644. Harrod to R. G. Hawtrey , 4 March 1937 [a]
[Follows on from 638 , answered by 662 ]
Ch[rist]. Ch[urch]. Oxford
4 March 1937
Many thanks indeed for the volume--and for the kind things you say in ch. 1!  I am not after all reviewing it for the Listener. On seeing my name on the jacket they wrote in haste to say that they expected I was feeling as much embarrassment as they were and that they would send it to someone [b] else. I replied that I hadnt been feeling any embarrassment at all, since the part about myself was confined to one chapter not closely related to the rest and that I regretted their decision but appreciated their point. So there it is.
I may say that I found your book most fascinating reading, quite extraordinarily clear and in many respects convincing. I liked the passages on Hayek & Douglas very much but do not agree with all you say about JMK, but I expect he is standing up for himself. 
With regard to what is I suppose the most essential matter, the possibility of deepening when the widening process is checked, I must say you seem to have withheld down your doctrine with regard to short-term rates to a condition in which it is most un-convincing. Formerly I had conceived you thinking of speculators used to narrow margins and directed my argument from the magnitude of price fluctuations against that. But now we learn that "it is manufactured products that require consideration" (p. 112) and that "the short term rate has an insignificant effect upon the speculator, but it does influence the legitimate trader."  I honestly believe this to be entirely mythological.  Producers usually have a standardized habit of laying in stocks 2 or 3 months in advance from which they seldom diverge. They may endeavour to increase this (and will probably be unsuccessful!) if they anticipate difficulties about prompt delivery in future, when a boom is being generated. You take manufactured goods as not being susceptible to big price changes; but the manufacturer who uses them will himself be subject to big demand changes and he dare not order his semi-finished materials too far ahead. He runs the risk of having to hold them too long. Even semi-finished goods are susceptible to some price changes; he runs the risk of completely messing up his balance sheet by having to include a lot of depreciated capital which might wipe out his profits for the year & more. Besides manufactured goods are almost all subject to frequent changes in design. He doesnt want his working capital to become obsolete! About this I am prepared to say quite boldly and publicly non credo, and to challenge you to find one out of a sample of ten or if you like fifty manufacturers who is influenced in the volume of manufactured working capital by the short term rate.
I am glad that on the whole you seem to give a qualified blessing to public works, but must add that your point on p. 125 seems unfair when you say that the amounts involved are "pitifully small".  (Small compared with the extra supply of nuts a manufacturer would lay in because the rate of interest had fallen?) Pitifully small certainly when you consider the deficiency of purchasing power when a great slump is under weigh. But not necessarily too small perhaps if undertaken before the slump has gathered strength, and not small at all, I submit, compared with the extra holding of working capital which you would stimulate by banking policy.
Then with regard to capital instruments. We are agreed in thinking the effect of the long-term rate too delayed to be very effective in averting a slump promptly. For you this means averting the vicious spiral of deflation, (where does the spiral end?), for me preventing net investment other that of the kind mentioned by you on p. 316 top half which I cordially recognize, falling to zero.  But you still have two strings to your bow (i) the queue of people with schemes lined up in the investment market and (ii) the deepening of the productive process. These, I suggest, we must take to be connected since schemes for deepening not already matured would be subject to the same delay that makes the fall in the long-term rate ineffective. Now it seems to me that deepening is associated with some kind of substitution in the productive process and that deepening is essentially connected with either (a) widening or (b) replacement--these give the opportunity for deepening. When the widening process is checked and indeed capital instruments become redundant, I suggest that your queue will melt away like the snow. Indeed in one place you recognize this point (p. 79) and we appear to be in agreement.  But then we are left with the moral (my moral!) that banking policy is likely to be ineffective in filling the gap when saving is adapted to a certain rate of widening and, on that reaching its inevitable limit, becomes redundant. Forward public works, please.
I was rather amused to read the following sentence:--"They both alike trace trade depressions to a deficiency of demand arising from absorption of cash" (p. 320). Later you give an excellent account of my monetary theory and I have no complaint. But that particular sentence should be interpreted by the reader with an eye upon the author. I do not trace trade depressions to an absorption of cash! That is your view. I dont deny that an absorption of cash occurs. But I claim that to be the consequence of the depression, which is itself traced to the interaction of the relation and the multiplier. I say I was amused, because precisely the same type of, dare I call it, egocentricity occurs in a review of my book by Robertson in the Canadian Journal. Having explained how the boom is going forward he says at this point M. Harrod supposes an increase of hoarding to occur,  as tho' I (and not D.H.R.) regarded that as the significant matter!
The causal forces seem to me to arise out of the nature of investment and saving; the consequence is a decrease in the velocity of circulation which has to be explained. My explanation is that in consequence of forces connected with real investment making for depression money is shifted over from active circulation to capital account. (I notice that you independently give a similar explanation of the absorption of cash by traders.) It can only get back into active circulation if something occurs to stimulate trade. What is that something? It can only be those forces already discussed on the preceding [c] pages. It may be that the long rate will fall and provide some stimulus; but I repeat that there is no reason to suppose that it must fall sufficiently to send all the money back. This is the crucial point on which Keynes' analysis of liquidity preference, though I agree in thinking it in many respects unsatisfactory and incomplete, seems to me a real contribution, needing further development.
One little point for your next edition. P. 145 line 4 after the block of formulae. It would make for easier reading if the words "capital raised" and "investment" were transposed. 
Well there are various minor points, but I must stop now!
Yours very sincerely
2. Capital and Employment, chapters VIII, X and VII, respectively.
3. Capital and Employment, p. 119.
4. This matter was later discussed with Robertson: letter 651 , [jump to page] .
5. "But anything that Governments can do in the direction of expenditure is pitifully small" (Capital and Employment, p. 125).
6. The passage on p. 316 of Capital and Employment refers to Harrod's Relation and the widening of capital.
7. Capital and Employment, section on "Limitations of the Deepening Process".
8. D. H. Robertson, "The Trade Cycle, by R.F. Harrod" (1937), pp. 125. Harrod later commented on Robertson's and Hawtrey's interpretation of his "trapped money" mechanism explaining the fluctuations in the velocity of circulation in letter 651 to Robertson, 3 April 1937, [jump to page] .
9. The passage remained unaltered in the second (1952) edition of Capital and Employment (p. 140).
- a. ALS, four pages on four leaves, in HTRY, file 10/49 (Churchill Archives Centre, courtesy of the Master and Fellows of Churchill College, Cambridge, and the Keeper and staff of Churchill Archives Centre). Photocopy in HP (NC).
b. Ms: «some one».
c. Ms: «preceeding».
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