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The Money Supply And Inflation

Volume 416: debated on Wednesday 21 January 1981

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2.54 p.m.

My Lords, I beg leave to ask the Question which stands in my name on the Order Paper.

The Question was as follows:

To ask Her Majesty's Government whether, as a consequence of the increase in the money supply in 1980, they now anticipate higher inflation in 1982.

My Lords, as the medium term financial strategy made clear, control of the money supply over a period of years will reduce the rate of inflation. But while the link between the money supply and inflation over time is clear it would not be right to assume that a short period of rapid growth, such as occurred in the second half of 1980, will necessarily feed through directly to inflation at some point in the future. If we maintain the thrust of the medium term financial strategy, then we can expect to maintain the downward momentum in inflation established in 1980.

My Lords, would the Minister agree that that is a little bit of a U-turn? Ever since they took office the noble Lord and his colleagues have been telling us that the changes in the money supply would be reflected in the changes in inflation after a period of 18 months to two years. Are they now departing from that philosophy?

No, my Lords, No U-turn is involved here. If I may quote the speech that I delivered in your Lordships' House a year ago, what I then said was this:

"There is general agreement that there is a considerable time lag between changes in the growth of money supply and changes in the rate of inflation. There is some dispute as to how long the time lag is but the noble Lord's right honourable friend Mr. Denis Healey claimed that it was considerable. He suggested a period of the order of two years".

My Lords, in view of the fact that for the first nine months of this financial year the public sector borrowing requirement is £3 billion higher than in the last financial year and that that part of it which is financed by domestic credit expansion, or by printing money as it is sometimes called, is 60 per cent. higher than the year before, would not the noble Lord agree that this Government are pursuing an increasingly inflationary policy which far exceeds, on their own criteria, any degree of inflation brought about by the previous Government?

My Lords, the excess growth both in the money supply and in the public sector borrowing requirement are matters of real concern. This is why my right honourable friend the Chancellor of the Exchequer announced on 24th November a series of measures both to reduce the level of public expenditure and to increase revenue. So far as the rate of inflation is concerned, I would draw the noble Lord's attention to the fact that after reaching a peak of 21·9 per cent. it has come down every month since then and has now been reduced to 15·1 per cent.

My Lords, in that case it appears to show a certain logic: an increase in the money supply. If inflation has come down 6 per cent., then the money supply has gone up far beyond the Government's target.

My Lords, the noble Lord is assuming an instantaneous connection between changes in the money supply and changes in the rate of inflation. This is a matter which I have also dealt with at length in debates in your Lordships' House.

My Lords, is it not true that inflation has come down very markedly and that we should congratulate the present Government upon bringing this about? Is it not also true that there are several methods of measuring the money supply, some of which are at direct variance with other methods? I believe that sterling M1 points to a totally different view from sterling M3.

My Lords, I am most grateful to my noble friend. In looking at the money supply the Government pay attention not only to M3, in terms of which the targets are announced, but also to other measures of the monetary aggregates. So far as the rate of inflation is concerned, it has come down very markedly and will continue to come down.

My Lords, would not the noble Lord agree that in fact the Government do not expect any such troubles in 1982, for the simple reason that they are now taking counter-measures to anticipate them?

My Lords, I am equally grateful to the noble Viscount. On 24th November the Government took vigorous measures, and they will continue to take measures to ensure that on both fronts we keep within the desired range.

My Lords, is the noble Lord aware, however, that the annual rate of inflation is still running 50 per cent. above the annual rate of inflation that was in existence when the noble Lord's party took office? Will he inform the House whether he intends to maintain a very close liaison indeed with Professor Alan Walters, the Prime Minister's new economic adviser, who predicts that there is a five-year time lag between the increase in the money supply and the development of the rate of inflation? When the noble Lord next addresses the House on this subject, upon which he is expert, will he pin himself down on the matter of time lags—and they have varied—which he has progessively expounded to the House during the last 18 months and let the House have fairly before it his own position?

My Lords, the noble Lord will find my own views on this matter, which coincide with those of the Government, set out in detail in a number of speeches that I have delivered.

So far as his first supplementary question is concerned, the position is that the rate of inflation at 15·1 per cent. at present is measured over a 12-month period. If one looks at the underlying trend, which is better measured by the six-months figure, that is below 10 per cent., and falling. At the end of the life of the Labour Government the underlying rate of inflation was 13 per cent., and rising. The position therefore is that matters were deteriorating under the Labour Government but they are improving under the Conservative Government. I am most grateful to the noble Lord for drawing attention to the matter.

My Lords, can the noble Lord explain to a non-expert why it is that every time the rate of inflation goes down one point we get 1 million unemployed? We do not understand why that is, and it is no good trying to convince us that it means anything at all.

My Lords, a lot of things are not connected, and the unfortunate fact is that excessive wage increases lead to unemployment as people price themselves out of jobs. The present level of unemployment is due partly to the world recession; it is also due to the exceptionally high level of wage settlements last year. Therefore it is a matter of particular encouragement that the figures released this morning show a sharp reduction in the rate of increase of earnings.

My Lords, if the underlying trends are so encouraging, as the noble Lord pointed out, can he say why there has been no further reduction in the interest rate?

My Lords, the noble Lord is always, very rightly, greatly concerned about the rate of interest. We share his concern. There have been two reductions in the minimum lending rate and we look forward to further reductions as the economic conditions improve.

My Lords, are the Government satisfied that their present attitude is in strict accordance with the doctrines promulgated by that great guru, Dr. Friedman?

My Lords, I am quite certain that the noble Lord is a great expert on gurus in the economic field and elsewhere. We always pay great attention to views expressed by distinguished people in the academic field, but it does not follow that we necessarily slavishly follow them in every respect.

My Lords, would the noble Lord agree, after his experience of the last 18 months, that every Government have to spend their way out of a depression? The only choice they have is whether they spend it on unemployment benefit or on aids to industry and thus increase the supply of goods and services.

No, my Lords, I do not agree with that proposition. It is of course true that in a period of recession expenditure tends to rise and revenue tends to fall, with the result that one has an increase in the public sector borrowing requirement over the desired long-term trend. That is precisely what has happened in the last few months.

My Lords, does the noble Lord attribute the welcome reduction of inflation, which he mentioned, to a reduction in the growth of money supply in the last year of the Labour Government, which is only just two years ago, or if not, why not?

No, my Lords, we do not adhere to a mechanistic view that there is a precise two-year time lag between changes in the money supply and changes in the rate of inflation. That again I have made clear in a number of speeches that I have delivered; I would suggest that the noble Lord should read them again.

My Lords, may we ask the noble Lord whether he is aware that the greatest time lag of all is that between Government promises and their fulfilment?

No, my Lords, that is not so. The Government are already succeeding in improving the underlying state of the economy, and as time goes by we shall put the economy on a sound footing, which has not been so for many years past.

My Lords, I think the House will agree that it has (a) had a good run and (b) had some good answers, and perhaps we should move on.