P1. Monetary Policy [1]

[Letter to The Economist, 4 June 1932, vol. 114(2), pp. 1242-43]

4 June 1932

Sir,--We may be grateful to Professor Robbins for having pointed out, when opposing reflation in your current issue, that an attempt to get back to the 1929 level of prices "involves something more than passive non-interference with naturally cheap money." [1] That should be plain enough; yet the situation gets graver and nothing more is done or promised.

Is it not time to admit frankly that we ought now to adopt the two expedients which are generally recognised as efficient instruments of monetary expansion? In the first place the Bank of England should try the experiment of purchasing securities on a great scale and loading up the joint stock banks with funds. The Federal Reserve Banks have purchased more than half a billion dollars' worth of United States securities in the last six weeks. Some time must elapse before the effects of this policy can be judged. [2] There are certain conditions peculiar to the United States at the moment, and not present in Great Britain, which must retard the natural effects of this policy there. In England the field stands clear for the experiment. The possibility must be recognised, however, that stagnation is now so great that the joint stock banks might fail to put the money placed at their disposal into active circulation.

Secondly, there is the surer and universally recognised expedient of government action. No one has seriously doubted that a government is able to inflate, and, therefore, to reflate. Few seriously doubt that reflation is urgently needed to save us from calamity. Why, then, is government action not only not advocated, but hardly mentioned? The mere suggestion of it is apt to evoke a host of foolish alarms. Inflationary orgies are recalled. History does not, however, show that controlled reflation tends to degenerate into inflationary disorder; since it provides no examples of the cause, it can teach us nothing about the probable effect. Prima facie there is no reason why an expansive movement, undertaken by a strong government that knows its own mind, should get out of control. The expansion may be undertaken either by the outright remission of taxation without countervailing economies, or by the adoption of new constructional work, financed by loans from the banks. Both methods may be attempted. Experience alone can show which would be the more effective in achieving the desired result of a rise in general prices. The important point is that so long as prices stand below the 1929 level, the government should disburse to its citizens more than it takes from them and thus get more money into circulation.

May I add a few words on the external situation, which seems to merit more attention in connection with our monetary policy than it usually receives. There are two sides to the problem with which we are faced, namely, how in the existing calamitous state of the world we can do the best for ourselves, and how we can assist the world to recovery. The second of these is usually thought of as necessarily involving international co-operation; everything should certainly be done to secure it. But this country is of such importance in world finance and trade that its every act of policy has some appreciable effect on the world situation. Unfortunately we have since last August struck two major blows, one of them willy nilly, at the rest of the world, by the depreciation of sterling, and by the tariff. [3] It is of great importance that we should henceforward do nothing tending to affect the outer world adversely, until there are some signs of recovery there. This means that we should not allow our internal reflation to depress sterling further; we should abandon altogether for the time the attempt to force our exports upon a shrinking world market; such an attempt can now only make the external situation more critical. Once there is world recovery our exports will float up on the rising tide; it will be time enough then to think of fixing sterling at such a level as will give our exporters their fair chance. This is not the moment to try to stimulate our exports by means of currency depreciation.

The reflation, if genuine and effective, should provide a strong stimulus to our industries working for the home market. It will, of course, also tend in the direction of increasing imports. This is a crucial matter. The external world, like this country, needs a rise of prices. The only influence we can have on world prosperity operates through our willingness to buy and sell goods on the world market. All countries, especially the weaker ones, are striving to obtain a favourable balance of trade, and by this very attempt are rendering it impossible for each to succeed. For some countries this struggle is inevitable, since they have external non-trading liabilities to meet, and cannot cover these by borrowing in the existing lack of confidence; they are seeking to secure a favourable balance out of dire distress. But others are actuated by a misplaced purism. It is these countries alone which can relieve the situation by being willing to endure an adverse balance for the time, and it is their paramount duty to do so. A notable example is Great Britain. Thus, if internal reflation tended to raise the volume of our imports, we should not try finally to burst the glutted world by forcing out more exports, but should be content to support sterling at a level not lower than its present one, and cover our adverse balance out of the abundance of our available assets. So and only so, can we contribute our mite towards world price recovery.

The exchange equalisation fund [4] which was hailed on many sides with unreasonable haste, appears in fact to be a new engine of deflation. Apart from technicalities concerned with profits and loss, its main object is to prevent the foreign funds which have recently been flowing in from exerting their primary effect in expanding our circulating medium. It enables the Bank of England to pursue a neutralising policy on a grand scale, to sterilise the foreign funds, as France sterilises her gold. The normal primary effect of the inflow would be to raise by an equal amount the liabilities of the Bank of England and so increase the cash basis of the country. Instead, the money has been tucked away, and the calamity of a credit expansion in England averted! Meanwhile the authorities feel very dashing, because they are holding sterling down. It is a curious result of the new monetary experiment we have tried during the crisis, that it should enable us to pursue the unique policy that is calculated to have a depressing effect both at home and abroad simultaneously.

To underline my view of our proper external policy, may I contrast it with one which appears to be widely held? If I asked how they hope that the world might be salvaged, there are many, I think, who would answer as follows. The leading powers should get together and, having abolished Reparations and War Debt payments, should once more carefully but bravely elaborate a scheme for lending to distressed nations. To do this, they must first have set their own house in order, and have an export surplus to make it possible for them to lend. When England, for instance, has depreciated sterling enough and imposed tariffs enough, she will at length, it is hoped, have an amply favourable balance; and, having obtained this, she will come forward and, with a generous but far-seeing policy, lend magnificently to a languishing world. Such a notion is surely quite topsy-turvy. The process of obtaining the favourable balance creates the distress which the loan is subsequently used to relieve. Meanwhile, the world is plunged into profounder gloom and fresh international indebtedness quite unnecessarily piled up. I hold that what the strong nations can and ought to do for the weak in a time of crisis is not to lend them money, but--what is diametrically opposed to that--to be prepared to buy their goods and endure for the time an adverse balance on current account. What is the much talked of international co-operation to mean if not precisely this--that the strong nations should agree to let in the goods of those nations, who must have a favourable balance on trading account to avoid bankruptcy?

With a resolute determination to reflate and to maintain the external value of sterling, England should be able to do much for herself and something for the rest of the world. Is it too much to hope that our leaders might be inspired with such a determination?--I am, &c.

R. F. Harrod

Christ Church, Oxford

  1. 1. L. Robbins, "Monetary Policy", letter to The Economist, 28 May 1932, p. 1188. This correspondence was stimulated by a leading article in The Economist of 7 May advocating direct action by the government and the Bank of England for a rise of sterling prices by 30 per cent, i.e. to the price-level of 1929 ("Factors in Recovery. 1. Monetary Policy", pp. 1007-8). Robbins commented on 14 May (p. 1081), O. T. Falk criticized Robbins on 21 May ("Monetary Policy", p. 1140), and Robbins rejoined on 28 May (pp. 1188-89). Robbins replied to this letter by Harrod on 11 June (p. 1295), and Harrod further contributed to the debate with a second letter, published on 18 June ("Monetary Policy", 1932:3 , reproduced as press item 2 ).

    Offprints of Harrod's letter were sent to ÆRobert Boothby (Boothby to Harrod, 14 June 1932, in HP IV/99-113/2). The letter was also commented upon by an unidentified member of Parliament (letter from the House of Commons, 6 June 1932, in HP IV-1263), by ÆErnest Dick (letters 239 R and 247 R of 7 June and 5 July 1932), ÆMelchior Palyi (letter 245 of 28 June) and ÆKeynes (letter 238 of 6 June). Harrod sent it and commented upon it, and upon the follow-up published in The Economist on 18 June, in two long letters to ÆWalter Runciman, President of the Board of Trade (letters 240 and 243 of 10 and 22 June 1932).

    2. Harrod later evaluated this operation as highly beneficial: see the collective letter 329 to ÆPresident Roosevelt, [jump to page] .

    3. Refers to sterling's departure from gold in September 1931, causing a devaluation of approximately 30 per cent with respect to the dollar by the end of the year, and to the introduction of the Import Duties Bill of February 1932, which imposed a general custom duty of 10 per cent. on most imports, only those from the Empire being exempt (rates on various kinds of goods were later modified on the advice of the Import Duties Advisory Committee).

    4. The Exchange Equalisation Account was established in the April 1932 budget to stabilize sterling in the short run.


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