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The Medium-Term Strategy And The Monetary Target

Volume 981: debated on Wednesday 26 March 1980

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This is one of the reasons—though by no means the only one—why I intend to consolidate the start that I made last year by publishing today the Government's financial and monetary strategy for the medium term. This strategy is contained in part II of the Financial Statement and Budget Report, better known, perhaps, as the Red Book.

This strategy is by no means to be confused with a national plan—Opposition Members may laugh—for it is concerned with only those things—very few of them—that the Government actually have within their power to control. The strategy sets out a path for public finance over the next few years. At its heart is a target for a steadily declining growth of the money supply. That is set alongside policies for Government spending and taxation, which will underpin that objective.

It will be clear from what I have already said that the Government continue to regard the fight against inflation as the first priority. It is an illusion to suppose that we have any real choice between defeating inflation and some other course. It is quite wrong to suppose that inflation is something with which only Treasury Ministers need be concerned. So long as it persists, economic stability and prosperity will continue to elude us. So long as it persists, social coherence will also elude us. Nothing, in the long run, could contribute more to the disintegration of society and the destruction of any sense of national unity than continuing inflation.

Inflation sets worker against worker, employer against employee, and sometimes even Government against their own employees. The violence of the picket lines and last winter's examples of hospital patients denied supplies, and of the dead denied burial, would have been unthinkable 20 years ago. They reflect the social disintegration caused by inflation. That is one of the reasons why the conquest of inflation is so important.

Monetary policy has an essential role to play in the defeat of inflation. Other countries recognise this very clearly. They recognise, too, that sustained monetary restraint is not an easy, automatic or painless solution. But they are convinced that it is essential. They are struggling to get back towards more balanced budgets, as we must. They recognise, as we must, that inflation cannot persist in the long run unless it is accommodated by an excessive expansion of money and credit. That is at the heart of what "monetarism" means in practice. It is a great pity that its practical, commonsense importance has been so confused by arid, theoretical dispute. Certainly the word "monetarism" should never have become a term of political abuse—least of all for use by those who have in the past claimed to make a virtue of practising it.

It is an illusion to suppose that there is any real alternative to the strategy that I have outlined. Some commentators seek to blame our present difficulties on the pursuit by Government of unnecessarily tough policies. That is totally to misunderstand the position. Britain's present difficulties are so deep-seated and serious as to make tough policies inescapable. Relaxed monetary and budgetary policies might bring higher output—even higher living standards—in the very short run, though even that is questionable, but in reality they would simply fuel fresh inflation. Such policies would inevitably undermine the confidence of financial markets, industry, and consumers. The action that would then be necessary to deal with the ensuing crisis would, equally certainly, destroy jobs and cut living standards still further.

Restraint of the growth of money and credit is, then, essential, and it needs to be maintained over a considerable period of time in order to defeat inflation. That underlines the importance of the medium-term financial strategy.

That strategy, as I have said, sets out a four-year path for monetary growth, public spending and tax policies. I shall deal first with the monetary targets. By 1983–84, the last year covered by our spending plans, the target rate of growth of money supply will be reduced to around 6 per cent.—just half the rate of growth over the past year.

The monetary target for 1980–81

In keeping with that medium-term monetary objective, the target range for the growth of sterling M3 in the period to mid-April 1981 will be 7 per cent. to 11 per cent. at an annual rate. The base for this will be the most recent published figures. The target will thus relate to the 14 months from mid-February this year.

I am glad to say that monetary growth has already begun to slow down. In the first four months after the Budget sterling M3 continued to grow at the excessive rate—over 14 per cent.—that we inherited. But in the succeeding four months it fell to an annual rate of 10 per cent. Moreover, in the earlier period sterling M3 growth had been below that of other measures of the money supply. Currently, however, all the other measures, M1, total M3 and the various indicators of wider liquidity, are growing less rapidly than sterling M3. The narrow measure, M1, actually fell over the last four months. So the turndown in the growth of sterling M3 probably understates the extent to which the measures in the last Budget and those that I took in November have already brought monetary growth under control.

This year's target will consolidate the substantial slowdown in the underlying rate of growth. At the same time the Governor and I have agreed— Interruption.]

I am referring not to any foreign or outlandish figure but to the Governor of the Bank of England. We have agreed that the supplementary special deposit scheme—generally known as the "corset"—should not be extended beyond mid-June, when the present guideline ends. One of the effects of the corset has been to encourage the development of credit channels just outside the banking system, such as the purchase of bank acceptances by the private sector. This process will be reversed to some extent when the corset ends. So sterling M3 will be swollen as earlier distortions unwind.

The increase in sterling M3 on this account will not, however, signal a change in underlying monetary conditions. The scale of this exceptional increase cannot be precisely measured or predicted, and we shall need to assess its effect both as it occurs and when the target is rolled forward in the autumn. If, as I hope, it can be accommodated within the target that I have just announced, that will point to a further slowing down of monetary growth.

By any standards this is a firm monetary policy. But it is an essential response to the inflation rate. As I have shown earlier, there is nothing unique to this country about what I have proposed. Other countries faced with similar problems have adopted similar remedies, as is shown by the determined measures introduced in the United States a fortnight ago.

Monetary control

It goes without saying that to accompany these policies we need to have efficient methods of monetary control. We already have the means to meet our medium-term objectives. The Green Paper on monetary base control, which I laid before the House last week, will provide a basis for public discussions of how to improve control over short periods. The Governor and I hope to hear a wide range of views before deciding whether any further changes should be made.

The recent pressure on companies has resulted in a strong demand for bank lending which has contributed to the upward pressure on both money supply and short-term interest rates. I am sure that banks and their customers would be well advised, in the difficult economic conditions foreseen, to be cautious about the scale of their lending and borrowing. When the growth of bank lending falls back, this will add to the downward pressure on interest rates from today's measures.