471. Harrod to J. M. Keynes , 30 August 1935 [a]

[Replies to 470 , answered by 472 ]

51 Campden Hill Square, W. 8. London 1

30 August 1935

Dear Maynard

No, no; you do me throughout great injustice. I have understood you much better than you think. You say that I think you mean as follows:--"we are left then with the rate of interest determining at what point, so to speak, the schedule of the propensity to save cuts the schedule of marginal efficiencies." [1] You suggest that I think you keep the twin classical determinants and shove in the rate of interest (itself determined otherwise). But that is not at all what I take your view to be.

Your view, as I understand it is broadly this:--

I think that you are saying--and rightly--that the inclusion of dependent variability of level of income necessitates radical re-construction on above lines.

None the less I hold that if you assumed income constant, classical view makes perfectly good sense. It may be open to criticism on minor points, but it isnt nonsense.

To quote from your letter "You say I am doing great violence to the fundamental ground-work of thought in getting rid of supply & demand analysis." I am not suggesting that you are getting rid of it in your own analysis. On the contrary you use it in the determination of employment, for instance. What I am objecting to you is your criticism (of the classical position) which implies that such an analysis doesnt make sense.

You write "you imply in passage after passage that if the schedule of marg. eff. is known & if the propensity to save is known, the rate of interest can be deduced". I never suggest that it can be so deduced, but only that it would be so deducible if the level (and distribution among different income-levels) of income were constant. You go on "But suppose that whenever the price of a German lesson went down the demand schedule also shifted its position, the whole thing would have no meaning." I agree entirely. That is precisely your point. The supply schedule of saving, according to you, moves automatically and necessarily to the right when the rate of interest goes down, and if the supply schedule (and not the supply) is a function of the price, the supply & demand analysis wont apply in that particular place. But that is no excuse for saying (as you have done) that the classical economists who assumed that the supply schedule could be treated as a constant, were not making sense when they said that the rate of interest was determined by supply & demand of saving.

"Any method which endeavours to arrive at the rate of interest without bringing in liquidity preference is bound to be circular in the worst possible sense of the word." Yes, if income is variable. No, [b] if income is constant. But, you say, income is variable. Granted. That brings us back to the old point:--they were wrong to take it as constant, but having made that mistake their argument was quite logical.

"Although you have lately accepted the view that S & I are equal, you still think of them as [c] being different things.' No; I always thought they were equal and the same thing. I always explained to students that they appeared unequal in the Treatise, because of a special & peculiar definition of income. [2] At my first reading of Hayek I noticed that he was assuming the possibility of inequality without accepting some arbitrary def. such as yours to allow that possibility.

"The demand for German lessons is a different thing from the supply even though the two may be equal. But saving and investment are the same thing." A German lesson is a German lesson. The demand schedule for saving is a different thing from the propensity to save. (Now dont accuse me of saying here that interest is determined by them. I merely re-iterate that thinking saving the same as investment doesnt itself make nonsense of the view that the amount of it is determined by two different things, [d] a demand schedule & a supply schedule.)

"Without bringing in liquidity preference the position of equilibrium is entirely indeterminate." I agree. And when I am seduced by the view that you give liquidity preference too much work, the view that I would then fall back on is that equilib. is indeterminate!

Only in one sentence explaining your constructive view do you seem to me to go too far. You say "the rate of interest has nothing to do with saving." This does seem rather extreme and isnt necessary. You dont need to deny that the rate of interest has some effect on the amount of any given income saved. All this would mean would be that the value of the multiplier is a function of, among other things, the rate of interest. [3]

"The supply curve of savings and the demand curve for investment have no determinate point of intersection, since they lie along one another throughout their whole length." Certainly: at least on one def. of supply curve of saving. But generally when you draw a supply curve , it is assumed that you are treating x as a function of a single variable, price, and other things including income were equal. That is the classical supply curve. To relate the classical supply curve to yours, you would have to draw a family of classical supply curves corresponding to different levels of income and to show that the value of each corresponding to a given rate of interest was identical with that of the demand curve, owing to the operation of the multiplier affecting the level of income. The value (x) of demand for each different value of y (interest) makes (via the multiplier) income such that when you draw the classical supply curve for that level of income (i.e. schedule of saving propensity at various interest rates at that level of income) the value (x) of this supply curve for the value of y used in computing that level of income is identical with the value (x) of the demand curve. I have tried to put this in other words again in note at end. [e]

"The propensity to save and the schedule of marg. efficiencies are 2 curves which do not intersect anywhere because they are not in pari materia." Agreed.

Mercantilist chapter. [4] I appreciate what you say about returning to age-long tradition of common sense. But the common sense was embodied in a hopelessly confused notion of economic system as a whole. I think you are inclined to rationalize isolated pieces of common-sense too much, and to suggest that they were parts of a coherent system of thought. It is that suggestion which seems to me to give the impression of the hopeless sterility of economics, swaying to and fro between 2 schools. [5] Unfortunately I have sent back that chapter which was a later proof.

Now; to sum up, I dont know if I have said enough to convince you that I do understand the broad outlines of your system (if I do!). Anyhow your representation of the way in which I took it was quite wrong. I think that I am well-placed, because I have thought a great deal about the implications of the Treatise, having lectured on it etc., & I have heard some of your views in advance. [6] What I fear is that less well-placed readers may not understand so much; and that the dust you want to raise will obscure the view of your central points. If the economists who read your book dont take the essential points, the outlook is bad. There is a limit to what the human mind can assimilate. Most of the readers wont have the time or opportunity or assimilative power of grasping the points raised in subsequent controversies.

What is important for the initial understanding, which is so much to be desired, is that their minds should be strongly directed onto your essential points. You present them with the most attractive kind of red-herring, namely controversial attacks on certain authors and about subjects they know well. The mind likes to take refuge from the un-familiar (your views which you want to get across) with the familiar (what exactly did Marshall mean in such & such a passage). And I dont think you lead them pleasantly from the familiar to the unfamiliar, because I think your criticisms are much too cursory and, I am bound to say again, unjust. \ I think the tactics suggested in your letter mistaken.

I dont know if you feel that anything is to be gained by oral discussion! A viva voce eliciting how far I have understood or mis-understood your position might determine what weight should be attached to my objections. I am scheduled to sail for Ireland on Tuesday night, though that fixture is not absolutely rigid. I shall remain there about 10 days.

Yours

Roy.

Your really important and effective criticism of the classical view occurs in Book I. It is implicit in the classical view that any given level of output is uniquely correlated with a given level of real wages (by princs. of dim. returns and increasing disutility of work). Once you knock that on the head, as you do most effectively, the level of output is either indeterminate or has to be determined by some new equation not provided for in the classical system. Thus the way is clear for a radical reconstruction. Your new equation is the liquidity preference schedule. [7] (This does not of course directly determine the level of output but does so in the roundabout way described on page 1 of this letter.) No further criticism of the classical system is required. All your subsequent criticism is fussy, irrelevant, dubious, hair-splitting and hare-raising.

 

See attached note


1. "Above address till Tuesday night.

Irish address:--Clandeboye, near Belfast, Ireland." [Harrod's note at bottom of page 5].


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