Did monetary policymakers step on a rake? A study of monetary-fiscal interactions in the British Great Inflation

Bush, Oliver (2024) Did monetary policymakers step on a rake? A study of monetary-fiscal interactions in the British Great Inflation. PhD thesis, London School of Economics and Political Science.

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Abstract

1960s-70s Britain experienced very high inflation relative both to its peers and its own previous history. The conventional wisdom blames both bad luck and bad monetary policy, leaving little or no role for fiscal policy. This thesis analyses the role of fiscal policy in the British Great Inflation and reinterprets the role of monetary policy through the lens of modern theory on monetary-fiscal interactions. I show that fiscal policy was used very differently in the 1960s-70s than in most of the rest of modern British history and that this had consequences for inflation. Policymakers abandoned the previous practice of using fiscal policy to stabilise the public finances. In this regime, shocks (fiscal or otherwise) which led to a deterioration in the primary balance were ultimately financed not by subsequent tax increases or spending cuts but by surprise inflation. I argue that, in this unusual fiscal financing regime, a series of such shocks were probably responsible for the Great Inflation in Britain. Where does a fiscal explanation of the Great Inflation leave accounts emphasising the role of monetary policy? Modern theory predicts that, in a regime such as Britain’s in the 1960s-70s, contractionary monetary policy shocks eventually lead to higher prices. This phenomenon has been labelled ‘stepping on a rake’. In fact, I find that surprise increases in the policy rate caused inflation to fall and – at least within conventional time windows of monetary analysis – there was no sign of it rebounding as per the rake hypothesis. This leaves a puzzle. My explanation for how monetary policy surprises had conventional effects appeals to the institutional arrangements governing macroeconomic policy in 1960s-70s Britain. Monetary and fiscal policy were both used to manage demand and were ultimately both controlled by the Chancellor. The fact that they tended to pull in the same direction meant that, whatever the intention, fiscal policy did give the backing required for monetary policy to have conventional effects. But the extent of that backing depended on the timing of monetary policy announcements, as did the impact on inflation. So I find no evidence that monetary policymakers stepped on a rake, but I do find evidence in favour of the theory’s prediction that monetary policy requires fiscal backing.

Item Type:	Thesis (PhD)
Additional Information:	© 2024 Oliver Bush
Library of Congress subject classification:	H Social Sciences > HC Economic History and Conditions
Sets:	Departments > Economic History
Supervisor:	Ritschl, Albrecht and Roses, Joan R.
URI:	http://etheses.lse.ac.uk/id/eprint/4760

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