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The myth that money supply controls inflation is being revived. Here’s how it failed its most ardent believer–Margaret Thatcher

The myth that money supply controls inflation is being revived. Here’s how it failed its most ardent believer–Margaret Thatcher


After a decade of unsatisfactory leadership and economic and political turbulence, Britons will soon be heading to the polls to elect a new government. Although, for many, Margaret Thatcher remains a divisive figure, others are looking back with nostalgia at her character and at her achievements as prime minister in the 1980s.

Even Keir Starmer, the leader of the opposition Labour Party and clear favorite to be the U.K.’s next prime minister, has praised her for effecting “meaningful change,” and for having “set loose our natural entrepreneurialism.” David Lammy, likely to be foreign secretary in a Labour government, has called Thatcher a “visionary leader.”

What no one has been paying homage to is the big policy mistake she made at the start of her premiership: her attempt to apply the theory of monetarism in order to bring down inflation.

The influence of Milton Friedman’s monetarism

For Thatcher, inflation was both a moral and an economic issue. During her years as leader of the Tory opposition in the late 1970s, she and her inner circle had become convinced that the “orthodox” Keynesian policy of trying to regulate output and employment and tackling inflation through changes in taxes and public spending was no longer working–and that it had actually been responsible for the upward march of inflation since the 1950s. Furthermore, she had no faith in the statutory or voluntary arrangements for limiting pay and prices of the kind that Labour and Tory governments had attempted over the previous two decades.

In 1979, the year she came to power, inflation was running at 13%. Bringing the inflation rate down was her number one priority—and monetarism as advocated by Milton Friedman in Chicago seemed to her to be the obvious and common-sense answer.

For Friedman, inflation was always and everywhere a monetary phenomenon. It was caused by the money supply increasing too fast. The only way, therefore, to curb inflation was to curb the growth of the money supply; and this could be achieved, he argued, with only minimal effect on output and employment. Friedman’s study of inflation in the U.S. going back nearly 100 years, and his later study of inflation in the U.K., purported to show a close correlation between monetary growth and prices over long periods of time—which in his view proved his theory.

In fact, it did no such thing. Leading critics in the U.S. and the U.K.–such as Paul Samuelson at MIT, James…

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