85 and 1991/92 they fell by 91.9 per cent, to 1.0 billion. The OBR's other box on the same subject, in the December 2014 outlook, puts the same cash figure at a different share of national income, so the share of the tax take is used here instead, and taken from the Bank.
[5] How big the oil was: Bank of England Quarterly Bulletin, December 1986, North Sea oil and gas. Table E: the North Sea share of government revenue rose to 10.1% in 1985/86, against 5.6% in 1980, while North Sea activity was 6.3% of national income in 1985. The revenue figure counts royalties, petroleum revenue tax, corporation tax from the North Sea and the gas levy, against all tax and national insurance. The article also says that the claim the oil caused the rise in the pound cannot be substantiated. On when the oil arrived: 'Self-sufficiency was achieved in 1980, and in 1983 export proceeds were sufficient on an annual basis to cover the full resource costs of the North Sea.' Opened again on 16 August for that sentence, because the module was using the oil before it had told anybody Britain had any.
[6] How much of it was the oil: Resolution Foundation, The Thatcher legacy, reporting simulations by Charles Bean. By 1983 the oil had raised the real exchange rate by 12 per cent, shifted employment away from making things by 1.5 per cent and towards services by 2.8 per cent. The paper sets that beside the actual fall in manufacturing employment of about 22 per cent between the second quarter of 1979 and the end of 1983. Oil production went from nothing in 1974 to 2.7 per cent of national income in 1979 and 7.2 per cent by 1984.
[7] The year the pound was held: Bank of England Quarterly Bulletin, 1988 Q2, Operation of monetary policy. Sterling rose above DM 2.9750 early in January and steadied at around DM 2.9800 for the first three weeks of the month. The strength of the upward pressure represented a considerable difficulty for policy, so sterling was allowed to rise on 7 March, reaching DM 3.10 and 1.86 dollars on 17 March, and that was offset in part by a 1% reduction in interest rates the same day.
[8] The Chancellor resigns: Margaret Thatcher Foundation, Nigel Lawson's resignation letter and the Prime Minister's reply. Lawson: 'The successful conduct of economic policy is possible only if there is, and is seen to be, full agreement between the Prime Minister and the Chancellor of the Exchequer. Recent events have confirmed that this essential requirement cannot be satisfied so long as Alan Walters remains your personal economic adviser.' Thatcher's reply opens 'It is with the most profound regret that I received your letter' and says 'There is no difference in our basic economic beliefs'. The archive page is headed 27 October and notes the exact time of issue is uncertain; Hansard fixes the resignation at 26 October.
[9] What he told the Commons: Hansard, HC Deb 26 October 1989 vol 158 and HC Deb 31 October 1989 vol 159, Lawson's resignation and his resignation speech. Howe, 26 October: 'My right hon. Friend the Member for Blaby (Mr. Lawson) has resigned as Chancellor of the Exchequer', and Walters resigned the same day. Lawson, 31 October: 'for our system of Cabinet government to work effectively, the Prime Minister of the day must appoint Ministers whom he or she trusts and then leave them to carry out the policy', and on the exchange rate 'my answer is, unhesitatingly, that it should be seen as an essential element of financial discipline'. The word 'half-baked' is attributed to Walters in the House on 24 October 1989 by John Smith, about Walters's article 'A Life Philosophy' in The American Economist; it is not verified from Walters's own text, so it is attributed to the Commons and not to Walters.
[10] The condition she set: Hansard, HC Deb 29 June 1989 vol 155, European Council (Madrid). Thatcher: 'On the exchange rate mechanism, our promise has been that we would go in when the time was right. I put conditions on that... One condition depends on us, which is that we get inflation well down, but some of the other conditions depend on the other members of the Community.' The tidy enumerated list of Madrid conditions found in secondary accounts is a reconstruction; the Madrid press conference itself contains no such list.
[11] How it ended: Bank of England Quarterly Bulletin 1992 Q4, Operation of monetary policy, and HM Treasury, The cost of Black Wednesday reconsidered, 6 August 1997. 16 September 1992: 'At 11.00 am, with sterling still at its lower ERM limit, it was announced that MLR had been set at 12%'; 'A rise in MLR to 15% was announced at 2.15 pm'; 'Just after 7.30 pm, the Chancellor therefore announced sterling's suspension from the ERM and rescinded the decision to raise MLR to 15%'; and at 9.30 the next morning it was reduced to 10%. The Treasury paper, released in 2005, puts the cost at 3.3 billion pounds measured at the end of February 1994, and it is an OPPORTUNITY cost of the intervention and the rebuilding of the reserves rather than cash lost on the day. The realised loss on reserves operations in August and September 1992 was 'nearly 800m'. The same Bulletin, p382: 'For the first eighteen months sterling's membership of the ERM was helpful in enabling base rates to be reduced from 15% to 10%.'
[12] What the Prime Minister said: Margaret Thatcher Foundation, interview for the Financial Times, 20 November 1987. Asked whether the pound was being run against the German currency, she said: There is no specific range. We are always free.
[13] Joining: Margaret Thatcher Foundation, press conference on joining the exchange rate mechanism, 5 October 1990. We would become members on Monday and I hope that they would agree to the central rate of 2.95 DM which was the one which we thought appropriate and, of course, we have a 6 per cent latitude. Interest rates are to be reduced by one percentage point on Monday.
[14] The Bank on joining: Bank of England Quarterly Bulletin, 1990 Q4, General assessment. Sterling entered on 8 October, having risen about 6% against the German currency and 16% against the dollar in the six months before. Base rates had been at 15% for a whole year. By September average earnings were as much as 10% higher than a year earlier. The Bank set a lending rate of 14% on the day, and sterling, which rose on entry, was near its DM 2.95 parity.
[15] Prices, month by month: Bank of England, A millennium of macroeconomic data, sheet M1, spliced monthly retail price index. Prices were 4.1% higher than a year earlier in November 1987, 3.5% in March 1988, and 10.9% in September and October 1990. Sheet D1 gives the Bank's own rate at 8.875% from 4 November 1987 and 13.875% from 8 October 1990, which are the days the banks moved to 9% and 14%.
[16] The decade in outline: House of Lords Library, The UK economy in the 1980s. High interest rates strengthened the pound by making assets held in it more attractive. The pound was also being strengthened by demand for North Sea oil, and that created significant challenges for the ability of the firms that made things to compete.
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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