Free Economics Dissertations - When They Turned Out To Be Unsuccessful, Resort Would Be Made To Devalue The
When they turned out to be unsuccessful, resort would be made to devalue the pound in order to restore competitiveness.
Monetary targets were first adopted by the Labour Chancellor Denis Healy, in 1977, and in 1979 became a centrepiece of Margaret Thatcher’s government’s macroeconomic strategy. Monetary targets proved to be unreliable guide to the conduct of monetary policy during the 1980’s, however, on account of unpredictable movements in the velocity of circulation. The first chosen target aggregate was a broad aggregate including sterling time deposits with the banking sector. In order to reduce inflation, the target ranges were set at 7 11% for 1980, and 6 10% in 1981; the result ended up being 18.4%, and 16.3% respectively. But other indicators did not point to monetary laxity, with narrow money growth slowing from 12.1% in 1979 to 2.6% in 1981. And monetary policy tightness was reflected in other developments in the economy: sterling rose by around a quarter, while output dipped more than 3% leading to a subsequent sharp fall in inflation.
Through the second half of the 1980’s, the then Chancellor of the Exchequer, Nigel Lawson, pursued an informal exchange rate peg by shadowing the Deutsche Mark. This evolved into a formal exchange rate target when the sterling entered the ERM in 1990 at 2.95DM to the pound; a rate was felt in some quarters as perhaps a little high. But that suited the government because it permitted lower interest rates, which was considered by the government at the time a sensitive matter in the United Kingdom on account of the prevalence of flexible rate mortgages, while still restraining inflationary pressures. The risks inherent with this strategy were brought home when the economy subsequently slowed sharply at exactly the same time as pressures of the German re-unification were pushing European interest rates upwards. Eventually tensions between following a tight policy in order to maintain the exchange rate peg and the desire to limit the domestic downturn by lowering interest rates became so great that the government’s policy ceased to be credible, resulting in speculative attacks on sterling and the decision to quit the ERM on 16th September 1992.
There was now an urgent need for an alternative framework for the conduct of monetary policy. Monetary targets, and intermediate targets more generally, were seen to have failed because of the lack of a predictable relationship with the ultimate goal of policy. Furthermore, shifts in the relationship between the intermediate target and the policy goal not only complicated the conduct of policy but also it communication. Additionally, advances in economic understanding might well lead to a changed view on the most appropriate intermediate target.
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