There have been repeated comparisons between the current Government’s approach and Thatcher’s early 1980s economics, including by Rishi himself, who declared last summer: ‘I am running as a Thatcherite and I will govern as a Thatcherite’.  The case is made that, faced with the same twin problem of an economic slowdown and high inflation, this government’s macroeconomic approach follows that of Mrs Thatcher’s first term. The argument goes that Sunak is copying Thatcher’s approach by refusing to cut taxes, because to do so would slow the planned reduction in the deficit and allow higher inflation.

Is that really the case though?

Let’s start by examining the current plan as set out in the November 2022 budget, which aims for the deficit to decrease from 4.6% in 2022-3, the current fiscal year, to 2.5% of GDP in the next fiscal year 2023-4. This 2% reduction represents a fiscal tightening worth some £46bn or so, given our economy is worth £2.3tn – despite the fact that the Budget assumed that the UK would go into recession and the economy shrink in size this year. In other words, faced with a shrinking economy, the Government will push the deficit down sharply and, in so doing, push down inflation. Meanwhile, interest rates have increased to 4% but remain very low historically – and way below inflation, which continues to run at double digits – and in real terms have actually fallen in the past few years.

The problem is that the current approach does not copy Mrs Thatcher’s. The fiscal consolidation Thatcher undertook was much less extreme than the proposed current fiscal squeeze. Thatcher from 1979 cut some taxes but raised others, and spent more on some areas but cut others. The best overall fiscal measure for her approach is therefore the deficit overall. As the table below shows, the Thatcher government which took power in spring 1979 inherited a public sector net borrowing deficit of 3.7% of GDP. Almost immediately, the UK moved into a recession that would last until the middle of 1981, caused primarily by a spike in the price of oil. And, as can be seen in the table, the result was that the deficit increased very moderately as a share of GDP from 3.7% to 4.3% between 1979/80 and 1980/81.

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Only as the economy stabilized and began to grow from spring 1981 onwards in 1981/2 did the deficit come down (and even then it subsequently rose slightly over the following years). The famous 1981 Budget where Thatcher refused to boost spending was largely a rejection of calls to increase the deficit. Thatcher’s approach was not expansionary in the sense of a Truss-style ‘dash for growth’, as we saw last autumn, but neither was it in line with Sunak’s strategy of trying to squeeze out inflation by rapidly reducing the deficit during a recession.

A broadly stable fiscal policy as the UK entered recession went along with Thatcher hiking interest rates, with the Bank of England base rate rising from 12% to 17% over the course of 1979. Annual inflation peaked at roughly the same level, so in real terms interest rates at their lowest were broadly neutral (as opposed to now when they are still hugely negative).

This 17% peak was the highest interest rate in the Bank of England’s 300-year history, with rates held at high levels for a long period of years until inflation came down. Thatcher regretted the impact of higher interest rates on mortgage holders and businesses, but as she put it when challenged on raising the Bank of England base rate to 17% in the early 1980s: ‘We do not flinch from taking the steps necessary to tackle inflation’. Overall, while from 1979 to 1983 the deficit fell by 1% of GDP, real interest rates went from -2% to +4% – a huge shift. 

Thus a sharp rise in interest rates was her main tool in beating inflation. Similarly, this was the approach that began to be taken by her administration the next time inflation rose in the early 90s. By the time she left office in late 1990 then, in order to beat inflation the rate of interest had reached nearly 14%, while the deficit would rise after her exit to over 5% of GDP. 

Is a stable deficit and high interest rates still viable?

The Thatcher approach was a broadly stable fiscal position with much higher interest rates. Rishinomics, on the other hand, has lower interest rates but a sharp reduction in the deficit. It’s a completely different macroeconomic strategy. 

While it is almost certainly true that in our debt-laden economy, interest rates cannot reach a neutral level (i.e. around 10% so they are no longer negative in real terms), they could certainly go higher than they have so far. If further measures are needed to beat inflation, or a reduction in the speed of deficit reduction was seen as potentially stoking inflation, raising interest rates would be in line with the Thatcher approach. The idea of higher interest rates has been consistently condemned as unpopular and politically disastrous by the political class, but the polls paint a rather different picture. 

A poll that asked 2019 Conservative voters whether they would rather be able to borrow cheaply or save profitably found by two to one, Conservative voters preferred being able to save more profitably rather than borrow cheaply. So higher not lower rates.

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In November 2022, after interest rates had already soared, only around 30% of the public wanted interest rates to come down, as the table below shows.

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The share of the public who wanted rates to rise further was roughly the same as that wanting rates to fall. Much of our political and media class, however, are in their 40s and 50s and living in London and the south-east, meaning many of them will have hefty mortgages and prefer lower interest rates as a result. But a craving for low interest rates is not the view of the public as a whole, and it is worth remembering only 28% of the public have a mortgage.

Once voters are made to consider the choice between inflation and interest rates – since higher interest rates will generally squeeze down inflation – they have a very strong preference for higher interest rates. Separate polling shows that by 61% to 16% the public prefer higher interest rates to higher inflation as a whole, a crushing preference among older voters, with 81% preferring higher interest rates and just 3% preferring higher inflation.

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That suggests that Thatcher’s combination of neutral fiscal policy allied to higher interest rates is entirely political feasible. It would not mean the big tax cuts some are calling for, but it would allow for targeted measures to support incomes or boost investment and the deficit coming down more slowly. It is likely this in turn would push the Bank of England to raise interest rates slightly higher.

Unlike the Government’s current plans, that approach would genuinely echo Thatcher’s strategy. If the Government wants to stick to its existing plans it can do so, but it shouldn’t pray in aid the Iron Lady while adopting an approach she never advocated.

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Alex Morton is Director of Strategy at the Institute of Economic Affairs.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.