P9. Banking Policy and Stable Prices (2) [1]

[Letter to The Economist CXIX, Monthly Book Supplement, 10 November 1934, p. 8]

10 November 1934

May I reply briefly to my critics? [2]

I am in complete agreement with Mr Stafford's first point. [3] In fact, I made it in the first draft of my original letter to you, but deleted it out of respect for your space. Owing to the plurality of possible index numbers, my principle does not exclude general prices falling as productivity increases. Whether this or stable prices in the ordinary sense is desirable, depends on a wide variety of considerations, which I shall not attempt to summarise. What I do claim to have shown is that the dictum that new loanable funds should be equated to new savings cannot validly be employed as an objection to a regime of stable prices in the ordinary sense. Mr Stafford's second point I am afraid I am unable to apprehend, perhaps owing to the brevity of his exposition. [4]

With Dr Kaldor's interesting letter I am in entire agreement. [5] It reinforces my point that the dictum that new loanable funds should be equated to new savings cannot serve to decide whether prices should be held stable or allowed to fall as productivity per head increases--i.e., in Mr Stafford's language, cannot serve to determine which index number of prices should be held stable.

Mr B arger's letter, on the other hand, I must regretfully characterise as fallacious. [6] If the banks are pursuing a policy of stable prices, then, if the public decides to add to its holding of money--in Mr Barger's words, "decides to hoard"--this does not involve a fall in the velocity of circulation. It follows that his last two sentences are incorrect and his conclusion does not stand. [7]

Dr Haberler [8] propounds a criticism based on the view that if the value of the community's money stock rises as the consequence of a price fall, this does not absorb savings. [9] This criticism requires a definition of savings somewhat different from, and perhaps more natural than, that implied by my first letter. I accept the criticism, but observe that Dr Haberler does not trace out its consequences.

On his definition of savings, the dictum that new loanable funds should be equated to new savings becomes completely sterile, because it is satisfied whatever banking policy is adopted; it cannot, therefore, be used as an objection to the policy of stable prices. The value of savings absorbed in extra monetary holding (other than gold) must always be equal to the value of the new bank credit extended in any period. The cross-entry must always be equal to the entry.

Dr Haberler is correct in supposing that, on his definition, if there is no fresh extension of credit, [10] there will be no cross-entry, and the dictum will be satisfied. [11] But he does not consider a regime of stable prices, and thus avoids having to admit that then there would be a cross-entry for absorption of saving in monetary holdings equal to the entry for expansion of credit, [12] and that the dictum would be satisfied in that case too. He says nothing to rebut my contention that the objection to stable prices under consideration omits the cross-entry and is therefore fallacious. [13]

My reason for implying a somewhat curious definition of savings in my first letter was that I supposed that those who sought to use this dictum as a criterion of banking policy must wish to imply a definition of terms such as that the dictum is not satisfied by any and every banking policy. But I find that Dr Haberler, at any rate, does not so wish. I joyfully accept his position and only point the moral. We must abandon all attempts to use this dictum to judge between banking policies, since it necessarily acquits them all, and we must revert to more effective methods of tackling the problem of banking policy.--I am, Sir, etc.,

R. F. Harrod

Christ Church, Oxford. October 31, 1934.

  1. 1. Of this letter, a previous partial draft exists. It was limited to the part responding to ÆHaberler's criticism, and was sent to Haberler for comments on 21 October 1934 (letter 381 ; see note 2 ). Haberler sent back to Harrod a typed transcription of it on 25 October (CcTL, two pages on two leaves, in HP IV-395-422. The first page is marked "EC." in the upper left corner): see letter 384 , [jump to page] . The relevant differences are reported in notes 7 , 8 , 10 , 11 , 12 and 13 below.

    2. This letter replies to the criticisms raised by Harrod's letter "Banking Policy and Stable Prices" published by The Economist a month earlier (Harrod 1934:9 , press item 8 ). See for context note 1 to press item 8 .

    3. Stafford's first objection was formulated as follows:

    • If it is true "that the value of additional bank loans should be equal to the value of the increment in the value of the community's holding of money", then it is important to specify how these values shall be measured, and, therefore, which price level, out of an infinite number, should remain unchanged. If we measure the values in terms, say, of given wages, then fluctuations in wholesale or retail prices cease to be significant in this connection. And it may remain true that stability is achieved with falling (wholesale) prices. Whether one should use some such method of measurement I am not prepared to say. (J. Stafford, "Banking Policy and Stable Prices", The Economist CXIX, Monthly Book Supplement, 10 November 1934, p. 7)

    4. Stafford's second objection was stated thus:

    • Even if the values are measured against a given selection of goods, fluctuations in the prices of these goods will not make impossible equality between the two values. The proof of this is not easily expressed in a summary fashion. Perhaps illustration will serve as an indication of proof. If the community hoards £10 of its receipts, the banking system can make this good by lending £10 for "investment" purposes. Equality is obtained. The price level then falls as the result of increased efficiency. A further £10 is hoarded and £10 lent. Equality is again achieved, but at a different price level; and so on, until £100 is abstracted from circulation and £100 put into circulation. I am by no means prepared to say that this equality between the values is as easy to achieve in practice as in the lecture room. And perhaps, with reasonable assumptions, a closer approximation is more likely than strict equality. But, without knowing the assumptions made, can equality be said to be utterly impossible? (J. Stafford, "Banking Policy and Stable Prices", p. 7)

    5. ÆN. Kaldor, "Banking Policy and Stable Prices" (1934).

    6. In Harold Barger's view,

    • if for some reason the public does decide to hoard, it is, of course, generally admitted that, to preserve equality between savings and investment, the banks should expand their lending. But here the action of the banks will merely offset a tendency for prices to fall more rapidly than productivity is rising. Mr Harrod does not seem to realise that the hoarding of cash involves a fall in the velocity of circulation--a phenomenon which has no necessary connection with an increase of productivity. If he wishes to stabilise prices at a time when both of these things are happening simultaneously, he must not only provide enough money (1) to offset the fall in velocity due to hoarding, but must further increase the money supply (2) in proportion to the rise of productivity. The first of these prevents deflation; the second is definitely inflationary. ("Banking Policy and Stable Prices", The Economist CXIX, Monthly Book Supplement, 10 November 1934, p. 8)

    7. The draft sent to Haberler begins with the following paragraph:

    • First, may I say that I agree that "if there is a case for stable prices, ... it rests on considerations other than those advanced" by me. In my letter I wrote, "I am not prepared to argue that the equating of loanable funds to savings is the sole, sufficient, or even necessarily the proper objective of banking policy". I was neither concerned to defend the dictum that loanable funds should be equated to savings as the proper criterion of banking policy, nor to make the case for stable prices. What I did seek to show was that the dictum can only be satisfied by a regime of stable prices. That was my limited object.

    8. In the draft sent to Haberler, the paragraph concluded as follows: "I will not attempt to rebut this criticism, for, if I did so, my argument would be concerned with the most suitable definition of the word saving; and, since the proper course of action cannot turn on the meaning we choose to assign to words, my attempt would be of no value."

    9. Haberler interpreted Harrod's expression "the value of a community's monetary holdings" as meaning "the value in terms of goods of the total existing stock of money", and argued that if this magnitude increased due to a fall of prices, it

    • does not absorb any savings. No money is hoarded, people spend the same amount of money per unit of time, although the same amount now buys a larger volume of goods (real income). If anybody wants to save a certain proportion of his income, it is impossible to see why a part of this amount should be "held of the loan market" by the fact that "the value of the monetary holding" in the above-defined sense has risen.

    Haberler suggested that Harrod was confusing between "the real value of monetary holdings" and "the proportion of real income or resources which the community chooses to keep in form of money (i.e., `k' in the Cambridge equation)" ("Banking Policy and Stable Prices", The Economist CXIX, Monthly Book Supplement, 10 November 1934, p. 8).

    10. The words "if there is no fresh extension of credit" substitute the words "with a constant amount of money policy" in the draft sent to Haberler.

    11. In the draft sent to Harrod, the following sentence was inserted at this point: "He omits to mention that, again on his definition, the dictum is satisfied by any monetary regime whatever."

    12. The clause "for absorption ... of credit" did not appear in the draft sent to Haberler.

    13. The draft sent to Haberler concluded as follows:

    • May I say, in conclusion, that this whole way of approaching banking policy proves, when subjected to proper tests, to be completely unfruitful, and its further use can only serve to confuse the public mind. By the omission of a cross-entry, it has already beguiled a number of people into believing that there is an objection to the policy of stable prices, which does not in fact exist. This is not to say that there may not be other objections. The moral is that we should revert to more effective methods of tackling this problem.

    It should be noted that the fact that the statement in Harrod's first letter to The Economist implied an unusual definition of savings was pointed out to Harrod by Kahn on 22 October (letter 382 , [jump to page] ) and Haberler on 25 October (letter 384 , [jump to page] ) after the draft of this letter was sent to Haberler.


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