541. H. D. Henderson to Harrod , 2 April 1936 [a]
[Replies to 540 , answered by 542 ]
2 April 1936
My dear Harrod,
I am very grateful to you for taking so much trouble over my paper  when you have only just risen from a sick-bed, and your comments will certainly be very useful to me in suggesting the desirability of underlining and emphasising some of my points. But I am afraid that the main effect of your letter and comments on my mind is a provoking one; and as, wisely or unwisely, I have decided to reply at some length, I have waited to do so until I could dictate my reply.
Your first criticism relates to pp. 4 and 5 of my paper.  You say that my point here is an ignoratio elenchi: now just consider. Maynard asserts that the rate of interest depends on two factors, the quantity of money and the state of liquidity preference. He puts this forward as his general theory equally applicable to the short period and the long, and he builds upon it the most sweeping generalizations of practical policy. One of his main precepts of policy is that for the objective of larger investment, interest rates should be brought down and kept down by increasing the quantity of money to whatever extent is necessary for the purpose. I show by a series of instances that even the largest changes in the quantity of money leave no enduring mark whatever upon interest rates, at any rate not in the direction which Keynes's argument implies. You reply that in all these instances the other factor of liquidity has altered so as to cancel out the effects of the change in the quantity of money. You do not suggest, I suppose, that it is a mere coincidence that this has happened. If then it is the case that changes in the quantity of money entail consequential changes in the factor of liquidity which neutralizes the influence of the former upon the rate of interest, the whole theory becomes empty of content and all the practical inferences that Maynard derives from it become untrue. As a matter of fact I cannot believe that yours is the answer which Maynard himself would attempt to make to me. He speaks throughout of the state of liquidity "preference" or of "the psychological attitude to liquidity", and there is no reason whatever to suppose that a large increase in the quantity of money which leaves the price-level say ten times higher than it was before will cause people subsequently to entertain a stronger preference for highly liquid as compared with less liquid assets. In other words, there is no necessary consequential alteration in the factor of liquidity preference as Maynard defines it. The reply which I think he would make is that the quantity of money should be reckoned in what he terms "wage units". There is one passage in his book in which he suggests that this should be done. My retort of course is that in that case experience shows that you cannot by monetary policy secure any permanent increase in the quantity of money reckoned in terms of wage units, so that along that line of dialectic the theory again becomes quite empty of content. In either case the essential point remains that Maynard argues throughout his book as though you could reduce the rate of interest permanently by increasing the quantity of money in the ordinary sense. I would really ask you to consider fairly whether Maynard does not convey this impression and whether he does not mean to convey it, and if you agree that he does, whether my argument on pp. 4 and 5 and indeed subsequently is not highly relevant to the issue.
As regards your criticism on my page 7, I would point out that the British public probably saves about 10 per cent. of its income per annum over the average of good and bad years without having three-quarters or one half or even a quarter of its population unemployed.
Your comments on pp. 8 and 9 of my paper are [b] that Maynard offers a perfectly adequate explanation of the phenomenon in question. He offers no explanation of it at all. He does not I think refer to the phenomenon, at any rate not in the central part of his analysis, and I should imagine that anyone whose only knowledge of trade fluctuations was derived from Maynard's analysis would be extremely surprised to learn that interest rates do normally fall in a slump and rise in a boom. You can only reconcile this phenomenon with Maynard's theory by treating an increased banker's ratio of cash to deposit liabilities as equivalent to an increase in the quantity of money. This is not the sense in which Maynard defines the term nor that which anyone reading his book would gather should be attached to it.
As regards your comment on p. 11,  i.e. my definition of investment, I shall only say briefly that I do not regard it as a demerit of a definition in economics that it is not always easy to say on which side of the line some rather peculiar case should be put. It is inherent in the complexity of the economic system that if definitions are to be fruitful and helpful in attacking problems of cause and effect such difficulties will arise. On the other hand to seek an escape from such difficulties by adopting formally precise but unreal definitions invariably leads either to sterility or to fallacy.
P. 13: In the early stages of slump stocks of all goods including [c] finished goods increase. I agree that stocks of finished goods fall off sooner than those of basic materials. Your other point on p. 13 intrigues me very much. You tell me that my sentence beginning "This is patently untrue if ..." is "wrong", and that I have not reflected sufficiently on the doctrine of the multiplier. Do you really mean to tell me that if consumption falls off so that unsold goods accumulate there will be a single moment during which incomes will increase? If you assert this on the basis of some mathematical formula I would appeal to you to reconsider the mathematical formula. I have done my poor best to consider the doctrine of the multiplier, and I have gone into it enough to see that Maynard's language on the point is frequently extremely loose and in some cases clearly inaccurate. Look, for example, at the last phrase in the middle paragraph of p. 123 of his book. The "marginal propensity to consume" obviously cannot be the multiplier. But that is no doubt just a slip. The crucial point I suspect arises on p. 115. Maynard builds up his formula on the basis of the equation DY w = DC w + DI w . but in the case of the undesired accumulation of unsold goods which I am supposing in the sentence which you challenge, that equation would not hold good: the true equation would be DY w = DI w - DC w = 0. 
As regards my p. 14, you tell me (1) that my point is not of "quantitative importance", and (2) that Maynard mentions it in a certain passage.  On the latter point the question is not whether Maynard mentions it somewhere but whether he takes account of it in formulating his general theory. It is one of the root causes of my exasperation with Maynard's book that it is incoherent. The general assertions which are so sweepingly made are contradicted by facts to which he does refer somewhere or other in his book but which at other points he appears completely to ignore. On the point of quantitative importance what matters is not the amount by which unsold stocks of goods may vary but the effect which such a variation may exert. Consider a parallel: suppose that the price of some share on the Stock Exchange is forced up by persistent buying by the public in excess of sales by the public. I say that the price of the share in question is raised by an excess of demand over supply, and that such a divergence if long-continued may exert an immense influence upon the price. But of course the buying of shares is a two-sided affair. There is a sense in which the demand and supply must always be exactly equal to one another, for the shares which the public buy must be supplied by someone even if this someone is a jobber. Now fluctuations in the supplies held by jobbers correspond to the fluctuations in stocks of unsold goods in my analysis. But jobbers do not hold very large quantities of shares, nor as a rule do they allow the quantities they hold to vary very much. What would you think of someone who denied that an excess of demand over supply for a share could exert any important influence on price on the ground that the variations in the quantities held by jobbers were not of quantitative importance? In practice, of course, a vast programme of public works except at the bottom of a severe depression would be balanced mainly by a contraction of private enterprise investment because of a lack of capacity in the constructional industries, even though unemployment might be very high. But there would also be an effect on stocks of goods which whether you call it quantitatively important or not would entail boom conditions, including inter alia a rise in interest rates. This reaction upon interest rates Maynard appears to deny categorically; what I cannot make out is whether you deny it.
As regards your comments on my pp. 15 and 16, I think I need merely refer you to the middle paragraph on p. 18 for my answer.  You say, by the way, that this argument of mine is pure Maynard doctrine though you cannot find it in his book. Even if you could find some reference to it in some passage it would not alter my complaint that his whole central analysis takes no account of the reactions which I indicate here, and is completely vitiated by the failure to take account of them. You again imply in this connection that Maynard would agree that an increase in savings would, other things being equal, entail a fall in the rate of interest and an increase in investment. I can only say again that this is contrary to the whole impression conveyed by his book. That increased saving will simply entail increased unemployment and will fail to influence investment, that increased investment must automatically entail increased saving, are its favourite themes.
Let me refer briefly to your final comment on my pp. 21-24. You say that this is a matter of fact about which if I were right the practical importance of Maynard's theory would be much diminished though not its theoretical interest. Now I do suggest that the primary object of an economic theory is to explain the economic world. If I am right on the issue of fact it is obvious that Maynard's theory gives a completely distorted impression of the working of the economic world. The question of fact is therefore really rather crucial. Now I should like you to ask yourself whether you really approach this vital issue of fact in an impartial mood. You say--if I were right, implying that you don't think I am. Now honestly, is it any study of the facts that induces in you that scepticism or is it not rather your desire to believe in the utility of Maynard's theory?
Just one final comment on your introductory letter.  I have allowed myself to be inhibited for many years from publishing many things by a desire not to quarrel in public with Maynard. Also I have a very lively sense which is confirmed by some incident or other nearly every day of the immense damage that is being done to economics as a subject, at a time when it is being presented with an unparalleled opportunity, by the logomachal controversies of recent years. I am appalled at the mischief that will be done from that standpoint by Maynard's book: but it is impossible to accept the position that Maynard is to be allowed to deliver the most extravagant attacks upon the main body of orthodox economic theory, conveying the impression that everything that has been said hitherto is nonsense and that here is a great new light to which the heathen must be converted, and that others must abstain from effective reply to avoid the impression of economists quarrelling. You see, I don't believe there is a great new light at all. I regard Maynard's book, as I say in my paper, as a farrago of confused sophistication,  and I find intensely exasperating the tacit assumption that prevails in certain circles that those who do not accept its general doctrine are to be regarded as intellectually inferior beings.
H. D. H.
On the basis of what you admit, calling it Maynard doctrine, I do not see how you can dispute my vindication of the orthodox theory on pp. 19 and 20. For if you mention your dubious long-term liquidity point, I insist that there is no rigid limitation on the quantity of money.
R. F. Harrod, Esq.
2. Letter 540 , [jump to page] .
3. Letter 540 , [jump to page] .
4. This argument was used in Henderson's "Savings and Investment", p. 5: see note 2 to letter 554 .
5. Letter 540 , [jump to page] .
6. Letter 540 , [jump to page] , and footnote [i] . The passage on p. 18 runs as follows: fluctuations in the abundance of bank-money during the cycle
7. Letter 540 , [jump to page] .
8. Henderson, "Mr. Keynes's Theories. Marshall Society, Cambridge. May 2nd, 1936", p. 1. The passage was also typed in in the second version of the paper, but was corrected in pen, and is not found in the version as published in H. D. Henderson, The Inter-war Years and Other Papers, edited by H. Clay, Oxford: Clarendon, 1955.
- a. CcTLI with autograph corrections, six numbered pages on six leaves, postscript typed directly on the last leaf, in HHP Box 10.
b. Ts: «is».
c. Ts: «uncluding».
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