UK Recession of 1981

The incoming Conservative govt inherited an economy with inflation of 27%. Also many industries were quite inefficient and trades unions were very powerful. There had been a winter of discontent with many strikes.

ON coming to power the govt adopted a strict Monetarist approach.
There overriding macroeconomic objective was to reduce inflation. They did this by

  1. Raising interest Rates (tightening of Monetary Policy)
  2. Tightening Fiscal Policy to reduce the budget deficit. ( monetarists believe that a budget deficit is likely to cause inflation because to finance it the govt may be tempted to increase the MS, also selling short term bond to the banking sector has the effect of increasing the Money Supply )
  3. Sticking to strict Money Supply targets for M3

The effect of these policies was

  1. Reduce AD significantly
  2. Increase the exchange rate ( as well as higher interest rates, the production of oil in the north sea caused a rapid appreciation)
  3. Therefore exporters struggled to cope with the rapid appreciation, many industries who relied on exports went bankrupt. Manufacturing output fell by almost a third during the recession.
  4. With a fall in manufacturing capacity the UK has had a bigger deficit on the balance of trade (part of the current account) ever since.
  5. Inflation was brought under control but unemployment rose to over 3 million and didn’t fall until 1986
  6. Real GDP fell by 2.2% in 1981

The govt argued that the recession was necessary to shake up the economy and get rid of inefficient firms. It is true that some firms were inefficient but most economists would argue that the recession was deeper than it need to be. With the rapid appreciation of sterling many good firms also went bankrupt.

Targeting the money supply proved to be a futile task because money supply growth proved to be very erratic and there was no direct link between inflation and Money supply by 1985 the govt had effectively abandoned Monetary targets.

Trade Union power was reduced by both political legislation and also the decline in manufacturing firms where trades unions used to be very strong.

See Economy under Mrs Thatcher 1979-1984

 

Essays and Revision Notes on Economic Growth