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The myth of monetarism


Themes: Economics and policy

Mr Michael KitsonWith a stagnating economy and rising inflation, we need an urgent change of policy and a coherent strategy for growth

In a new podcast interview for Cambridge Judge Business School’s expert comment series, Michael Kitson, Senior Lecturer in International Macroeconomics at Cambridge Judge Business School, says the Prime Minister and The Chancellor, David Cameron and George Osborne, will need a ‘plan B’ if they are to put the UK economy back on track.

Mr Kitson said he felt ‘pessimistic’ about the chance of Britain pulling out of recession by following a ‘monetarist’ approach of cutting back and that the economic indicators showed the extent of the problems looming on the horizon:

“The outlook for the UK economy in the next 18 months is not good. We are going to have slow growth or perhaps no growth, a stagnating economy and high and rising inflation, which also creates problems for trying to generate stimulus for the economy, it’s not good.

“GDP growth was negative in the last quarter; we know this data is subject to revision, but even if it was revised up we are still going to have stagnant or low growth. The forecasts going forward over the next 18 months are not good and the Consumer Price Indexs are all indicating inflation is going to go up. This creates a double bind for the economy because it has slow growth and inflation. We have a problem now too of unemployment going up and inflation going up at the same time – it creates a real problem.”

Challenged on whether his favoured approach of fiscal stimulus would work better Mr Kitson said he believed that history had some lessons the Chancellor George Osborne should pay attention to, particularly the need for a ‘plan B’:

“Economists always disagree with each other – different economists give different perspectives – but if you look at the past and more recent evidence you see from the Great Depression in 1929 to 1932 and the Thatcher recession of the early 1980s, that governments need to change policy to generate growth. Sticking to ‘plan A’ has never worked; we have always had to have ‘plan B’.

“What we see from the 1930s is that governments tried to have balanced budgets and it just made things worse. In the end they had to have policy regime change. They lowered the exchange rate and introduced cheap money and protectionism. It was a change in policy that generated growth. The same thing happened in the 1980s.”

Mr Kitson said it was untrue to think that Margaret Thatcher didn’t change course and that she did indeed have to re-think her policies on the economy:

“People think Thatcher got it right by reducing the role of the state and having tight monetary policy. But it wasn’t tight monetary policy that generated growth. It was loosening monetary policy and also by having financial de-regulation in the mid 1980s which created the credit and housing bubble and high debt levels for consumers. It was policy change. It wasn’t sticking to this notion of strict monetarism and reducing the role of the state throughout the UK economy.”

Michael Kitson said the lessons from America where growth has been created through fiscal stimulus where the right ones to follow at the present time and that the UK needed to re-generate its manufacturing base to succeed particularly in low cost manufacturing:

“Britain is following monetarism and the US the fiscal stimulus approach, but I think America is in growth and the American policy is correct. When we have recession we need expansionary policy to generate growth. Monetarism started with the Labour Prime Minister James Callaghan in 1976. But the only way you get out of recession is to get somebody to spend something.

“When firms can’t produce things, they cannot sell, so we rely on demand coming from somewhere. In the UK you can’t rely on households or many firms or the public sector to do this because of their own real concerns, so what we are doing is relying on foreign consumers to get us out of the recession. We are relying on selling our goods abroad and mainly from the manufacturing sector. But these exports are a difficult ‘ask’ because manufacturing is only 12 per cent of our economy – we’ve neglected it and now it is not large enough to create a sustained recovery over the next five years.”

He said a coherent industrial strategy was urgently needed:

“We can’t compete in low cost manufacturing with Asia and elsewhere, but we can compete in high technology manufacturing. But we need a coherent industrial strategy; however we haven’t had that for forty or fifty years. The government is concerned about budget deficit and reducing expenditure, but it hasn’t got a plan for growth. We haven’t got a ‘plan A’ yet alone a ‘plan B’. I think the economics at the moment of balanced budgets are very suspect.”

He said the coalition government was playing ‘politics’ with its economic policies:

“The coalition government wants to reduce the role of the state in society, and I think that is very difficult to do. Mrs Thatcher didn’t achieve that. The ‘let’s have the pain now’ approach and more expansion later is based on both short term and long term politics, it is not just about economics. But the problem is you are in danger of killing the patient and harming our long term growth prospects. I think the government is cutting the deficit too quickly and they’re focusing too much on the public expenditure side.”

Mr Kitson said the UK needed to focus on growing three sectors:

“We need a coherent industrial strategy and a coherent economic strategy for growth. We need to grow those sectors where we can compete in the long term. These are high technology manufacturing, education and our universities and our creative industries. We need to improve our infrastructure and communication systems to help our economy grow.”

He ended by repeating his warning that ‘monetarism’ by itself would fail:

“Monetarism has never succeeded; that’s a myth.”