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Overcoming Inflation

Volume 981: debated on Wednesday 26 March 1980

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A firm monetary policy, as the past year has shown, contributes to a strong exchange rate. Furthermore, sterling now has some of the characteristics of a petrocurrency. A strong exchange rate plays an important part in diminishing inflationary pressures, but at the same time it obliges United Kingdom industry to restrain costs and improve its competitiveness. That requires a fundamental change in attitudes.

Over the past years we have sunk into an unquestioning "cost-plus" mentality, where the impression is given that whatever wage increases are agreed can simply be passed on to customers. But exporters have been learning that their prices must be related as closely to their competitors' prices as to their own costs. The same lesson has to be learnt in pay negotiations. Just as exporters must base their prices on what their customers will pay, so pay settlements must be based upon what companies can afford, while remaining competitive.

There is a need for much greater public awareness of the link between pay increases, price inflation and unemployment. This subject has already been discussed in the forum of the National Economic Development Council, and we shall be returning to it again at future meetings. The more pay settlements can be moderated, the lower the transitional costs of the fight against inflation in terms of bankruptcies, lost production and reduced employment.

It is still a widespread, if tacit, assumption in too many places that if wages and prices go up fast the exchange rate will fall before long and restore any loss of competitiveness. This rests, not unreasonably, on repeated experience. But the authorities are no longer in a position to engineer a major reduction in the exchange rate in order to bail out those who have sought and granted excessive pay claims. Even if we could do this, it would create more inflation before long.

It is not only in collective bargaining and selling overseas that we must move away from a blind attachment to cost plus and the idea of full protection against RPI movements. The problem goes far wider than that. There are many parts of our economic life where it is right to take some account of inflation, but a very damaging rigidity has grown up in how we do it. For example, until recently public spending programmes were controlled entirely in volume terms, without regard to changes in their costs. With cash limits an important step was taken away from an increasingly harmful practice. Again, it has been assumed that the real value of all social security benefits must always be maintained, whether production and incomes go up or down. This places the entire burden of adjustment on the working population. They, for their part, have responded by pressing for the income tax system to be fully indexed and by adding to their demands for higher wages. Inevitably, a substantial part of the burden of adjustment then falls on profits, and so on jobs.

So long as inflation persists there has to be some measure of price protection in relation to social benefits and taxation in a civilised society, but full protection for some is possible only at the expense of others. The proposals in this Budget recognise both the need to offset some of the effects of inflation and the fact that it is impossible to maintain the real value of all personal incomes when total national income is likely to fall.

If we are to master inflation the adjustments required of all of us are difficult but perfectly feasible. We should beware of the fashionable but misleading parallels with what happened in 1974 and 1975. They are merely a recipe for self-fulfilling pessimism.

After the oil price increases of 1973–74 our inflation went on rising for two years, reaching a peak year-on-year rate of 26 per cent. in the autumn of 1975. The oil price increases in the second half of 1979 have been just as large, but this time we have a good chance of seeing our inflation rate decline in the latter part of 1980. Monetary growth is now under better control. Unlike then, we have no backlog of inflation in the system, caused by earlier falls in sterling. There are encouraging signs of realism in private sector wage settlements. This is clear, for example, from information provided by the CBI data bank and from evidence of settlements linked to genuine productivity deals. The underlying rate of inflation over the last six months is well below the present year-on-year rate.

Projections of growth and tax revenue can only be illustrative and imprecise, but those published today show that for the first time the Government of the day have coherent policies for money, tax and spending over the medium term. There should be scope simultaneously to reduce Government borrowing and to lower taxes, including progress towards a 25 per cent. rate of income tax. Publication of this strategy will assist decision-makers throughout the economy to work with the grain of Government policy, understanding the limits that it imposes and the opportunities that it presents. This strategy is the best foundation for higher growth, fuller employment and a return to rising living standards.