Describes the continuing efforts to offset transient fluctuations in autonomous factors. Examines in particular the decision of the Treasury to keep virtually all of its cash balances at Federal Reserve Banks (in order to benefit indirectly from historically high short-term interest rates) and the consequences of that decision for open market operations.

Monetarism was at the core of the ideological and policy wars of the 1980s, and of the strategy of the Conservative government headed by Margaret Thatcher. The UK had the highest rate of inflation in the industrialized world. By the 1970s, inflation was tearing the British social fabric apart: especially in its interactions with a government-imposed prices and wages policy. The British policy-making community could not agree whether money should be an overall objective of policy, or simply a target for an indicator that might be a temporary expression of how far the objective was being met, or an instrument for the conduct of policy in pursuit of the target. The Bank was initially quite sceptical about monetary targeting and hostile to monetarism. It believed that proposals for monetary base control ignored the structure of the British banking system, the knowledge of whose complexities and intricacies formed the core of the Bank of England’s professional competence. The keystone of the UK government’s approach was to target a range for £M3 growth as part of a Medium Term Financial Strategy. Meanwhile the Bank felt that it was shut out of policy formulation.

In practice, the early 1980s UK policy involved sporadically – but surprisingly often – responding to exchange rate movements, even when the exchange rate was specifically not designated as either a policy goal or an instrument, as well as raising interest rates as a way to cool down inflation but also economic growth. The 1981 budget, the most controversial of the Thatcher years, was accompanied by the attempt to take the pressure off manufacturing industry by lowering interest rates. The Bank responded to a surge in broad monetary aggregates by overfunding, that is, selling more than the amount of long-term debt (mainly gilts and National Savings instruments) required to finance the government. In 1983, a new Governor, Robin Leigh-Pemberton, who seemed more aligned with Thatcher’s view, came to the Bank of England, replacing Gordon Richardson, whose relationship with the Prime Minister had been strained. In the same year, a new Chancellor the Exchequer, Nigel Lawson, began a slow move away from monetarism and the application of monetary targets. The exchange rate came to play an increasing role in policy.