Keynes and Hawtrey: The Treatise on Money and Discovering the Multiplier

In my previous post on Keynes and Hawtrey, I tried to show the close resemblance between their upbringing and education and early careers. It becomes apparent that Keynes’s brilliance, and perhaps also his more distinguished family connections, had already enabled Keynes to begin overshadowing Hawtrey, four years his senior, as Keynes was approaching his thirties, and by 1919, when Hawtrey was turning 40, Keynes, having achieved something close to superstardom with the publication of The Econoomic Consequences of the Peace, had clearly eclipsed Hawtrey as a public figure, though as a pure monetary theoretician Hawtrey still had a claim to be the more influential of the two. For most of the 1920s, their relative standing did not change greatly, Hawtrey writing prolifically for economics journals as well as several volumes on monetary theory and a general treatise on economics, but without making much of an impression on broader public opinion, while Keynes, who continued to write primarily for a non-professional, though elite, audience, had the much higher public profile.

In the mid-1920s Keynes began writing his first systematic work on monetary theory and policy, the Treatise on Money. The extent to which Keynes communicated with Hawtrey about the Treatise in the five or six years during which he was working on it is unknown to me, but Keynes did send Hawtrey the proofs of the Treatise (totaling over 700 pages) in installments between April and July 1930. Hawtrey sent Keynes detailed comments, which Keynes later called “tremendously useful,” but, except for some minor points, Keynes could not incorporate most of the lengthy comments, criticisms or suggestions he received from Hawtrey before sending the final version of the Treatise to the publisher on September 14. Keynes did not mention Hawtrey in the preface to the Treatise, in which D. H. Robertson, R. F. Kahn, and H. D. Henderson were acknowledged for their assistance. Hawtrey would be mentioned along with Kahn, Joan Robinson, and Roy Harrod in the preface to the General Theory, but Hawtrey’s role in the preparation of the General Theory will be the subject of my next installment in this series. Hawtrey published his comments on the Treatise in his 1932 volume The Art of Central Banking.

Not long after the Treatise was published, and almost immediately subjected to critical reviews by Robertson and Hayek, among others, Keynes made it known that he was dissatisfied with the argument of the Treatise, and began work on what would eventually evolve into the General Theory. Hawtrey’s discussion was especially notable for two criticisms.  First Hawtrey explained that Keynes’s argument that an excess of investment over saving caused prices to rise was in fact a tautology entailed by Keynes’s definition of savings and investment.

[T]he fundamental equations disclose . . . that the price level is composed of two terms, one of which is cost per unit and the other is the difference between price and cost per unit.

Thus the difference between saving and investment is simply another name for the windfall gains or losses or for the difference between prices and costs of output. Throughout the Treatise Mr. Keynes adduces a divergence between saving and investment as the criterion of a departure from monetary equilibrium. But this criterion is nothing more or less than a divergence between prices and costs. Though the criterion ostensibly depends on two economic activities, “investment” and “saving,” it depends in reality not on them but on movements of the price level relative to costs.

That does not mean that the price level may not be influenced by changes in investment or in saving in some sense. But Mr. Keynes’s formula does not record such changes till their effect upon the price level is an accomplished fact. (p. 336)

Hawtrey’s other important criticism was his observation that Keynes assumed that a monetary disequilibrium would manifest itself exclusively in price changes and not at all in changes in output and employment. In fact this criticism followed naturally from Hawtrey’s criticism of Keynes’s definitions of savings and investment, from which the fundamental equations were derived, as not being grounded in the decisions of consumers and entrepreneurs.

With regard to savings, the individual consumers decide what they shall spend (or refrain from spending) on consumption. The balance of their earnings is “savings.” But the balance of their incomes (earnings plus windfall gains) is “investment.” Their decisions determine the amount of investment just as truly and in just the same way as they determine the amount of savings.

For all except entrepreneurs, earnings and income are the same. For entrepreneurs they differ if, and only if, there is a windfall gain or loss. But if there is a windfall gains, the recipients must decide what to do with it exactly as with any other receipt. If there is a windfall loss, the victims are deemed, according to Mr. Keynes’s definition of saving, to “save” the money they do not receive. But this is the result of the definition, not of any “decision.” (p. 345)

Preferring the more natural definition of savings as unconsumed income and of investment as capital outlay, Hawtrey proceeded to suggest an alternative analysis of an increase in saving by consumers. In the alternative analysis both output and prices could vary. It was Hawtrey therefore who provided the impetus for a switch to output and employment, not just prices, as equilibrating variable to a monetary disequilibrium.

It has been pointed out above that a difference between savings and investment [as defined by Keynes] cannot be regarded as the cause of a windfall loss or gain, for it is the windfall loss or gain. To find a causal sequence, we must turn to the decisions relating to consumption and capital outlay. When we do so, we find the windfall loss or gain to be one only among several consequences, and neither the earliest, nor necessarily the most important.

Throughout the Treatise Mr. Keynes refers to these decisions, and bases his argument upon them. And I think it is true to say that almost everywhere what he says may be interpreted as applying to the modified analysis which we have arrived at just as well as to that embodied in his fundamental equations. (p. 349)

To a large extent, Hawtrey’s criticisms of Keynes were criticisms of Keynes’s choice of definitions and the formal structure of his model rather than of the underlying theoretical intuition motivating Keynes’s theoretical apparatus. Hawtrey made this point in correcting Keynes’s misinterpretation of Hawtrey’s own position.

Mr. Keynes attributes to me (rather tentatively, it is true) acceptance of the view of “Bank rate as acting directly on the quantity of bank credit and so on prices in accordance with the Quantity Equation” (vol. 1., p. 188). But the passage which he quotes from my Currency and Credit contains no reference, explicit or implicit, to the quantity equation. Possibly I have misled him by using the expression “contraction of credit” for what I have sometimes called more accurately a “retardation of the creation of credit.”

The doctrine that I have consistently adhered to, that an acceleration or retardation of the creation of credit acts through changes in consumers’ income and outlay on the price level and on productive activity, and not through changes in the unspent margin [Hawtrey’s term of holdings of cash], is, I think, very close to Mr. Keynees’s theory. (p. 363)

In drawing attention to his belief “that an acceleration or retardation of the creation of credit acts through changes in consumers’ income and outlay . . . not through changes in the unspent margin,” Hawtrey emphasized that his monetary theory was not strictly speaking a quantity-theoretic monetary theory, as Keynes had erroneously suggested. Rather, he shared with Keynes the belief that there is a tendency for changes in expenditure and income to be cumulative. It was Hawtrey’s belief that the most reliable method by which such changes in income and expenditure could be realized was by way of changes in the short-term interest rate, which normally cause businesses and traders to alter their desired stocks of unfinished goods, working capital and inventories. Those changes, in turn, lead to increases in output and income and consumer outlay, which trigger further increases, and so on. In short, as early as 1913, Hawtrey had already sketched out in Good and Bad Trade the essential concept of a multiplier process initiated by changes in short-term interest rates, by way of their effect on desired stocks of working capital and inventories.

Thus, it is a complete misunderstanding of Hawtrey to suggest that, in the words of Peter Clarke (The Keynesian Revolution in the Making  pp. 242-43) that he was “the man who, having stumbled upon [the multiplier], painstakingly suppressed news of its discovery in his subsequent publications.” The multiplier analysis was not stumbled upon, nor was it suppressed. Rather, Hawtrey simply held that, under normal conditions, unless supported by credit expansion (i.e., a lower bank rate), increased government spending would be offset by reduced spending elsewhere producing no net increase in spending and therefore no multiplier effect. In fact, Hawtrey in 1931 in his Trade Depression and the Way Out (or perhaps only in the second 1933 edition of that book) conceded that under conditions of what he called a “credit deadlock” in which businesses could not be induced to borrow to increase spending, monetary policy would not be effective unless it was used to directly finance government spending. In Keynesian terminology, the situation was described as a liquidity trap, and we no refer to it as the zero lower bound. But the formal analysis of the multiplier was a staple of Hawtrey’s cycle theory from the very beginning. It was just kept in the background, not highlighted as in the Keynesian analysis. But it was perfectly natural for Hawtrey to have explained how Keynes could use it in his commentary on the Treatise.

UPDATE (03/12/13): In reading the excellent doctoral thesis of Alan Gaukroger about Hawtrey’s career at the British Treasury (to view and download the thesis click here) to which I refer in my reply to Luis Arroyo’s comment, I realized that Hawtrey did not introduce the terms “consumers’ income” and “consumers’ outlay” in Good and Bad Trade as I asserted in the post.  Those terms were only introduced six years later in Currency and Credit. I will have to reread the relevant passages more carefully to determine to what extent the introduction of the new terms in Currency and Credit represented an actual change in Hawtrey’s conceptual framework as opposed to the introduction of a new term for an a concept that he had previously worked out.


13 Responses to “Keynes and Hawtrey: The Treatise on Money and Discovering the Multiplier”

  1. 1 Greg Hill March 10, 2013 at 8:01 pm


    You’re cranking out some fine posts! A few ill-considered reactions are all I can offer in return.

    The Fundamental Equations may be a tautology, but what an illuminating tautology! Who would have thought that Profits = Investment – Saving? or that the price level depends on the ratio of Investment to Saving? (Granted, the definitions are open to question; after all, Keynes abandoned some of them too.)

    In the Treatise on Money, Keynes assumed fixed output, so the multiplier applies to prices rather than quantities. Kaldor later developed this relationship into a theory of income distribution in which profits depend on investment and the saving propensities of capitalists and workers. Keynes, himself, returned to this theory when he wrote “How to Pay for the War,” which advocated mandatory saving to limit price increases during wartime, which, in addition to being a good thing itself, protected the real wealth of workers. Question for you: Is Hawtrey’s theory consistent with this theory of income distribution? If not, what takes its place?

    Shouldn’t you include R.F. Kahn’s article about the employment multiplier? In the GT, Keynes no longer takes output as fixed, and so, when output is less than the maximum, new expenditure leads to an increase in real output that’s a multiple of the initial expenditure (holding the interest rate constant, which, subject to important constraints, Keynes thought could be achieved by central bank policy).

    Thanks for sharing your thoughts.


  2. 2 David Glasner March 11, 2013 at 9:31 am

    Greg, Thanks, I am glad that you approve.

    I certainly didn’t mean to sound dismissive of Keynes’s effort in the Treatise, which is a great book, but the fundamental equations turned out not to be all that fundamental.

    I am afraid that I have no answer to your question about whether Hawtrey’s theory is consistent with Kaldor’s theory of income distribution. I have only a vague familiarity with it, and would have to really work hard to try to put the two together. But if you have any thoughts on the subject, I’ld be happy to listen. But let me answer your question with another question. Why can’t a monetary theory be consistent with more than one theory of income distribution?

    Everybody knows that Kahn taught Keynes about the multiplier. The point is that Dimand has documented that Hawtrey was writing about the multiplier in 1929 before Kahn and even presented an algebraic model of the multiplier. My point is that Hawtrey’s discussion of the multiplier was not an outlier as Peter Clarke and others have suggested but that it followed naturally from his exposition of the relationship between consumer income and consumer outlay which was integral to his cycle theory going back to 1913 in Good and Bad Trade.


  3. 3 Luis March 11, 2013 at 1:21 pm

    David, very good as usual; but I don’t see very well the superiority of Hawtrey above Keynes in these very short lines. I find him a little confusing. True I have not read The Treatise, and Keynes is not specially clear about saving & investment.

    I’m reading Tract on Monetary Reform. I find it a little difficult but interesting. What is the most interesting for me is the keynesian division of people in “rentiers”, investors & consumers. I suppose that is the first step toward the clear division between investment & saving – which I don’t know if it is original of him, but of crucial importance, I think.
    I’ll appreciate very much any about these years, Genoa Conference, Cassel, and so on. Thanks very much


  4. 4 J. Bradford DeLong (@delong) March 11, 2013 at 2:05 pm

    Let me (unfairly) complain that what I thought (and wanted) to see in this post was a discussion of: R. G. Hawtrey (1925), “Public Expenditure and the Demand for Labour,” Economica 13 (March).

    Mind you, this is very good free ice cream. It’s just that I also want the sprinkles and chocolate sauce on top…

    Brad DeLong


  5. 5 David Glasner March 11, 2013 at 7:23 pm

    Luis, I was quoting just brief snippets out of a much longer essay, so the points that he was making may not have come out clearly. You may just have to go and read the original. The unpublished doctoral dissertation of Alan Gaukroger “The Director of Financial Enquiries: A Study of the Career of R. G. Hawtrey, 1919-1939” is a wonderful piece of work for anyone interested in Hawtrey. It is available on the web and you can download it.

    Brad, I hope to talk a bit about the paper you refer to in a future post, but I am not sure that I will have much further insight to offer beyond what you have read (and perhaps digested) in this post. Stay tuned.


  6. 6 Greg Hill March 11, 2013 at 8:09 pm

    David, you might want to take a look at G.L.S. Shackle’s “The Years of High Theory,” where he discusses several economists who worked out something very close to the multiplier before either Hawtrey or Kahn. In addition to Shackle’s illuminating discussion of the multiplier, you can treat yourself to some his beautiful prose.

    You ask, “Why can’t a monetary theory be consistent with more than one theory of income distribution?” I don’t know of any a priori reason that would preclude this, but it’s worth thinking about.


  7. 7 David Glasner March 11, 2013 at 8:17 pm

    Greg, I read The Years of High Theory at least 30 years ago with great profit and enjoyment, but obviously I have completely forgotten the part about the precursors of the multiplier analysis. It’s obviously time for me to go back and read it again. Thanks for mentioning it.


  8. 8 Luis March 12, 2013 at 2:26 am

    Thanks very much, David


  9. 9 Alan Gaukroger March 13, 2013 at 5:38 am

    Your use of me as an authority, David, made me a little nervous and so I rushed to my books to check that what I had written on Consumers’ Income and Consumers’ Outlay was factually correct. Not having ready access to a large library I had to rely on my personal copies which are the 1970 (Good and Bad Trade) edition, and the 1930 (Currency and Credit) edition. There is no mention of these terms in my copy of Good and Bad Trade but they are introduced in chapter 4 of Currency and Credit. Hawtrey first published Currency and Credit in 1919 and there is no indication that he revised the early chapters for later editions – so I think I am on safe grounds with my assertion.

    I am sure that you are right in gainsaying Clarke on the matter of Hawtrey’s suppression of the multiplier. One of the more impressive aspects of Hawtrey is the extent to which he understood his own model. Many original scientists – Newton, Einstein, Keynes – seem to have had wonderful insights, but their understanding of their own developments have been less than perfect (hence Keynes’s frequent changes of mind). Hawtrey had no such flaw; hence the confidence with which he defended his model against criticism. He must surely have understood the implications, within his model, of the multiplier effect. Clarke is an excellent historian of the development of economic ideas but on this occasion I am sure he underestimates Hawtrey. Perhaps a warning to Historians not to trespass too far into specialist matters!


  10. 10 David Glasner March 13, 2013 at 7:57 am

    Alan, Thanks for confirming your accuracy. Hawtrey was a remarkably thorough and systematic thinker, a quality which shows up not only in his discussions of his own model, but in his discussions and criticisms of the work of others, in which he was always judicious and fair-minded. He wasn’t necessarily right, but he clearly thought through carefully all his arguments, so there are very few logical gaps in his reasoning. Since this year is the 100th anniversary of the publication of Good and Bad Trade, I would like to write up something about that work. I read it somewhat superficially two or three years ago. I now need to read at least parts of it more carefully to see whether the multiplier argument is already latent in Good and Bad Trade or was only introduced later in Currency and Credit.


  11. 11 Blue Aurora March 13, 2013 at 9:21 am

    If you don’t mind me asking, Alan Gaukroger, have you considered publishing your doctoral dissertation on Ralph Hawtrey’s Treasury career?

    Also, would you work with David Glasner on future journal articles?


  12. 12 Alan Gaukroger March 13, 2013 at 4:44 pm

    B.A. – in answer to the first part; no, but I may do.

    As I have explained to David in a private e-mail, I am neither economist nor professional historian. As a 16yr. old I reluctantly dropped my favoured subjects of literature and history to study the sciences for the better employment opportunities they afforded (no small matter for a working-class boy). On moving from full-time employment to retirement I set myself some objectives. These included doing some worthwhile work in the subjects I had reluctantly dropped many years ago (they also included being fluent in the French language, passing a motor-bike test and being a proficient bass singer in a choral society). Writing the doctoral dissertation gave me enormous pleasure, but since I had no professional ambitions I did not feel the need take it further by seeking to publish it – and I also wanted time to devote to some of my other interests.

    I do agree with David that Hawtrey’s contributions to economic theory have been underestimated. As David says, his analysis of of other people’s contributions to economics were painstaking and fair – despite clinging to his own somewhat idiosyncratic terms he was willing to analyse the work of others in their own terms. It is right that the centenary of his first publication (which I believe to be a work of of ground-breaking originality) should be recognised.

    As a monetary economist David is leagues ahead of me, which might make collaboration something of a problem, but I would be very willing to make some contribution to a special centenary tribute.


  1. 1 TheMoneyIllusion » Recommended reading Trackback on March 24, 2013 at 7:00 am

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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