The UK Monetarist Experiment

The UK Monetarist Experiment
Author(s): P. Arestis
Source: Journal of Public Policy, Vol. 4, No. 1 (Feb., 1984), pp. 39-56
Published by: Cambridge University Press
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Jnl Publ. Pol., 4, I, 39-56
The UK Monetarist Experiment
P. AREST IS* Economics Division

Thames Polytechnic
ABSTRACT
The paper argues that the monetarist 'experiment' of the first Thatcher
government in Britain ( I979-83) has been unsuccessful. Alternative
monetarist philosophies and their specific application to Britain are
outlined. These propositions are then re-examined in the light of the
actual experience of economic policy in Britain, and are found to be
inadequate. Inflation in Britain has come down, but ironically after a
period when money supply grew quickly - well above the government's
target ranges. Unemployment has also risen much more severely than
monetarists predicted. 'Monetarism' in Britain can be interpreted less in
terms of theoretical and empirical economic analysis as in terms of value
judgements about the size of the public sector and about paying a high
cost in unemployment to stabilise prices.
'Milton thou should'st be living at this hour

England hath need of such a one as thee . . .'
(from Lines written upon Westminster Bridge,
by W. Wordsworth)
i. Introduction
The purpose of this paper is to argue that the monetarist 'experiment' of

the first Thatcher government (1979-83) has been unsuccessful. This is
so, we argue, since the results of the experiment indicate quite clearly the
failure of monetarism as a consistent body of doctrine able to provide a
framework for a coherent economic policy. It is true to say, though, that
monetarism has been successful at a different level: it has helped to a very
large extent to undermine Keynesian orthodoxy and policies (Artis and
Bladen-Hovell, I983). This has been particularly so in view of the Lucas
( 976) attack on the orthodox Keynesian macroeconometric methods of
evaluating policies via large-scale econometric models (the critique being
that the estimated coefficients of such a model are not policy-invariant).
* I am grateful to C. Driver, G. Koolman,J. Harrison, E. Karakitsos, B. Moore and R. Morgan for

helpful suggestions and comments on an earlier draft of this paper. The usual disclaimer applies.
40 P. Arestis
Also, monetarism in the UK has emphasised the importance of the

'supply-side' effects of fiscal policy; orthodox Keynesianism has been
mainly concerned with fiscal policy as a means of regulating aggregate
effective demand. However, in as much as no convincing alternative(s) to
Keynesian policies has been proved successful the monetarist 'experi-
ment' in the UK would have to be considered a closed chapter.
We will first of all attempt to identify monetarism in general and its
relationship to 'UK monetarism' in particular and secondly, to assess UK
monetarism as it was applied during the period under investigation. We
argue that monetarism as it has been applied in the UK is of the
Friedmanite kind and that its failure was inevitable given that most of the
'monetarist' propositions are based on very weak theoretical premises.
2. The monetarist economic philosophy
The core of the economic philosophy of monetarism is basically that of

laissez-faire economics as it is epitomised in the famous Walrasian general
equilibrium model. The model asserts that 'market forces', in the absence
of government interference, ensure that a capitalist economic system
would always come to rest at full employment with deviations from it
being temporary and self-correcting. This means, of course, that markets
behave like general equilibrium 'Walrasian markets' in that there is
perfect competition, complete flexibility of wages and prices in both
directions, with all markets assumed to 'clear' at positive prices and the
denial of the possibility of involuntary unemployment as an equilibrium
phenomenon. It also means that there is a dichotomy between the real
and monetary sectors of the economy, with relative prices being
determined in the former, whilst the latter is concerned with the
determination of the absolute price level within a quantity of money
theoretic framework. The state protects the economic foundations of such
a system; however, any overt state intervention in the economy or exercise
of trade union power is condemned as causing rigidities in the system and,
therefore, as a source of all disequilibrium phenomena. It is, then, not
surprising that monetarists take the view that active stabilisation policy
causes more fluctuations than it cures and is not likely to be beneficial; the
monetarist policy prescription is therefore for only limited non-discretion-
ary government intervention (Friedman, I960, 4).'
Monetarist thinking may be rationalised as follows: the effects of
monetary policy are felt only after a long and variable time lag, and
therefore the use of discretionary monetary policy, although intended to
be stabilising, is likely to be destabilising. Indeed Friedman argues that
this is precisely what has happened in the case of the UK economy - and
other economies too - where every major instability has been produced
The UK Monetarist Experiment 41
and intensified by monetary instability arising from government interven-

tion. In fact all inflations and depressions are seen as the result of failure
by governments to provide a stable monetary framework. Thus Fried-
man, and other monetarists, believe that every major depression in
history resulted from an absolute decline in the money supply and that
every inflation was the result of excessive expansion of the money supply.
Hence, the use of discretionary anti-cyclical monetary policy increases
instead of dampens the cyclical behaviour of the economy.
These economists argue that the economy is inherently stable if left to
its own devices and not necessarily subject to recurring periods of severe
recession and inflation.2 Destabilising shocks in the economy are not
caused by instability in the behaviour of the private sector, e.g. by
autonomous changes in private investment, but by instability in the
application of monetary policy. For while monetarists insist upon a stable
demand for money, they assume at the same time an unstable supply of
money. The private sector is then stable because its demand for money is
stable with most observed instability being caused by changes in the
money supply, themselves induced by the behaviour of the monetary
authorities. Thus, the main factors that explain fluctuations in economic
activity are monetary rather than real impulses (see Mayer, I978, for
more details).
In this latter respect, the monetary approach to the balance of pay-
ments (chiefly Johnson and Frenkel, I975) can be thought of as an
extension of monetarism to the international sphere. The spirit of the
approach is that the balance of payments is essentially a monetary
phenomenon in which the central feature is the relationship between
demand for and supply of money. A persistent balance of payments
disequilibrium in a fixed exchange rate system, is caused by discrepancies
between actual and desired money balances which can be due only to
faulty monetary policy and cannot be remedied by adjusting the country's
exchange rate or by tariffs since these policies can only have a transitory
effect.3 At the heart of this approach is the assumption of a stable demand
for money; in fact, the monetary approach would be absolutely irrelevant
to balance of payments theory without it (Mussa, 1974). With a stable
demand-for-money function, the theory postulates that exchange rate
movements in a flexible exchange rate system can be ascertained from the
Purchasing Power Parity, the other central assumption of this approach.
It follows that, for the monetarists, the obvious way of preventing major
instability in the economy is to adopt a monetary policy that avoids sharp
swings between monetary ease and restraint. The best way to do this is to
abolish discretionary monetary policy and adopt a simple rule. Indeed,
the stock of money is the only relevant magnitude in terms of which to
formulate monetary rules, the simplest being one that dictates a constant
42 P. Arestis
rate of increase of the money supply. To monetarists, the precise rate is

not as crucial as its constancy, for the theoretical validity of a monetary
rule stems from the principle that the economy is basically stable.
As well as asserting the destabilising nature of discretionary monetary
policy, the monetarists have also attempted to demonstrate the efficiency
and impotency of pure fiscal policy (i.e. changes in government
expenditure and taxation which do not affect the money supply).4 This
manifests itself in the monetarists' belief in 'crowding-out'; this belief is of
course closely related to the monetarists' 'dislike of government interven-
tion'.5 It is postulated that a change in government spending financed by
either borrowing or taxes has only a negligible effect on GNP over a period
of about a year. It is asserted that expansionary fiscal actions have an
initial positive effect which is followed in later quarters by an approx-
imately off-setting negative effect. 'Crowding-out', therefore, occurs
within a very short time period. This proposition is consistent with
Friedman's assertion that an 'expansionary' fiscal action might first be
reflected in a rise in output but the financing of the deficit would set in
motion contractionary forces which would eventually offset the initial
stimulative effect (Friedman, I972, 9 I 7).
Indeed, the 'crowding-out' thesis is an important aspect of another
feature of monetarism; namely, the distinction between flows and stocks
and the contention that long-run positions are ultimately determined by
stocks, particularly the stock of money - not by flows. While in the short-
run stocks and flows interact, in the longer run flows do adjust to stocks
(Brunner and Meltzer, I976a; Brunner and Meltzer, I976b). It therefore
follows that flow changes arising independently of stock changes have no
lasting effects on economic variables. Most importantly, changes in
government expenditure unaccompanied by changes in the stock of
money are considered to be flow changes which have no lasting effects.
Thus, for the monetarists, complete 'crowding-out' prevails.
In terms of unemployment, the monetarist philosophy espouses the
'natural rate' hypothesis which, quite simply, stipulates that there is no
long-run stable trade-off between inflation and unemployment (for a good
review see Santomero and Seater, I978). An important policy implication
is that inflationary policies which attempt to reduce unemployment below
the 'natural rate' will be accompanied by accelerating inflation and
continuous disequilibrium. In the end unemployment will revert back to
its 'natural rate' with the inflationary pressures being sustained.
Whereas this hypothesis accepts the possibility of a short-run Phillips
curve, but not a long-run one, there exists a more 'radical' monetarist
group, the so-called 'New Classical' or 'rational expectations' school, that
flatly denies the existence of both a short-run and a long-run Phillips
curve.6 This school also supports the view that the economy is inherently
stable, unless of course governments interfere with the normal working of

the economic system. Even in the unlikely event of there being a small
residual instability, this would be beyond the power of human beings, let
alone the government to do anything about it. The school of thought
which really constitutes 'the apotheosis of monetarism' makes two further
important assumptions: first, as with classical economists prices are
flexible; second, expectations are emphasised and are assumed to be
formed 'rationally'. 'Rational expectations' is essentially an assumption
about the behaviour of economic agents in that they, when making
economic decisions, take into consideration all available information,7
including information about government policies, and more importantly
use this information so as not to repeat their previous errors. Thus,
economic agents are supposed not to make systematic errors in terms of
their perceptions as to how the economy works and as to the impact of
policies. The implication of this assumption in terms of policy issues is
that 'business cycles' are part of a properly working market economy and
that cyclical swings in production and employment are inherent in the
micro-level processes of the economy that no government macropolicies
can, or should attempt to, smooth out.
With flexible prices, rational expectations and credible policies, the
rate of inflation equals the excess of the rate of growth of the money supply
over the rate of growth of real output in both the short-run and long-run.
Furthermore, since real output is determined by the real 'supply side'
factors of the economy, the way to reduce inflation quickly and without
side effects on the real sector is for the monetary authorities to reduce the
rate of growth of the money supply and to announce their determination
to stick to their policies. It would also require that fiscal policy is
consistent with monetary policy. A floating exchange rate is considered to
be one flexible nominal price which is also determined by monetary
forces. A clear proposition of all these, then, is that monetary policy does
not affect the real part of the economy; it only affects money prices.
Monetary policy can have an impact on the real economy only when it is
initiated and implemented unpredictably so that it surprises economic
agents. It is, thus, the case for the 'New Classical' school that, to the extent
that monetary policy is announced early, predictably and convincingly
enough and the monetary authorities stick to their plans, there would be
quick and powerful effects on prices but not on real magnitudes such as
output and employment.
There are, of course, differences between Friedman's 'monetarism' and
the 'New Classical' type of monetarism. These differences are spelt out by
the Treasury and Civil Service Committee (HMSO, I98I) and can be
summarised, quite succinctly, as follows: The 'New Classical' economists
argue for 'instant' monetarist policies while Friedman argues for gradu-
44 P. Arestis
ally declining monetary growth rates - it is for this reason that this type of
monetarism has been labelled 'the gradualist approach' (Laidler, I980).
Perhaps more importantly, though, they differ on the response of prices to
monetary impulses. The 'New Classical' school believes in instantaneous
price adjustment while the 'gradualists' accept that prices may take some
time to adjust to changes in the money supply. They, thus, accept the
possibility of changes in the money supply having an impact on output
and employment. But 'ultimately' the impact must be on prices (Laidler,
I980, I58). Clearly, it is for this reason that they accept a 'gradual'
reduction in the money stock to fight inflation. Similar differences prevail
in the case of 'inflation expectations'. Expectations about inflation can
only change once prices themselves have slowed down in the Friedman
tradition (the very well known adaptive expectations), whereas the
announcing of the intention to reduce the growth of money stock is enough
to cause expectations to change in the 'New Classical' tradition. These
differences, however, are a matter of degree. For ultimately the two types
of monetarism do belong to the Walrasian general equilibrium model;
and both adopt the assumptions enumerated at the beginning of this
section which form the basis of laissez-faire economics.
Along with these theoretical developments, there have been attempts at
empirical verification. One of the first is the Friedman and Meiselman
(i 963) paper where they claim to show that monetary policy is quicker in
its effects and more reliable than fiscal policy. Andersen and Jordan
(1 968) - see also Keran (i 969, I 970) - took the debate one step further by
purporting to have empirically verified the 'crowding out' thesis.8 Fur-
thermore, Friedman and Friedman ( I980) claim that the central proposi-
tion of monetarism, that every observed inflation has always been the
result of monetary phenomena, has comprehensive and universal empiri-
cal support. The 'rational expectations hypothesis' has also received
empirical backing, especially so in studies concerned with price deter-
mination in financial markets (Sargent, 1976 is a very good example in
this context). This hypothesis has also been embodied in some economy-
wide econometric models (Minford, I 980a is an early example).
However, Desai (i 98 I) wonders whether the new classical macro-econo-
mists have in fact managed to produce such a convincing and satisfactory
estimated model of the business cycle. Furthermore, the one proposition
that has failed to receive any empirical support whatsoever is the
Purchasing Power Parity assumption. This is clearly stated by Frenkel
(i98I) who concedes that the Purchasing Power Parity doctrine has a
dismal performance during the I970s; Desai (I98I, 200) arrives at a
similar conclusion when surveying the empirical evidence of the monetar-
ist claims. The same author doubts, in addition, the empirical validity of
Walras' theory and also the contention that commodity and labour
markets function with the rapidity and flexibility assumed by the neo-
classical general equilibrium theory.
It is of paramount importance to note at this stage that one significant
postulate in the monetarist thinking is the close link between money and
prices. Such a close link may very well exist. But the crucial question is the
direction of causality. Do increases in the money supply cause inflation, as
the monetarists claim? Or, do changes in inflation cause changes in the
money supply, as most economists suggest? Monetarists insist that they
have shown, statistically, that increases in the inflation rate are preceeded
by increases in the money supply. For them this proves that causation
runs from money supply to prices. They have also argued that this process
operates especially strongly in the UK. But one cannot establish causality
by statistical associations alone.
To illustrate, let it be assumed that business people expect an upturn in
sales. They will install new equipment and expand inventories. To do so
they increase their borrowing. Faced with increased orders, suppliers of
machinery behave in a similar way. This increase in economic activity can
generate higher prices. Providing the monetary authorities make extra
finance available, then there will be a close statistical relationship
between changes in the money supply and in inflation. A similar relation-
ship would be established if the monetary authorities did not make the
required extra finance available. In this case interest rates will rise and to
the extent that businessmen manage to obtain the required finance, at
higher interest rates, an increase in the money supply will again ensue.
But the monetary authorities usually pursue policies to minimise changes
in interest rates because they believe large swings cause chaos; they, thus,
operate to maintain orderly conditions in the bond markets and stabilise
market interest rates. In fact, orderly markets are necessary if financial
assets are to possess liquidity and it is for this very reason that violent
fluctuations in their prices are usually avoided. So the extra finance is
generally forthcoming. Quite clearly, then, business decisions have
caused the change in both money supply and prices.
The causality question is probably one of the most important issues in
economics; at the same time one could justifiably argue that no little
confusion prevails over the causal interpretation of economic relation-
ships. A number of economic studies have attempted to deal with the
concept of causality, and various econometric techniques have been
developed and applied which aim to throw some light on this issue. The
causality between money supply and inflation in the case of the UK
economy has been investigated in this way, but the evidence gathered
from these studies is by no means conclusive. However, this body of
evidence does show that the claim that changes in the money supply cause
changes in prices cannot be sustained (for a survey and some evidence see,
46 P. Arestis
Arestis and Hadjimatheou, I 98 I). In fact, Hendry (i 980) has pointed out
that past accumulation of rainfall provides a better statistical 'explana-
tion' of inflation than changes in the money supply!
3. Monetarism in the UK
Monetarism in the UK is based on the same economic philosophy as

discussed above.9 It is asserted:
(i) that money supply changes are the dominant cause of inflation; so
monetary targets have been announced for each year since 1979.10 In
fact, monetary targets have been set out over a period of years ahead in the
so-called medium-term financial strategy (MTFS) laid down in March
I 980. The aim of the MTFS was to integrate fiscal and monetary policies
in the following way: inflation was to be controlled by restrictive monetary
policies (through monetary targetry on sterling M3 as mentioned above)
without relying on interest rates really, but, instead, through the Public
Sector Borrowing Requirement (PSBR)"I - the MTFS did impose
targets on PSBR as well. Thus, fiscal policy became subordinate to the
needs of monetary policy with no role at all assigned to fiscal policy for
stabilising output and employment. Furthermore, the public announce-
ment of the MTFS was expected to have a 'rational expectations' effect as
well, in that the announcement and, perhaps more importantly, the
determination to stick to the targets signals to economic agents future
reductions in prices which are immediately discounted, so that a quick
downward pressure on prices materialises.12 Inflation has been the
government's overriding objective of economic policy;'3 this was stated
very clearly in the Queen's Speech on I5 May I979: 'Government will
give priority in economic policy to controlling inflation through the
pursuit of firm monetary and fiscal policies'. Presumably this concern
arises from the fact that inflation is 'a disease, a dangerous and sometimes
fatal disease, a disease that if not checked in time can destroy a society'
(Friedman and Friedman, I980, 298). StJohn-Stevas (I982, 4) has also
argued that inflation is 'a deadly threat to our well being, our institutions
and our mode of life itself'.
(ii) that there is no stable trade-off between inflation and unemploy-
ment; in the long-run particularly, unemployment is independent of the
rate of inflation and is fixed at a rate determined by the 'natural rate of
unemployment'. Unemployment is, then, considered to be wholly 'volun-
tary' and would disappear if only everyone accepted a 'realistic' wage.
For, according to the then Chancellor, Sir Geoffry Howe, 'Pay settlements
must be based upon what companies can afford while remaining competi-
tive ... 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'. (Budget Statement, Hansard,

March I980).
(iii) that there is 'crowding out' of private expenditures, and as the
Chancellor has put it, 'Government borrowing has made a major con-
tribution to the excessive growth of the money supply in recent years. The
consequence of excessive borrowing have been high nominal interest rates
and, in capital markets, the crowding out of business by the State' (Budget
Statement, Hansard, March I980). It is, therefore, asserted that the PSBR
must be reduced, which would help to reduce the money supply'4 and
also contribute towards the lessening of the size of the public sector which
is important to monetarist philosophy as expounded above.'5 It is thus
hoped that a smaller PSBR would mean an expansion of business;
crowding-out is consequently operative in the government's view.
(iv) that the 'supply side' of the economy must be strengthened; this is
important, according to the government, since the unsatisfactory per-
formance of the economy is not due to insufficient demand but to
difficulties emanating from the 'supply side' of the economy. Thus by
'reducing the burden of direct taxation and restricting the claims of the
public sector on the nation's resources' 'supply side' policies 'will start to
restore incentives, encourage efficiency and create a climate in which
commerce and industry can flourish. In this way they will lay a secure
basis for investment, productivity and increased employment in all parts
of the United Kingdom' (Queen's Speech, I 5 May I979). Anti-inflation-
ary policies are, therefore, expected to enhance production by making
British products more competitive and by restoring profitability; reduc-
tion in taxes will improve industrial performance while policies aiming at
increasing incentives to work will help towards reducing unemployment.
In the interim, though, it is conceded that 'we will have to go through a
period of high unemployment' (StJohn-Stevas, I982, 5).
We may summarise by saying that, ultimately, monetarism encapsu-
lates current conservative economic theory and policy; for it relies on
monetary controls to conquer inflation, creating unemployment and
depressing real wages if necessary. Anti-inflationary policies are expected
to remove inefficiencies from the economic system, thus improving
productivity and enhancing competitiveness. At the same time policies
directed at the labour market especially are designed to eliminate rigidi-
ties so that the rate of wage settlements would be determined by market
forces. The operation of the latter is to be assisted by fiscal measures such
as reducing the rate of direct taxation and the volume of government
expenditure; it is thus hoped that these measures would favourably affect
the supply side of the economy. In this way it would not be an exaggera-
tion to say that what is being attempted in the UK is the creation of con-
ditions reminiscent of those that prevailed before I9I4.
48 P. Arestis
4. The defects of UK monetarist economic philosophy
We begin this section with the alleged success of monetarist policies in

lowering the inflation rate. It is, surely, the case that according to the
monetarist principles (as expounded above, especially the time lag
between changes in the money supply and subsequent changes in infla-
tion) the rate of inflation in the UK should now be increasing not
decreasing. This must be particularly embarrassing for the UK monetar-
ists, and Friedman, since it is difficult to explain the fall in the inflation
rate in I982 and I983 when the growth of sterling M3 in I980 was well
over 20% (and in 1979 not very far from it) despite the target for this
variable being 7%-I i%! Even worse for the monetarists, the available
evidence shows that the time lag of up to two years referred to usually (e.g.
Laidler, I980) cannot be established for other countries either. For
example, Kaldor (1 982, table VII, p. 85) has shown that this lag does not
exist in the case of ten industrialised countries.
Another problem here relates to the monetarist postulate that an
increase in the money supply will temporarily affect output and employ-
ment and eventually inflation. The proposition does amount to saying, of
course, that a stable 'demand for money' exists with respect to variables
such as prices, income and interest rates. Surely though, after the
economic upheaval of the early I970S the stability of the 'demand for
money', in conjunction with many other 'established' economic relation-
ships, is very much in doubt. Laidler (I98I) points to the evidence
gathered in the I970S to suggest that the relationship shifted unpredict-
ably in a number of countries, let alone in the UK. Desai (I98I, 192-3)
argues along similar, but stronger, lines: 'For the present we may
conclude that the velocity of circulation is not stable . .. the demand for
money function has either not shown stability . . ., or, if stable, has
nonmonetarist features such as the nonconstancy of ... the income
velocity'.
An interesting critique of the monetarist position is the contribution by
Buiter and Miller (I98I). It concentrates on the channels of monetary
policy and its ultimate impact on real variables such as output and
unemployment, which is thought to be much stronger than the impact
hypothesised by the 'gradualist' strand of monetarism. In terms of the
channels of monetary policy their argument is that the impact of changes
in the money supply is not directly related to changes in prices, as the
monetarists claim, but through the exchange rate. In an economy, like the
UK, of freely floating exchange rates and high degree of capital mobility,
restrictive monetary policies result in an immediate appreciation of the
exchange rate. This comes about since a decrease in the money stock
results in higher interest rates and with foreign rates given, the exchange
rate appreciates - for it is postulated that exchange rates are determined

by interest rate differentials. An important assumption made by Buiter
and Miller is that the domestic labour market is at disequilibrium with the
behaviour of money wages dominated by inertia. As a result a significant
loss of competitiveness ensues which induces a recession in output and
employment (Buiter and Miller, I981, 33I, table 4).16 The trouble with
this analysis is that the determinants of the exchange rate cannot be just
monetary variables. There is simply not enough evidence to sustain this
particular postulate of the Buiter-Miller argument. At the same time,
there are theoretical arguments which suggest that other factors, such as
the strength of the real sector of the economy, economic performance as
the speculators see it, North Sea Oil etc., may be more important than the
monetary variables in determining the sterling exchange rate.
It appears, then, that the UK rate of inflation is not determined by the
rate of growth of the money supply. What, then, does cause inflation? The
view held here is that although inflation is precipitated by different things
at different times, inflationary pressures are sustained mainly by the
struggle over income distribution between firms, trade unions and the
government. When any group presses for a higher share it is likely to spark
off a wage-price spiral (similarly, a downward pressure is exerted on the
spiral when any group is forced to accept a lower rate of increase in its
share). In this analysis the role that money can play is simply to validate
inflationary pressures. Clearly, a refusal by the monetary authorities to
allow the money supply to adapt fully to other exogenous inflationary
influences must eventually bring inflation under control. In this sense
increases in money supply can be thought of as being a necessary
condition for inflation; not a sufficient condition as in the monetarist case.
But even in this case one cannot forget the Radcliffe argument that control
of the money supply may not even be a necessary condition for controlling
inflation since economic units, when faced with lower real money
balances, would simply turn to using other assets as money.
What seems to have happened recently in the UK is: (i) a lower rate of
increase of money wages due to the rapid rise in unemployment, (ii) lower
costs of imported raw materials because of depressed world markets and
especially so because of the high exchange rate, and (iii) compressed
profit margins in both manufacturing and distribution as a result of the
'monetarist' policies. What is more, though, is that the government have
on a number of occasions accepted these propositions, however surprising
this may seem. The high exchange rate and the government's persistence
on maintaining an overvalued pound, as well as ministerial pronounce-
ments about the necessity of a short-term squeeze in profit margins,justify
this claim. More importantly, the insistence on moderate pay settlements
and the proposed measures introduced to weaken the workers' bargaining
50 P. Arestis
position, such as the Employment Acts, imply that the government is

attempting to weaken the unions and therefore induce workers to accept
lower real wages, a policy which has been reinforced by the sharp rise in
unemployment. Clearly, though, this constitutes an open admission of the
inconsistency of monetary policies. For since the government have
accepted that pressures on prices are due to workers' demands for
inflationary wage demands, the proposition that a slow and steady rate of
monetary growth puts downward pressure on prices is severely weakened.
On the question of 'crowding-out', it is clear from both theory and the
available empirical evidence that complete crowding out does not occur
(Arestis, I982). In the latter study it is further argued that fiscal policy
matters, indeed it matters a great deal, for even if crowding out was
complete, or even over-complete, fiscal policy would still be important.
Desai (I98I) is also very categorical on the question of the effect of fiscal
policy when he concludes that fiscal policy does have considerable impact
on real variables such as output and employment. Further evidence
comes from more recent experience. Fiscal policy has been deflationary in
the UK over the period since 1979, so much so, in fact, that it has been
asserted that it is far more deflationary than at any time since the war
(Ward, I982) and that it bears tremendous similarities with the onset of
the Great Depression (Buiter and Miller, I98I, figure I). Notwithstand-
ing the argument that the current depression may be due to other factors,
the deflationary character of fiscal policy must have contributed a lot to it.
This is clearly contrary to the crowding out thesis of monetarists, who
would argue that contractionary fiscal policy should not result in lower
output! Additionally, on the assumption that the level of economic
activity varies with effective demand, savings available for investment are
positively associated with the PSBR and not negatively as monetarists
would argue. It, therefore, follows that not only do we not have crowding
out, but indeed, the possibility of 'crowding in' could very well arise.
On the 'supply side' aspects of the 'monetarist' policies the argument
has been put forward (Kaldor, I982, for example) that given the amount
of unutilised and underutilised capacity in the economy what is required
is expansion of demand (the opposite to what the government have been
arguing for some time now). Experience has shown, though, that such
stimulation of demand would result in imports soaring, which could well
imply reversal of the initial policies before the latter start bearing any
fruits; and inflationary pressures may very well set in, in spite of unutilised
and underutilised capacity. Nevertheless, this should present no prob-
lems to the authorities since 'import controls' could always be imposed
(Godley, 1979), while inflation could be tackled through an 'incomes
policy'. The success of the latter will be enhanced to a very large extent if it
entails compensation to workers in the form of 'profit sharing' (Arestis
and Driver, 1983; Wood, 1975). But even in these circumstances there is
no guarantee that investment will be stimulated; hence a further require-
ment is that all these must be accompanied by 'social control' of
investment (Arestis and Driver, I 983).
Validation of the UK 'monetarist policies of the present government
rests upon three additional and important issues:
First, there is the question of the controllability of the money supply. It
must be quite obvious that ever since I976 attempts to control the money
supply in the UK have met with continuous frustration and embarrass-
ment on the part of the authorities and the proponents of monetarism; it is
also true that control of the money supply has been so difficult as to render
it impossible. This should come as no surprise since the money stock is not
a control variable; changes in the money stock are, in fact, 'credit-driven'
(Moore, I979). In this view the Bank of England can only directly
influence short-term interest rates, and that within limits defined by the
openness of the economy, the level of foreign interest rates, and balance of
payments and exchange rate considerations; but not the money stock.
Table i makes the point quite convincingly.
TABLE I: UK monetary targets and outcome
Annual percentage
growth
Date ?M3 ?M3
announced Period Target range Out-turn Error
Dec 1976 Apr I976-Apr I977 9-13 7.7 -I 3

Mar 1977 Apr I977-Apr 1978 9-13 i6.o +3.0
Apr I978 Apr 1978-Apr 1979 8-12 10.9 -
Nov I978 Oct 1978-Oct 1979 8-I2 13-3 +1.3
June 1979 June I979-Apr ig80 7-Il 10.3 -
Nov 1979 June 1979-Oct 1980 7-lI 17.8 +6.8
Mar ig80 Feb Ig8o-Apr Ig8I 7-II 22.2 + 11.2
Mar i981 Feb 198i-Apr I982 6-io I3.5 +3.5
Mar I 982 Feb I 982-Apr 1983 8-12 12.7 +0.7
Source: Adapted from Financial Times, 9 April I982; completed by referring to Bank of England,
Quarterly Bulletin, latest issues.
Ever since I 976 most of the official targets on sterling M3 (iM3) have
been exceeded. Yet inflation has been reduced, the real exchange rate for
sterling has reached absurd heights and unemployment has reached a
level which even the unbelievably pessimistic conservative forecasters
would not have dared to predict in May I979. Regardless of the money
supply figures it is true to say that monetary policy has been tight given
the behaviour of the narrower monetary aggregates and the high interest
rates and exchange rate that have prevailed over the 'monetarist' period
in the UK (Ward, I982, 5I8-i9; Buiter and Miller, 198I, 342-9). This
52 P. Arestis
weakens severely the monetarist proposition that the best indicator of

monetary policy is 'money supply' or some monetary aggregate and
supports the Keynesian contention that more appropriate indicators of
monetary policy are interest rates and exchange rates. This comment is
particularly relevant in view of the Buiter-Miller (I98I) contribution
(summarised above) on the way and the channels through which monet-
ary policy may have worked over the period under investigation. Fur-
thermore, there is the problem of the appropriate definition of the 'money
supply'; this problem is epitomised in what has come to be known as the
'Goodhart Law', that 'any observed statistical regularity will tend to
collapse once pressure is placed upon it for control purposes' (Goodhart,
198I, I I6).
Second, there is the cost of present policies in terms of unemployment
and loss of production; Artis and Bladen-Hovell (1983) have shown that
the recession experienced in the first Thatcher period is due for the better
part to monetarist policies pursued during this period. Even if the target of
bringing down inflation is eventually achieved, it should by now be quite
clear that the final cost will be very high both in absolute terms and in
terms of the cost associated with an alternative strategy. One cannot but
remind the monetarist camp of their predictions in relation to this
particular problem. Friedman's (I980, 6i) answer to a relevant question
was 'I conclude that (a) only a modest reduction in ouput and employ-
ment will be a side effect of reducing inflation to single figures by I 982 and
(b) the effect on investment and the potential for future growth will be
highly favourable'. Minford (i98ob, 17) was as optimistic: 'The objec-
tives of the present government do not in any view imply any likelihood of
a return to prewar conditions of unemployment'.
Third, one wonders just how monetarists support their typical state-
ment that 'If monetary growth is held in check in the UK and by gradual
steps reduced further, the economic recovery will gather momentum,
unemployment will begin to decrease and inflation will fall further.' By
what magical mechanisms would unemployment decrease and inflation
fall further if the money supply is further reduced? If anything, these types
of policies would imply a higher exchange rate and higher interest rates,
thus making competition for the industrial sector exceptionally difficult,
resulting in more losses in output and export markets. Thus depression
will deepen not stop. Desai (1 98 I, ch. 5) offers some evidence to show that,
in fact, reliance on further reductions in the money supply could only
mean higher unemployment. A related but even more crucial problem is
that monetarists have not spelt out clearly how unemployment, having
reached high levels, would be reduced to acceptably low levels without
causing a recurrence of inflation and/or balance of payments difficulties.
The recent fall in the rate of inflation does not mean that inflation has been
'cured'. For there is no guarantee that prices will not start rising again
when unemployment starts falling, given that wages constitute the largest
element in costs and that there is no way of predicting the behaviour of
wages once the upturn begins. There is also the argument expounded by
Desai (I98I) that the Phillips curve may have not been refuted since
empirical evidence is lacking either for the absence of money illusion (in
the adaptive-expectations hypothesis) or in the case of 'rational expec-
tations' for the 'natural rate' assumption.
5. Conclusions
One cannot but conclude that monetarism stems far less from theoretical
and empirical considerations than from value judgements in terms of
minimising the public sector and for paying a high cost in unemployment
to stabilise prices. And one cannot but agree with Keynes (I925) who
remarked that monetarism 'is simply a campaign against the standard of
life of the working classes' necessitating 'deliberate intensification of
unemployment . . . a policy which the country would never permit if it
knew what was being done'.'7 One, however, can go further than Keynes
and argue that the severe deflation propounded by monetarists to cure
inflation, aims at weakening workers' bargaining power by resorting to
the fear of redundancies and closures. This, it is hoped, will remove
inefficiencies and, therefore, increase productivity and improve com-
petitiveness, which, then, will favourably effect the conditions for capital
accumulation. Monetarism can, thus be seen as working from capital's
perspective.
NOTES
i. Desai (I98I, chs. I and 2) offers a lucid account of the evolution of 'monetarism'.
2. The hypothesis about the stability of the private sector is accepted by all monetarists; see, for
example, Friedman (I968), Laidler (1976), and Brunner and Meltzer (I976a).
3. The proponents of this approach would, therefore, put the blame on the USA government for the
worldwide inflationary pressures in the 1970S which are seen as the result of increases in the world
money supply caused by excessive increases in the USA money supply. For an early critical look at
the monetary approach to the balance of payments see Currie (1976).
4. There is, however, a 'brand' of monetarism, due to Brunner and Meltzer (their I976a study is a
good representative of their views), which recognises that budget deficits can have an influence on
output and the price level. This 'brand' of monetarism has been labelled as 'fiscal monetarism'
(Burton, I982) but it need not concern us in the present study.
5. Indeed, according to Stein (1976) the acceptance or rejection of the 'crowding-out' effect
constitutes a fundamental difference between monetarists and non-monetarists. See also the
papers by Blinder and Solow (973) and Tobin and Buiter (1976).
6. The term 'rational expectations' was first introduced in the literature by Muth (I96I). Its use,
however, to challenge macro-economic policy of the interventionist kind is much more recent. See,
for example, Sargent and Wallace (I976).
7. The 'rational expectations' hypothesis breaks down here since it does not explain how economic
54 P. Arestis
units learn with costly information (Santomero and Seater, 1978) One might also argue that the
real world is more complex, indeed less perfect than the theoretical world of the 'rational
expectations' examples.
8. Since then a lively discussion has developed and a considerable number of publications ensued.
For a relevant survey of the literature see Arestis (1982). An interesting implication of all these
studies is the question of 'large versus small econometric models' and 'structural versus reduced
form estimation' (Desai, I98I, 6).
9. Burton (i982) argues that the UK monetarism possesses characteristics of various 'strands' of
monetarism (he identifies five 'monetarist varieties'). We would agree with this view only to the
extent that these characteristics are orchestrated around Friedman's 'monetarism'.
io. In fact monetary targetry began in the UK in 1976 by D. Healey, the Labour Chancellor. His,
however, was a qualified form of monetarism (see Arestis and Hadjimatheou (i 980, 19-2 I) for
more details on this point).
i i. It is important to note here that the variable utilised for targetting purposes is sterling M3 and not
a narrower monetary variable such as Mi. The apparent reason for a broad definition is that
sterling M3 is linked directly to the level of government borrowing and financing, to the level of
bank lending to the private sector and to external monetary flows (Fforde, i983).
12. The argument has been put forward that the downward pressure on prices is not so much
influenced by the announcement of monetary targets but by the willingness of the government to
incur significant losses in output and employment to achieve lower inflation rates (Buiter and
Miller, 1981, 367).
13. Hahn (1 981 ) argues that 'bringing down inflation cannot be a top priority', since the monetarist
proposition that inflation retards growth is simply not backed up by either theoretical or empirical
arguments.
14. One should note at this juncture that Friedman and the government depart on this particular
point. Friedman does not believe that there is 'any necessary relation between the size of the PSBR
and monetary growth' (Wickens, I 98 I, I 6). The government's view in this respect is nearer to the
Brunner and Meltzer (I976a) position, in that they have argued that containment of budget
deficits is a necessary condition to the control of monetary growth.
15. Clearly, the squeeze in the size of the public sector hits particularly hard women who are the main
users of the welfare state and primary recipients of the social wage.
i6. The channels of monetary policy and the impact of the latter on unemployment as exemplified by
Buiter and Miller (i 98 I) had already been emphasised by Tobin (see, for example, his evidence to
the Treasury and Civil Service Committee: HMSO, I98I).
I 7. This quotation is from Kaldor (1982, ix). Kaldor holds similar views when he argues that
although the present governmental policies may not be futile, their real effect nevertheless,
'depends on the shrinkage of effective demand brought about through high interest rates, an
overvalued exchange rate, and deflationary fiscal measures (mainly expenditure cuts) and the
consequent diminution in the bargaining strength of labour due to unemployment. Control over
the "money supply" which has in any case been ineffective on the Government's own criteria, is no
more than a convenient smoke-screen providing an ideological justification for such anti-social
measures' (Kaldor, I982, 70).
REFERENCES
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The UK Monetarist Experiment

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The UK Monetarist Experiment

The UK Monetarist Experiment

P. AREST IS* Economics Division

'Milton thou should'st be living at this hour

The purpose of this paper is to argue that the monetarist 'experiment' of

* I am grateful to C. Driver, G. Koolman,J. Harrison, E. Karakitsos, B. Moore and R. Morgan for

Also, monetarism in the UK has emphasised the importance of the

2. The monetarist economic philosophy

The core of the economic philosophy of monetarism is basically that of

and intensified by monetary instability arising from government interven-

rate of increase of the money supply. To monetarists, the precise rate is

stable, unless of course governments interfere with the normal working of

Monetarism in the UK is based on the same economic philosophy as

lost production and reduced employment'. (Budget Statement, Hansard,

4. The defects of UK monetarist economic philosophy

We begin this section with the alleged success of monetarist policies in

rate appreciates - for it is postulated that exchange rates are determined

position, such as the Employment Acts, imply that the government is

TABLE I: UK monetary targets and outcome

Dec 1976 Apr I976-Apr I977 9-13 7.7 -I 3

weakens severely the monetarist proposition that the best indicator of

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