498. Harrod to D. H. Robertson , 18 November 1935 [a]

[Replies to 497 ]

Christ Church, Oxford #

18 November 1935

My dear Dennis

Dash it, I committed a grammatical ambiguity which has obscured the issue. When I wrote "he sells and, to cover himself, buys spot", [1] I meant spot to apply to both verbs and not the latter only. I wanted to get out of the way all questions of future deals as irrelevant for the analogy. However you dont lay great stress on that part of your reply.

Your main objection is that I imply that it is the banker's covering himself that lowers the rate whereas by the analogy it ought to raise it. But this is not really what I imply. If the banks dont cover themselves but pay out gold, then the rate will be lowered on this analysis, since the non-interest bearing assets in the community are increased (for export of gold vid. inf.). At the other extreme if the banks covered themselves by negotiating a loan of illiquidity equal to that they give the rate of interest would be unaffected. But if, as is the usual case, they cover themselves by increasing their deposit liabilities, then the effect on the lowering of rates is almost as great as, if not equal to, what would occur, if they did not cover themselves at all but paid out gold. It is their willingness to increase their holding of illiquid assets against liquid deposit liabilities that lowers the rate.

In the case of gold export, we have to consider whether it is directly due to their loan. If not, we have to suppose that their loan is covered by an increase of deposits and treat the effects of the gold withdrawal separately. But if the two are linked, e.g. if they lend a certain sum to the foreigner to be paid in bar gold, their extra loan does not lover the rate of interest.

I hope that you do feel that this method of approach is at least not incorrect--does get the right result. I should regard your method as a short cut--for some purposes the holding of bank i.o.u's need not be regarded as loans and can \ be left out of the picture--so long as it used with proper reservations. The trouble is that it has recently been flagrantly misused. I refer to Hayek. Prices & Production. p. 23 last paragraph, which appears to me to be the merest nonsense. [2] Yet it is upon this fundamental passage in his book, that a vast superstructure of monetary theory and interpretations of boom and slump, tending to affect public policy in important ways, have been built.

The new treatment of the holding of bank money as loans to banks may seem a trifle pedantic. But I fear that this pedantry is necessary in view of the gross abuse of the short hand treatment



  1. 1. Letter 496 , [jump to page] .

    2. Hayek, Prices and Production (1931), pp. 23-24. For Harrod's annotation in the margin of this passage see note 7 to letter 368 .

    1. a. ALS, three pages (the last of which is numbered) on two leaves, in DHR 3/2 7-8 .

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