Milton Friedman's monetarist strategy to end inflation has been the British government's established policy for nearly a year. So far, things have been getting steadily worse.
Since Margaret Thatcher's conservative government took office last May, both inflation and unemployment have risen sharply. Investment has been falling.
The government, and Friedman as well, would immediately point out that they expected an initial decline, and publicly predicted it. There will be a recession, they say, as the country begins breaking its addiction to inflation. But there have been developments that neither the theory nor the government anticipated.
The public reaction? There's a lot of skepticism that the theory will work as advertised. But there's also a strong sense of relief and reassurance that there's a government moving on a clear and committed path. Last week's budget, in a daring departure, laid out specific targets for spending and the money supply for the next four years.
Friedman, the American economist from the University of Chicago, seems an unlikely figure to become a major force in British policy. He won his Nobel Prize in the most esoteric of subjects, the influence of the monetary system on the real world of production, jobs and standards of living. But Friedman is a formidable debater as well as an outstanding scholar. As one senior member of the government puts it, Friedman made it respectable, academically and intellectually, to hold the ideas toward which many British conservatives were moving. Friedman is now very much a figure on the British scene, defending his ideas in public and talking in private with Thatcher and her chancellor of the exchequer, Sir Geoffrey Howe.
The government says that nothing has happened so far to cast doubt on its monetarist strategy. But there have obviously been several unwelcome surprises along the way.
First surprise: inflation has surged. The inflation rate was 9 percent a year ago when Thatcher came to power. Now it's 19 percent and forecast to go higher.
One contributor is the tax policy. To encourage investment, the government began last spring to shift the tax burden from earnings to consumption, cutting income taxes and raising the sales rax. The higher sales tax immediately raised prices, setting off a chain of further price and wage increases, larger and faster than the government evidently had expected. Now those increases are being aggravated by the effects of the oil-price increases.
A crucial element in the government's strategy is to break the pattern of inflationary expectations throughout the country. But inflationary expectations now seem stronger than ever.
Second surprise: the money supply is very slippery, and squeezing it to restrain its growth is not so easy as it might sound.
Controlling the growth of the money supply is the central mechanism by which the Thatcher government intends to force the inflation rate down. Following the Friedman theory, it believes that by refusing to create new money -- mainly in the form of credit -- it can prevent employers from paying higher wages and buyers from paying higher prices.
Maybe so. But throughout most of last year, the money supply was growing a good deal faster than the government wanted. More recently, money has seemed to respond better to government control -- according to the statistics. But it appears that a good deal of money has been created outside the government's statistical definition. Money is, after all, whatever people are willing to use as money. People who urgently need credit will sometimes settle for unorthodox forms of it. The money markets are full of people who are highly ingenious at satisfying their customers without offending the government.
Friedman regards the whole controversy over the definition of money as a red herring. Restricting the money supply by any definition will necessarily pull down the inflation rate, he says. But to other economists, the recent British experience suggests that it isn't going to be quite so simple.
Third surprise: the announcement of the monetary plan last spring was supposed to cast a salutary chill over wage negotiations, warning unions that the money wouldn't be there for big increases. That clearly has not happened. The government currently claims some success in holding down wage demands, but the average settlement is running close to a 15 percent increase per year.
The center of attention is the steel strike, now in its 13th week. Since the corporation is nationalized, the employer is the government itself, and it has already offered 14 percent. The strikers are holding out for something closer to 19 percent. British Steel, heavily overmanned, with high costs and low productivity, is the kind of enterprise that ought to be standing last in line for pay increases. The only good thing about the steel strike is that its effect on the rest of the economy so far has been surprisingly slight, and other unions have not lent much support.
As the Thatcher government's program is working out, it is clearly not following Friedman in detail. Howe, the chancellor of the exchequer, thinks -- unlike Friedman -- that simply sitting on the money supply is not going to be enough.
Restricting the supply would mean, in the absence of other action, higher interest. But the government has already taken rates higher than they ever have been -- to the great pain of two of its most important constituencies, business and middle-class homeowners. Most British mortgages are written with variable interest charges that rise with the current rate.
To get rates down, the government is cutting its own spending. It reasons that one major upward force is its own need for credit to finance its deficits, and therefore the remedy is to reduce the deficits. As a practical matter, you will observe, Britain's monetary policy comes out at about the same place as the much more conventional policies being pursued by the United States.
Squeezing the money supply too hard also means the failure of businesses cut off from credit, and that in turn means unemployment. Friedman can airly dimiss rising unemployment as a temporary phenomenon, but the Thatcher government knows that if unemployment gets out of hand, it can undo them. It is now very high by British standards, and still rising dangerously.
When will it turn around? When will the inflation rate begin to drop? When will the British see the stability and prosperity that Friedman promises? The government is very careful not to set dates. The politicians are less inclined than Friedman to believe that these relationships between cause and effect are mechanical.
"You cannot demonstrate the time scale over which these things will become effective," comments John Biffen, No. 2 at the treasury and himself a considerable intellectual force.
The only fixed time scale that Biffen and the government acknowledge is the one that gives them four years or a little less until the next election. That election will depend less on economic statistics than on the voters' judgment on whether they have been governed effectively and fairly. "Economics is central," says Biffen with a tight smile, "but not exclusive."