378. Harrod to G. Haberler , 19 October 1934 [a]

[Follows on from 368 , answered by 384 ]

Christ Church, Oxford #

19 October 1934

My dear Haberler

I was very greatly impressed with the masterly ability of your League of Nations memorandum. [1] I have not yet studied it with the care that I intend to. I dont know how afflicted you are by the pressure of a time-table. But if it is of any use I should like to let you have my further reflexions on it at a later date. And I hope you will not hesitate to call upon me, if I can be of any assistance to you on further points that may crop up.

May I first make this suggestion? I do not know how you intend to proceed. But I feel that your powerful analysis has cleared up so much in regard to these theories, that it could take us much further. I suggest a second theoretical part in which, as a preliminary to verification, you probe still further into their logical relation. By so doing, you might reach a further stage of simplification with regard to the logical schema of actual or possible theories. This would of course be inappropriate in your first part in which you are still trying to show us the theories as conceived by the authors. In Part II, as I think of it, the theories would no longer be recognizable as Hawtrey's, Spiethoff's etc. but would contain all the logically valid elements of these theories re-arranged by you. [2] If you did this, certain passages of the existing memo should, I think, be transferred to Part II. For instance, those passages in which you indicate that certain non-monetary theories imply an expansion or contraction in MV. These passages at times seem more appropriate to a critical than an expository section--I give as an example the passage about purchasing power at the top of page 46 [3] --in that they introduce a technique of analysis which might be thought inappropriate by the authors of the theories.

I have 2 special points I would like to make now.

1. I think your para at the top of page 27 introduces a confusion which may be of far-reaching [b] importance. I mean particularly the last sentence of it, which I take to be incorrect. [4]

Suppose an increase in the production of consumers' goods. (The cause might be a removal of trade barriers allowing an expansion of employment at the existing level of real wages.) For the time, supposing no excess capacity, there will be, as rightly explained by the type of theory you are examining in this para., a disproportionate demand for extra producers goods. When the capital equipment is increased to meet this, there will be an absolute relapse in the demand for producers' goods without any relapse in the demand for consumers'. Consider the period of high production of producers' goods. Is it right to say that this means that the average period of production is lengthened? I think not. All this might occur without any change of productive technique or relative productivity of the factors. In no case can you point to a final good being produced by a more roundabout method than before. But for the time a larger proportion of factors are engaged on the higher stages. This looks prima facie like an increase of roundaboutness, but the appearance is deceptive. Further, the larger proportion of employment at the higher stages will occur without any change in the real market rate of interest--which could not happen if this higher proportion was a sign of a genuine increase of roundaboutness.

Of course the consequences are different. In this case there will be no need to re-adjust production to a lower degree of roundaboutness if a period of normality supervenes on the period of expansion.

In any case I think the conflation attempted in this paragraph is really wrong and might lead you into trouble later.

2. I dont think you have attached, in spite [c] of two interesting references, sufficient importance to the views of Keynes. [5] You may be sceptical of this, thinking that I have come under his "spell". To that I can honestly plead that I dont think that is so. If his main view is right--of course it may be proved wrong, but I dont think it has been so yet, and it cant be dismissed as obviously so like those of Douglas & co. [6] --I think it must be of importance.

The orthodox view is that if a market price diverges from a natural, <forces> are set up to bring the market price towards the natural. The case of interest is a special application. Ah, but in the case of credit, it may be objected, this tendency is obstructed if the banks artificially increase (or decrease) supply by their credit policy. But Keynes claims to show that the rates do not tend to converge even if the banks do not artificially alter the supply. Surely if that is right, it is very interesting & important. The puzzle of the cycle is that when a departure from equilibrium occurs, the system tends to move further from and not back to the equilibrium position. This movement seems contrary to the principles of supply & demand. Now if Keynes shows that these principles dont operate in the case of interest, which clearly lies at the heart of the system, it would seem that he is supplying just the very kind of explanation that is required. [7] Why dont the principles of s[upply]. & d[emand] operate? Well, that simply takes one to the heart of his theory, where I cant go in this letter. Suffice it to say here that I do feel a lacuna in your summary, in that you do not note that there is someone [d] professing to give--by reasoning not obviously and palpably absurd--just the very kind of explanation which a rational account of the trade cycle requires. Mentioning one or two side points, you entirely pass over this central point. I do feel you need an extra section calling attention to this notable claim somewhere [e] . Otherwise you are treating him like Douglas, which is harsh!

Unfortunately it is no good urging you to a more intensive study of the Treatise, when a revised draft of the theory is about to appear. Perhaps he would let you have an advance copy. [8]

May I put a poser which though not expressed in terms of his thought, is allied to the difficulty which he professes to solve?

Suppose an increase in MV due to an increase in V, and a consequent rise of prices and what would generally be deemed an inflationary situation. We shall probably find a disproportionate increase in the output of producers' goods. Is the market below the natural rate? If so, that means that funds are being found to finance a more roundabout process of production--say an abnormally roundabout process that cant normally be maintained. Where do these funds come from? Not from the banks, since by hypothesis there is no increase in M. Then they must come from the savings of the people. Then the market rate isnt below the natural rate. Yet in the sense relevant to cycle analysis it is below! I believe you cant reply to this poser without being forced a long way into Keynesian territory.

I hope I havent bored you about Keynes. You may feel that at this point you dont see your way to a final critical estimate of these theories. But I think that is an additional reason for a paragraph giving a faithful, if you like, a photographic, rendering.

It may interest you to know that D. H. Robertson has written a reply to my article (Economica) and I have written a Rejoinder. [9] In my opinion this Rejoinder makes my position much clearer than the original Pt II of the Economica article. (I will send you an offprint.)

May I finally say that if your studies are brought to a successful conclusion, they will raise League of Nations publications far above any level hitherto reached.

Yours

R. F. Harrod

  1. 1. G. Haberler, Systematic Analysis of the Theories of the Business Cycle (1934).

    2. Harrod's suggestion was consistent with Haberler's plan (letter 384 , [jump to page] ), and with the final layout of the Report: Haberler, Prosperity and Depression, 1937.

    3. The passage, critical of the view that good harvests affect general business by changing the purchasing-power of the agricultural population, runs as follows:

    • [...] what the farmer gains in purchasing power, the consumer is bound to lose, and vice versa. Additional reasons would have to be adduced to show either that harvest changes somehow bring about an increase in aggregate purchasing power (an increase in MV), or that a mere shift in purchasing-power can produce a general stimulation. It could be said, for example, that a good crop or, better, an increase in the purchasing-power of the farmer, has a tendency to reduce the velocity of circulation of money, because it takes some time before the additional money which the consumer spends for agricultural products will arrive as demand somewhere else in the economic system. (Haberler, Systematic Analysis of Business Cycle Theories, pp. 45-46).

    The first sentence passed unaltered into the published version (Prosperity and Depression, 1937, p. 151), while the remainder of the passage was eliminated.

    Other passages subject to Harrod's criticism are on pp. 30 and 33 of Haberler's memorandum. Neither of them appears in the final version: the section containing p. 30 was eliminated altogether, while in the other passage the sentence "... saving produces deflation, a decrease in MV." was substituted by "... saving produces a deflation, a decrease in aggregate demand for goods ..." (Prosperity and Depression, 1937, p. 116).

    4. In the passage Harrod refers to, Haberler discusses the "Acceleration of Derived Demand" due to an increase in stocks and to the existence of durable means of production (fixed capital):

    • ... in order to increase the rate of output, it is very frequently necessary to make heavy immediate investments (in the shape of stocks or--practically, a much more important case--in fixed capital), the fruit of which will mature only in the more or less distant future. This process of investment is essentially a discontinuous one. In the terminology of the monetary over-investment theory, this fact can be expressed by saying that roundabout methods of production must be undertaken, or that the average period of production must be lengthened (Haberler, Systematic Analysis of Business Cycle Theories, p. 27).

    The interpretation of the consequences of the acceleration principle in terms of an increase in roundaboutness was not taken up in Prosperity and Depression. For further details see note 1 to letter 395 .

    5. Harrod probably refers to two passages on pp. 8 and 32 of Haberler's Systematic Analysis of the Theories of the Business Cycle (1934), where Keynes's Treatise on Money (1930) is cited in connection to the cumulative effects of credit contractions and expansions, and to the possibility that savings are invested in old rather than new securities. These passages were also cited in Prosperity and Depression (pp. 16, 236). Other references to the Treatise on Money, both in the draft and the final version, are incidental only.

    6. In the section dedicated to under-consumption theories, Haberler refused to consider "the crude versions of the doctrine of which there exists a great number of varieties in all countries (e.g., the theories of Major Douglas and Lt.-Col. Powell)", "for these theories are clearly fallacious" (Haberler, Systematic Analysis of Business Cycle Theories, 1934, p. 32). References to Douglas and Powell were substituted in the final version by references to Durbin's and Gaitskell's criticisms to under-consumption theories (Prosperity and Depression, p. 111n).

    7. For an analogous statement see letter 392 , [jump to page] . This interpretation of the trade cycle theory at the core of Keynes's Treatise on Money in terms of cumulative deviations from equilibrium is consistent with, and probably at the origin of, the interpretations later expounded in the "Essay in Dynamic Theory" (see the draft here reproduced as essay 19 , [jump to page] , and Harrod 1939:7 , p. 19), which was eventually approved by Keynes (letter 811 , [jump to page] ).

    8. It is not easy to ascertain what gave Harrod the impression that The General Theory (1936) was "about to appear". His statement rather seems to reflect Harrod's curiosity for the new theory, for he was unaware of the recent developments of Keynes's thought (as certified by the contemporary exchange of views with Kahn: see in particular letters 375 , [jump to page] ; 383 , [jump to page] ; 387 , [jump to page] ; 389 , [jump to page] ; 391 ; 392 ).

    9. Robertson, "Mr. Harrod and the Expansion of Credit" (1934); Harrod, "The Expansion of Credit in an Advancing Community" ( 1934:8 ) and "Rejoinder to Mr. Robertson" ( 1934:11 ).

    1. a. ALS, nine pages on five leaves, in GH Box 66. TCc, with MS corrections probably in the hand of the typist, three numbered pages on three leaves, in HP IV-395-422; this is a transcription Haberler sent back to Harrod for reference. Another TCc is in LoN 10B/12653/12653.

      b. Ms: «far reaching».

      c. Ms: «inspite».

      d. Ms: «some one».

      e. Ms: «some where».


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