Bonus essay: A Comment on the Questions for Discussion [1] , [2]

1. As a preliminary to my argument it is necessary to ask what was the fundamental nature of the series of catastrophes which have overwhelmed the economic world since 1929. I notice two possible explanations.

(i) One is that they constitute a deferred aftermath of the Great War and the post-war settlements. It is possible to construct a complete chain of cause and effect linking recent troubles with war mal-adjustments. None the less I cannot subscribe to this view. I believe that mal-adjustments connected with the war aggravated the difficulties, but were not the primary cause. As evidence I cite--(a) the great increase of the real wealth of the world in the years 1925-29, which should have eased the troubles connected with the war, and (b) the fact that the recent troubles have appeared in their most severe form in the U.S.A., which, of all the great economic powers, should have suffered least from troubles specifically caused by the war.

(ii) The alternative explanation, to which I subscribe, is that the events since 1929 represent a recession in the ordinary course of the trade cycle, with which we were familiar before the war, but appearing in a more intense form than anything of which we have had previous experience. As evidence I cite the similarity in the nature, as opposed to the magnitude, of the fluctuation which has occurred, viz. the fall in prices, the relatively greater recession in the output of capital compared with consumable goods, the relatively greater fall in agricultural compared with general prices, the comparative stability of agricultural output, the banking and financial difficulties.

Further, if it is true that the causes of the cycle, still unhappily incompletely understood, are connected with the relation between the output of capital goods and of consumable goods and with the operation of the banking system--explanations of this type are most generally accepted,--then, as the importance of capital goods in the world economy and the magnitude of savings seeking investment grows, and as the influence of banking operations becomes more pervasive throughout the economic field, we should expect the amplitude of fluctuation to become greater, until suitable correctives are found. Fluctuation is the price we must expect to pay for a high level of real income, a high level of saving, a rapid rate of capital development, and a highly developed banking system, until we have discovered suitable remedies. Further, if this explanation is right, the severity of the troubles in the U.S. ceases to be a paradox, and is, on the contrary, precisely what we should expect, since the U.S. is the most highly developed country in all these respects. Her difficulties may be regarded as a foretaste of what we are to expect in this continent, as we ourselves get richer in the ordinary course of technological progress. [3]

2. It follows, in my judgment, that in planning policies we should have it in our minds that the main overhanging problem is to find a remedy for the trade cycle, and that all plans should be tested by reference to this.

We are at present in the world as a whole in the upward phase of the cycle. Some countries, indeed, have not yet reached it. No one knows when the next recession will come. But as we in England know by experience, a country which has lagged behind in the general advance (as we did in 1925-29) is not exempt when a world recession occurs.

3 It may seem unduly pessimistic to write now of the next recession. Yet another economic reverse of a magnitude equal to or greater than that following 1929 would, like another war--of which another depression might well be the cause--be such a fearful catastrophe, endangering the political structure of nations and much that we value, that every nerve should be strained to avert it.

One recipe for slumps, dear to economists, is to damp down the preceding boom. This policy is, however, to a great extent impracticable. For one thing these same economists can give no certain criterion for judging when the damping process should begin. Further I am confident that there will be general agreement that it is not psychologically or humanly possible to embark on deliberate restrictive measures, before what may be considered as a reasonable measure of prosperity has been achieved and while there is still widespread unemployment and distress. Yet it is quite possible that the present advance may have run its full course and a new depression may come upon the world, as it came upon England in 1930, while there is still a large degree of unemployment present. I regard therefore the policy of damping down the advance as Utopian, or rather, as purely academic.

On the contrary what is more likely to happen, human nature being what it is, is that as prosperity returns, Governments will be encouraged by the prevailing optimism to apply more rather than less stimulants to revive activity and to re-employ the people. There are signs of that in England now. Who will blame them? Not I.

This being so, the measures necessary to counter a depression, when the first phases of it appear, will have to be all the more radical and drastic, since the milder palliatives will have been used up in the period of prosperity. Into the nature of these I will not enter. Suffice it to say that everything should be done to maintain the power of purchasing consumable goods and the output of capital goods.

4. Depression may be combated on a national or an international scale. For these measures to be really effective international co-operation is necessary. But I ask you, what chances are there of securing international agreement for the rapid simultaneous application of drastic corrective measures to combat the next depression? Each nation, while urging international co-operation, should be ready to act on its own account.

5. For this purpose vigorous expansionary measures will be necessary; purchasing power must be maintained. Above all timely and rapid action will be essential. In these circumstances it would be fatal for everything to be delayed by reason of the necessity of maintaining an unalterable gold standard.

I appreciate the advantages of exchange stability and will say something under that head presently. I believe that much may be done in the coming period to secure it. But what is essential is that the country which has decided to do all it can to combat another depression, should not be committed in honour to maintaining a given par of exchange at all costs. In the face of a great fall of world prices, the maintenance of the internal level of prices and internal purchasing power, may necessarily entail some fall in the external exchange rates. If the country were thought to have pledged itself to maintain a fixed rate, and foreign deposits were held on that tacit or expressed understanding, there would be a great reluctance to abandon the rate, months, even years, might be spent in haggling over the matter, and the time for suitable action would then have gone by. Then, when the par was finally broken, and foreign depositors had to cur their losses, most undesirable repercussions would occur in the [b] outside world and the depression would be aggravated. How much better had the foreign deposits never come, or, if they came, were made on the express understanding that they were subject to the risk of variation in the par of exchange. I am thinking of my own country primarily, but the argument applies to Belgium also. Let there be no pledge that the new standard is fixed and immutable.

6. It must not be supposed that currency depreciation associated with a policy of combating the boom [4] is necessarily selfish. A distinction should be drawn between depreciation that occurs as a corollary of a vigorous internal policy of expansion and depreciation that is introduced as a lever to effect a revival. The first of them is not necessarily harmful to other countries. The second may be regarded as unneighbourly and is to be condemned. (This, of course, does not refer to depreciation by the gold-bloc or ex-gold-bloc countries, whose rates of exchange have been, by general agreement, at a level above the equilibrium.)

If the par of exchange is fixed and a world depression is occurring, a particular country may have to adopt restrictive measures, e.g. high bank rate, in order to protect its exchange. Finding its exports reduced, it may have to restrict purchasing power at home in order to reduce imports or foreign lendings by an equal amount. The external world is injured by this deflationary action. If, instead of this, the particular country refuses to adopt measures of internal restriction in order to reduce purchasing power, but on the contrary expands, then its exchange may have to depreciate. It is true that in consequence of this the external world may find exports fired at it at cut prices, but on the other hand the power of this country to buy imports from the external world is greater than it would otherwise have been, and what the external world loses in one way it gains in another. Generally, it is probable that if by these means the particular country succeeds in maintaining its own activity at a higher level than otherwise, the external world will benefit. Deliberate depreciation regarded as a primary weapon for improving a country's position is different, since there is no guarantee that its buying power will be at once increased, and it would be proper to endeavour to secure international agreement that such predatory depreciation should not be adopted. (Subject to the qualification at the end of the last paragraph above.)

7. The primary desideratum is that no par of exchange should be regarded as immutable. There remain the alternatives of a provisional gold standard, or a free standard protected from excessive fluctuation by an Exchange Equalisation Account.

So far as the convenience of traders is concerned, I do not believe that there is much to choose between these. So long as large day-to-day fluctuations are prevented by the Equalisation Account, I do not believe that the absence of a fixed par is felt to be a severe nuisance by traders.

In favour of the free system, it may be said that it prevents forces coming into existence likely to resist a movement of the exchange rate, if and when that becomes necessary or desirable later. It might be possible to adopt a compromise by which the Equalisation Account declared a fixed par for short (say, three-monthly) periods. Whether such a system would entail more or less speculation than a free system I must leave it to the experts in foreign exchange dealings to judge. One drawback to this system is that if the Equalisation Account were regarded as pledged, it might be in certain circumstances, even within the short space of three months, be compelled to ask the Central Bank to adopt restrictive measures.

8. It is urged that the free system might be a hindrance to foreign lending. I agree with Mr. Henderson that it is not clear that this is necessarily a disadvantage. [5] The magnitude of international trade in the future is still uncertain. So long as this is so, there is danger in making international lending too easy. For there is danger in a situation in which the flow of foreign lending or the interest thereon constitutes a very substantial fraction of the total volume of international payments falling due.

Nor am I clear that the free system is, in all circumstances, a large obstruction to foreign lending. It should not be so if the authorities in the country adopting it declared a policy of maintaining continuity in the value of the currency in terms of commodities. There is advantage in knowing that in the event of a great fall of prices occurring, the real burden to the debtor of his obligation in respect of the loan will not be correspondingly increased. Such an assurance might actually prove welcome to would-be borrowers.

9. As an economist I am in favour of absolutely free trade, while recognising that its introduction in the near future is not practicable. I regard this as perfectly consistent with the view that nations ought in the present situation to take independent action to combat depression. And I hold it to be most unfortunate that confusion has arisen on this point in the public mind, namely, that a national determination to combat trade fluctuation by vigorous methods regardless of what other nations are doing, is supposed to be necessarily associated with economic isolationism.

The trade cycle is a world phenomenon. Every effort, isolated or co-operative, to combat it is in the interest of the world. A successful effort in a particular country is likely, save in exceptional circumstances, to mitigate conditions outside.

It is true that international trading connections may make the problem of the internal reflationary policy more difficult, but it does not follow that this increase of difficulty would be such as to justify sacrifice of the advantages derived from the trade, in order to avoid it.

10. I have suggested that when the depression is threatening, each nation should take severally (and jointly if possible) vigorous measures to combat it. One such measure, from its own point of view, is the imposition of new tariffs or quotas. Many nations have recently been driven to that by the state of their balance of payments. I suggest, however, that this is the most undesirable of all methods, for it aggravates the difficulties of others.

At first sight it might appear that exchange depreciation and the imposition of new tariffs have equally bad effects on the outer world, since each tends to restrict the imports of the country. This, however, is fallacious. (I am not discussing here the bad effects of an unexpected depreciation, due to the losses of foreign depositors, vid. sup.) The fallacy may be exposed by reference to the new position of equilibrium. If a tariff or quota has been imposed, there is a fresh obstacle to trade, which was not present before, and, given any particular level of activity in the tariff-imposing country, there will be less international trade than would otherwise have taken place. Exchange depreciation imposes no such obstacle. Trade in both directions is as free as before. What depreciation does is to enable a country which has a fairly rigid cost structure--and all countries have that in some degree--to maintain its level of activity in the face of falling world prices, and consequently to maintain its level of international trade.

11. I conclude as follows:

(i) It is most undesirable that any nation should be so committed to a par of exchange, that it would be hampered in promoting internal measures of reflation in the event of a world recession.

(ii) Every effort should be made to eliminate day-to-day exchange fluctuations by the operation of an Exchange Equalisation Account.

(iii) Exchange depreciation as a weapon for promoting recovery (as contra-distinguished from depreciation which is the inevitable effect of successful recovery measures) should be eschewed. (I do not refer to countries whose exchange rates are already too high for equilibrium.)

(iv) Every effort should be made to re-open the channels of international trade, by the reduction of tariffs, quotas and prohibitions. [6]

R. F. Harrod

  1. a. Note on the copy text and the version in Compte-rendu des travaux de la Réunion d'économistes organisée par la Chambre de commerce d'Anvers, les 11, 12 et 13 juillet 1935.

    b. .Printed text: «the the».

  1. 1. Paper read before the Meeting of Economists organized by the Antwerp Chamber of Commerce, held on 11-13 July 1935, with the participation of F. Bauduin, M. Ansiaux, L. Dechesne, G. De Leener, R. Miry, B. S. Chlepner, G. Craen, L. H. Dupriez, R. P. Muller (Belgium), Bertrand Nogaro (France), Harrod, Henderson and Keynes (Great Britain), Ohlin (Sweden) and G. M. Verryn Stuart (Netherlands). The proceedings are published as Compte-rendu des travaux de la Réunion d'économistes organisée par la Chambre de commerce d'Anvers, les 11, 12 et 13 juillet 1935. Report of the proceedings of the Meeting of economists, held at the Antwerp Chamber of commerce, on July the 11th, 12th, and 13th, 1935, Brecht-Anvers, Typ. Braeckmans, 1935.

    The meeting aimed at finding some common terms among famous economists on the means for stabilizing currencies and reviving international trade, in a context of serious differences in the policies pursued by different countries which were characterized by nationalism rather than international co-operation (Préface, in Compte-rendu des travaux de la Réunion d'économistes).

    Harrod was invited at Keynes's suggestion. Keynes was asked in January to take part in the conference by A. Le Jeune, and was invited to suggest the names of other British economist who could participate (JMK PS/6/21). Keynes at first suggested Henderson (10 January 1935, in JMK PS/6/22), Le Jeune inquired about Robertson (JMK PS/6/26-27), and Keynes added Kahn's name (28 March 1935, in JMK PS/6/28). The organizers of the conference decided to invite Henderson and Kahn (JMK PS/6/32), and Keynes forwarded the invitation to Kahn (9 April 1935, in JMK PS/6/33). Kahn seems to have accepted at first and later changed his mind, as on 18 June Keynes anticipated to Harrod that he might be invited to participate in the meeting (letter 450 R). Keynes suggested that Harrod could present an updated version of a memorandum originally written for the Royal Institute of International Affairs (letter 452 R, and in particular note 1 for references to previous correspondence on the Chatham House memorandum. For a comment see note 3 to this essay). Harrod's note was sent to Keynes, who approved of it on 6 July (letter 455 R).

    2. The questions for discussion were:

    • 1st question: Monetary policy and International trade.

      a) In what measure does the development of International relations depend on the restoration of an international monetary system, and

      b) Consequently what monetary policy should the countries of the world pursue?

      2nd question: The future of International Trade.

      Assuming the monetary problem to be solved, what are the prospects of a return to a greater freedom in trade, taking into account the evolution which has taken place in international trade during the last few years and structural changes which such an evolution does and may still entail? (Report of the proceedings of the Meeting of economists, p. 8).

    3. This preliminary section follows in content the premise of Harrod 1933 Chatham House memorandum on "Continuity of Values and the Long-Term International Problem" (essay 13 ): on the explanation of the world slump based on the consequences of the war see [jump to page] , on its subsumption under the heading of the trade cycle see [jump to page] . This suggests that Harrod may have indeed followed Keynes's suggestion to make a paper out of a proposed Addendum to the Royal Institute of International Affairs' report on The Future of Monetary Policy (1935), which Harrod did not publish (letter 452 R). The Addendum is not extant, and cannot be compared to the Antwerp note. However, the subject of no interest loans, which failed to convince both Robertson and Keynes (letters 370 and 386 , respectively), was not taken up in the version read at Antwerp. The argument was discussed again and expanded a few months later, in a lecture on "The Choice of a Currency Policy" delivered before the British Import Union in Copenhagen on 10 January 1936 (essay 16 ).

    4. Harrod surely meant to write "recession" or "depression".

    5. In his paper, Henderson pointed out that technological progress tends to homogenize production conditions in different countries or area (for instance, the natural humidity which favored Lancashire as a cotton spinning and manufacturing region can be artificially recreated, thereby cancelling the natural advantage derived from climatic peculiarities), and thus to reduce the advantages deriving from international trade. He concluded that international investment, which "in the nineteenth century was intimately connected with the development of the division of labour between the old world and the new", was bound to diminish, "no matter what monetary system may be established" (H. D. Henderson, "Memorandum", in Report of the proceedings of the Meeting of economists, pp. 49-51).

    6. In the general discussion which took place on the following two days, Harrod further specified his thought as follows:

    • I do not want to go into a discussion as to whether and how far it was possible for foreign countries to adapt themselves [to Britain's September 1931 departure from gold]. But even leaving that on one side, one might get a general agreement on the statement that this departure from the gold standard did have bad repercussions: I accept that.

      I should like, having accepted this, to contrast it with the question as to how far the present fluctuations of small magnitude, which are still occurring in the pound sterling, have the same detrimental effect, and I should like to suggest that these fluctuations are not producing a disastrous effect in the outside world. I believe that for men engaged in commerce, the most damaging effect of the present situation is the uncertainty whether France will or will not, and, if so, when she will, depart from the present par of exchange.

      I should like to link these two points together and say of both cases, that if any country sticks to a particular gold parity that cannot well be sustained in the general economic situation, the result must have a depressing effect on trade transactions, both owing to the sudden depreciation itself when it comes, and owing to the endeavours of the country in question to sustain a parity it cannot well keep up, by means of restrictive measures, protection and quotas.

      Now, what I would suggest is that the only means for preventing the unfortunate effect of measures of protection and quotas, is to allow those moderate fluctuations which do not cause serious damage to people engaged in commerce and industry. My reasons for that I have given to some extent in the memorandum I have submitted; I would only mention one or two further points.

      I believe we have to face up to the fact of a tendency to more severe world fluctuations in economic activity; that with these fluctuations there is a big chance of future disequilibrium in the balance of trade and the balance of payments; that such fluctuations produce a most severe affect on the relation between particular sets of prices--e.g. prices of raw materials and of finished goods--and also on the interest and profit from foreign investments.

      All these factors, which threaten us in the future, as it seems to me, are likely to produce a situation in which, when such fluctuations occur, certain countries will be subjected to severe trials in regard to their balance of trade and balance of payments.

      Now, when such big fluctuations occur, the question is bound to be raised: Can such and such country maintain its present standard? And the mere question whether a country will be able to maintain its standard has a bad effect on the other countries and on the world's trade generally.

      I think a much better way to meet the situation is to allow the rate of exchange to adapt itself naturally to events.

      I do not believe that in England, during the three years before 1925 or during the last three years, we have felt acutely any evil effects of fluctuation.

      For these reasons, I have the feeling that until such scheme as you have international cooperation on a great scale sufficient to prevent the actual fluctuations in the level of world economic activity, it is very dangerous for any country to commit itself to an absolutely fixed par.

      I am not opposed to a scheme of temporary, provisional stabilization, but could not accept it, if thereby a country is committed to an interior monetary policy which involves raising the bank rate of interest; and I do not want stabilization of a kind that leads the country to pledge itself in any way to maintain a fixed par.

      Finally I should like to say that we ought to condemn anything like a depreciation as a means to effect a revival or the use of a change in the foreign exchange rate as a means of stimulating the economic system. I think no manipulation of the nature of deliberate devaluation, used as a weapon to promote recovery, should be accepted as a part of an agreed policy; but a movement, which occurs as a result of the factors I have mentioned, ought to be recognized as legitimate. (Report of the Proceedings of the Meeting of Economists, pp. 106-108).

    On the following day (12 July) he added:

    • I believe that one of the most de-stabilizing factors in the existing situation, with the existing instability of trade and the protectionism in the world as a whole, occurs as a result of countries being too definitely committed to a given par of exchange. I am thinking not only in terms of the American question, but also of the possibility of further fluctuations at later dates.

      I think it is important to avoid the situation in which a country of special importance gets into a condition when doubt is possible as to its being able to sustain a par to which it is definitely engaged. That is a state of things to avoid and therefore I support the notion of the provisional character of the stabilization.

      I do not think one ought to regard the desire of England to have something of a free hand, as being in any sense hostile to the general international interest. On the contrary, I feel that progress towards a return to prosperity in England, and also in countries whose currencies are more or less loosely associated with the pound sterling, is of the greatest importance from the point of view of international recovery and that any halt caused to their progress would do more harm in the international trade position, than a certain moderate change in the par of exchange between, say, the sterling currency and gold. (ibid., pp. 151-152).


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