P20. Banking and Trade Recession (1)
[Letter to The Economist, 9 July 1938, p. 68]
9 July 1938
To the Editor of The Economist
Sir,--Your article on Banking and Trade Recession  summarises the situation as follows:--
I suggest that this is too easy a view, that more might have been done and still can be done. While we may agree that short-term rates could not well be lower, this does not exhaust the possible influence which the banking system can exert by operating upon the quantity of credit.
Your readers are already aware of the variety of reasons for supposing that we are well on the downward slope of a recession. The re-armament programme may save us from sinking as low as in 1931; the situation in the United States may possibly improve as surprisingly and as rapidly as it deteriorated last year. But it would surely be foolishly optimistic to imagine that, in the absence of a deus ex machina, we shall escape with just as much recession as we have already had and no more, and that the process of the vicious spiral of recession will fail to follow that melancholy course which the universal experience of the past marks out for it. Surely the setback is now sufficiently definite and protracted to justify trying every possible expedient.
In a general way, I am of the opinion that a large-scale programme of public works is alone sufficient to avert a modern slump. But the present situation is a little peculiar, since we already have a moderate-scale programme of public works in the form of re-armament. It is possible that a reflationary banking policy might be more effective as a salvage measure, if operated in conjunction with re-armament that it would be if unsupported by public loan expenditure.
What I have in mind is this.  The effect of a year of doldrums on the Stock Exchange has been that the new issue market has been unable to absorb any issues other than the most superfine. I suggest that a reflationary credit policy might be brought to bear upon this market. Indeed, there is much to be said for the view that the normal modus operandi of monetary reflation is via the long-term capital market.
What is required is that the joint-stock banks should be put into a position in which they feel that they can safely increase their investment portfolio by a considerable sum, say, £100,000,000. For this there are two pre-requisites, namely (i) an increase in their cash basis and (ii) an increase in their other more liquid assets. The first can be brought about by the Bank of England, the second by the Treasury.
The London clearing banks' holding of investments has recently stood at about 27.8 per cent. of their total deposits. We may take the average for 1935 of 30.8 per cent. as the greatest they feel disposed to allow. (It is assumed that the joint-stock banks will co-operate in the reflationary policy.  ) If the Bank of England provided £15,000,000 of additional cash (by the open-market purchase of securities) and the Treasury increased the average number of Treasury bills available in the market sufficiently to allow the joint-stock banks to hold an extra £35,000,000, they could buy £100,000,000 of additional long-dated securities, without their investments rising above 30.3 per cent. of their total deposits.
The argument is that the injection of £100,000,000 of new money into the Stock Exchange would relieve the doldrums and improve the issue market. It may be that this sum would be sufficient. But all the figures I have given could be multiplied by 3, without the policy producing any strain in our normal mechanism of credit control.
There are two possible obstacles to this reflationary policy having a reviving influence: (i) the stock market may be so bearish that a new set demand for securities of £100,000,000 or £300,000,000 would have no appreciable effect on prices; (ii) it may be that the frozen condition of the new issue market in the last year has not been an important obstacle to capital expansion. I do not believe that there is anyone who can speak with authority on either of these points.
But surely the experiment is worth trying. If all proceeds normally, in a year's time our economic and social and political structure will be subject to the painful and dangerous pangs of a great recession. Surely every experiment is worth trying. It is probably too late for the Government to develop a large-scale scheme of public works, even if it were willing to do so. In favour of my proposal I plead that it can do no possible harm. And it is not unreasonable that it might just save the situation.
I am, etc.,
R. F. Harrod 
Christ Church, Oxford.
2. Harrod had been thinking along these lines for some time, as a similar suggestion was expressed in letter 762 to ÆJoan Robinson of 14 March 1938, and even earlier in letter 334 to ÆCannan of 12 December 1933. The argument was taken up again in an article for The Times on "Meeting a Trade Recession", published on 11 August and reprinted as a pamphlet (Harrod 1938:11 , here reproduced as press item 22 ).
3. Harrod later qualified this statement, and a similar one expressed in "Meeting a Trade Recession" ( 1938:11 : press item 22 , [jump to page] ) in a letter to the Chancellor of the Exchequer, whom Harrod had sent a copy of the articles (Harrod to ÆSimon, 11 August 1938, letter 804 , [jump to page] ) .
4. This letter stimulated comments from ÆKeynes and G. E. Ross, to which Harrod replied with a further letter with the same title published on 23 July (Harrod 1938:10 , here reproduced as press item 21 : see in particular notes 1 and 2 for references to Keynes's and Ross's comments).
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