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BBC TwoNewsnight
Last Updated: Tuesday, 14 March 2006, 15:04 GMT
Were 364 economists all wrong?
By Stephanie Flanders
Economics Editor, BBC Newsnight

Cast your mind back to 1981 - what do you remember? Adam Ant? Charles and Di's wedding, maybe? The Brixton riots? Or perhaps you weren't even born.

A "young" Stephanie Flanders

I was 12. And my strongest memory of that year is Geoffrey Howe's third Budget.

"What a sad lonely 12 year old you must have been," I hear you cry. Well, maybe. But trust me, the 1981 budget was pretty memorable.

We were two years into the Thatcher experiment, and so far it wasn't doing very well at all. The government was dedicated to monetarism: controlling the money supply with high interest rates, so as to tame inflation without resorting to union-negotiated pay policies. But so far, all Chancellor Howe had to show for it was the high interest rates, and the pain.

Public borrowing was going through the roof. Inflation was heading toward 20%. Howe had presided over the largest one-year drop in industrial output since 1921. And unemployment had risen by more than a million, to a previously unimaginable 2.5 million. The government hadn't even managed to control the money supply - its number one stated objective.

Anti-inflation policy

Inside Number 10, Sir Alan Walters, Thatcher's American economic advisor, was arguing for another tough budget to give the anti-inflation policy credibility. As Professor Patrick Minford, one of the few committed British monetarists at that time, admits, this was entirely new thinking:

Geoffrey Howe
We saw this borrowing going up and up and concluded we needed to raise taxes still further, and Margaret said at a meeting, 'but we weren't elected to put taxes up!'
Geoffrey Howe
"The traditional Keynesian approach said if you contracted the budget in a recession, you contracted the economy. But," he continues, "that didn't allow for things like credibility... The Walters, and my, thinking was that the boost to credibility would lower long-term interest rates and therefore stimulate the economy."

There weren't many on the monetarist side. Business groups and union leaders were lobbying hard for looser policy, and so were many moderate ("wet") Tory ministers inside the government. Even Treasury officials advising Howe thought the toughest he could possibly achieve would be a "neutral" budget: one that didn't take money out of the economy or put any in.

There were no visible wobbles from either the Prime Minister or her Chancellor. (Thatcher had given her famous "the lady's not for turning" speech at the party conference the previous September.)

But, as Lord Howe told Newsnight, "for Margaret Thatcher and I and the people working closely with us, there were moments of doubt, because we saw this borrowing going up and up and concluded we needed to raise taxes still further. And Margaret said at a meeting, 'but we weren't elected to put taxes up!'"


Thatcher was so nervous of her internal critics, she'd prevented discussion of economic policy in the cabinet for months. She certainly wasn't going to make an exception for the budget. The result was that when Geoffrey Howe left for the House on budget day 1981 - March 10th - only he and the Prime Minister knew what he'd decided to do.

Geoffrey Howe and Margaret Thatcher in 1981
Only Howe and the PM knew what was going to be announced on Budget day
He announced to a stunned House of Commons that he was going to raise taxes substantially, in the middle of a recession. To do so he used a "stealth tax" that has been used many times since then: he didn't raise income tax allowances to take account of inflation. Only with inflation running at 16% in those days, it wasn't very stealthy. There was also a windfall tax on oil and bank profits that wouldn't look out of place in a budget from Gordon Brown.

Headline-writers and commentators were incensed. And economists were, for once, united. Some 364 of them later signed a letter to The Times, claiming that monetarist policies had no basis in economic theory, would deepen the recession and should be abandoned. Everyone who was anyone, it seemed, had signed, including two past and future Nobel Laureates (James Meade and Amartya Sen), several future Blair advisors (including Julian LeGrand and Anthony Giddens) and at least one future Governor of the Bank of England, Mervyn King.

Were they wrong to protest? Geoffrey Howe and Patrick Minford are convinced they were. After all, the economy started to grow again almost days after the letter was signed. That was embarrassing for the economists, to say the least.

'Over the top'

A "young" Stephanie Flanders
The young Stephanie wasn't the only one perplexed by the Budget
But when Newsnight brought several of the protagonists together for an anniversary dinner at the Institute of Economic Affairs - the intellectual birthplace of Thatcherism - we discovered there were several who were still prepared to defend the spirit of the letter. Notably, Stephen Nickell, now a member of the Bank of England Monetary Policy Committee, still thinks that the budget was over the top, and that it did deepen the recession, because unemployment continued to rise for several years afterwards.

They could all agree that the 1981 budget was a turning point in one important respect - it marked the time when inflation was placed irrevocably at the top of the list of government economic priorities, ahead of employment. That shift had begun in the final years of the Callaghan government, but the 1981 budget made it irreversible. The economists who signed the letter thought that it would be impossible for any government to survive unemployment of 3 million. Margaret Thatcher proved them wrong.

And the letter itself? Well, unfairly or not, the letter became something of a joke on the economics profession, as Lord Howe confirmed. "I've actually produced a definition of economists as a result: that an economist is a man who knows 364 ways of making love, but doesn't know any women." Budgets, and Chancellors, sure aren't what they used to be.

Stephanie Flanders' report was shown on Newsnight on Monday, 13 March, 2006.

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