'Muddling through or tunnelling through?’ UK monetary and fiscal exceptionalism and the Great Inflation

Discussion of the causes of the Great Inflation in the UK during the 1970s has centred around the relative importance of ‘bad luck’ – the occurrence of unusually large commodity price and supply-side shocks – and ‘bad policy’ reflecting failures in both monetary and prices and incomes policies. By reconsidering the historical and empirical record of inflation from 1950s to the early 1990s we show that the persistence of the Great Inflation in the UK cannot fully be explained by these factors, although these can account for some of the major fluctuations. Instead, underlying inflation and inflation expectations appear to be the result of a sequence of regime shifts. We argue those regime shifts are as much related to fundamental changes in fiscal policy as they are to monetary policy and union reforms. Our empirical evidence suggests that fiscal policy was at the heart of many of the problems in the UK during the Great Inflation. In contrast to most of British history, it was not used to stabilise the public finances. Instead, it was used to keep unemployment down and growth up, to subsidise losers from terms of trade shocks and to secure deals with the unions.