§ The reason I attach the greatest importance to monetary policy is not my sudden conversion to some obscure foreign cult. Important but arcane arguments go on among professional economists about the nature of the causal relationships between the money supply on the one hand and demand on resources on the other. No doubt these arguments will continue, but it would in my view be over-optimistic to believe that they will quickly lead to a consensus.
§ There will, however, be little dispute that fiscal policy and monetary policy will both be more effective if each is working in harmony with the other. The increases in indirect taxation which I made in the autumn were, therefore, accompanied by the import deposit scheme designed partly to help syphon off some of the excess liquidity in the system, as well as by a further tightening in the credit field.
§ Since these measures came right at the end of 1968, they had very little effect on the monetary outturn for that year. During 1968 the money supply rose by £986 million, an increase of 6½ per cent. and more or less in line with the rise in G.N.P. over the period. Even so, this was a pretty big increase. Moreover, it occurred in spite of an adverse balance of payments of nearly £460 million which itself, because a balance of payments deficit is financed either by borrowing from overseas or by drawing down assets, is in this sense an extension of credit to the domestic economy. Such an increase in credit at a time when we are striving to switch real resources into the balance of payments was a great 1008 deal more than we could afford. We cannot allow credit to be supplied on anything like this scale in the coming year.
§ For these reasons, I am especially concerned that the improvement we need in the balance of payments over the next twelve months should be accompanied by restraint in the provision of bank credit at home—not only to the private sector, but to the public sector also.
§ With regard to the private sector, bank credit increased in 1968 by £753 million, considerably higher than I hope it will be in 1969. Indeed, as part of the autumn measures, I asked the London clearing and Scottish banks to reduce their lending to the private sector by March, 1969, to a level two percentage points lower than at the time of devaluation in November, 1967.
§ When I met the representatives of the banks on 27th February, it was clear that they were unlikely all to be able to reach the target which I had set them by mid-March. While acknowledging their difficulties, I left them in no doubt of my determination not to run the risk of allowing failure here to undermine the effectiveness of other policies. The March figures showed that they had made some progress, though not enough. If the April figures do not show a satisfactory further improvement, I shall have to consider very early action to reinforce the pressure on the banks to bring their lending within the ceiling.
§ Bank lending to the public sector rose by only £54 million in 1968. Lending to the local authorities and nationalised industries amounted to about £194 million, but the Central Government repaid £140 million debt held by the banking system.
§ The Government were able to reduce their borrowing from the banks last year in spite of needing to finance substantial debt repayments to the public outside the banks. But it was a difficult period for gilt-edged, especially towards the turn of the year. Rising interest rates in the United States and other overseas markets, together with continuing uncertainty about the international monetary system, combined to depress the market, and over the year the non-bank public sold net some £200 million of gilt-edged.