The 70s were a bad decade for the British economy. 'Failure'
is probably the most fitting word for the period. From 1974 to 1979
unemployment had crept up to pushing on 5%, growth had fallen to 2% but the
real issue was inflation at 16%. Part of the rise in prices can be attributed
to the collapse of the Bretton Woods system, this led to a global commodity
price rise which saw oil rise four fold in a 2 year period. Domestically,
though, the supply side issues discussed in a previous post weren't helping and
a lot of errors were made in macroeconomic policy cause partly by confusion
over the actual cause of inflation.
The confusion was theorists thinking they understood the tradeoffs
between economic objectives, such as inflation and unemployment. Stagflation
occurred in the early 70s which shocked theorists - inflation and unemployment
was rife at the same time, the government were struggling to achieve any of
their objectives.
The government needed to re-think. They put the priority
on targeting unemployment in the early 70s. During this period the Barber Boom
took place. The chancellor at the time (Barber) injected a large monetary and
fiscal stimulus to raise output but not inflation because of the spare capacity
in the economy. Sterling was also allowed to float freely to stop a balance of
payments crisis choking the growth. Did it work? In the short term - yes.
Growth peaks at 7% in 1973. But, over the longer term, the balance of payments deficit
soars, inflation starts to runaway and smaller financial institutions collapsed
- the three things that really weren't wanted.
Because of the soaring inflation the government makes
controlling this the main priority as the 1970s progress. Unemployment falls
down the pecking order. Revised Keynesian theory defined the inflation as
cost-push. Wages were rising faster than productivity forcing up the prices.
Pay rises needed to be checked - were income policies the solution to this? Income
policies worked like so: pay rises would be limited by setting a norm that
everyone should follow. Some would be voluntary, some would be forced, others
would be more complex. It worked for small periods of time, but it always
failed eventually as people became dissatisfied and it defied the point of
trade unions.
The monetarists attacked the income policies claiming
they didn't curb inflation at all they just distorted the labour market.
Tighter financial policy was required. This was true, public spending was high
and still increasing. It rose faster than national income from 1970-75 and
reached 9% of GDP during 1975. This high spending was crowding out private
sector investment by pushing up interest rates. In 1976, Labour realise the
problem and agree to a deflationary package. Their new budget regime centred
around cash limits. 60% of their spending would now be subject to 'cash limits' and different programmes received a fixed
cash sum year on year regardless of inflation. In real terms, this change meant
public spending fell and brought inflation down to some extent.
What can we conclude from this then? Was this the end of
the Keynesian era? The government were still trying their hardest to adapt
Keynesian demand management policies rather than find a new, improved framework.
This just resulted in what seemed like aimless policies that didn't solve any
problems. Real living standards on the whole were hit, especially the middle
income people, which led to a lot of resentment.
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