Uneasy Money Marks the Centenary of Hawtrey’s Good and Bad Trade

As promised, I am beginning a series of posts about R. G. Hawtrey’s book Good and Bad Trade, published 100 years ago in 1913. Good and Bad Trade was not only Hawtrey’s first book on economics, it was his first publication of any kind on economics, and only his second publication of any kind, the first having been an article on naval strategy written even before his arrival at Cambridge as an undergraduate. Perhaps on the strength of that youthful publication, Hawtrey’s first position, after having been accepted into the British Civil Service, was in the Admiralty, but he soon was transferred to the Treasury where he remained for over forty years till 1947.

Though he was a Cambridge man, Hawtrey had studied mathematics and philosophy at Cambridge. He was deeply influenced by the Cambridge philosopher G. E. Moore, an influence most clearly evident in one of Hawtrey’s few works of economics not primarily concerned with monetary theory, history or policy, The Economic Problem. Hawtrey’s mathematical interests led him to a correspondence with another Cambridge man, Bertrand Russell, which Russell refers to in his Principia Mathematica. However, Hawtrey seems to have had no contact with Alfred Marshall or any other Cambridge economist. Indeed, the only economist mentioned by Hawtrey in Good and Bad Trade was none other than Irving Fisher, whose distinction between the real and nominal rates of interest Hawtrey invokes in chapter 5. So Hawtrey was clearly an autodidact in economics. It is likely that Hawtrey’s self-education in economics started after his graduation from Cambridge when he was studying for the Civil Service entrance examination, but it seems likely that Hawtrey continued an intensive study of economics even afterwards, for although Hawtrey was not in the habit of engaging in lengthy discussions of earlier economists, his sophisticated familiarity with the history of economics and of economic history is quite unmistakable. Nevertheless, it is a puzzle that Hawtrey uses the term “natural rate of interest” to signify more or less the same idea that Wicksell had when he used the term, but without mentioning Wicksell.

In his introductory chapter, Hawtrey lays out the following objective:

My present purposed is to examine certain elements in the modern economic organization of the world, which appear to be intimately connected with [cyclical] fluctuations. I shall not attempt to work back from a precise statistical analysis of the fluctuations which the world has experienced to the causes of all the phenomena disclosed by such analysis. But I shall endeavor to show what the effects of certain assumed economic causes would be, and it will, I think, be found that these calculated effects correspond very closely with the observed features of the fluctuations.

The general result up to which I hope to work is that the fluctuations are due to disturbances in the available stock of “money” – the term “money” being take to cover every species of purchasing power available for immediate use, both legal tender money and credit money, whether in the form of coin, notes, or deposits at banks. (p. 3)

In the remainder of this post, I will present a quick overview of the entire book, and, then, as a kind of postscript to my earlier series of posts on Hawtrey and Keynes, I will comment on the fact that it seems quite clear that it was Hawtrey who invented the term “effective demand,” defining it in a way that does not appear significantly different from the meaning that Keynes attached to it.

Hawtrey posits that the chief problem associated with the business cycle is that workers are unable to earn an income with which to sustain themselves during business-cycle contractions. The source of this problem in Hawtrey’s view is some sort of malfunction in the monetary system, even though money, when considered from the point of view of an equilibrium, seems unimportant, inasmuch as any set of absolute prices would work just as well as another, provided that relative prices were consistent with equilibrium.

In chapter 2, Hawtrey explains the idea of a demand for money and how this demand for money, together with any fixed amount of inconvertible paper money will determine the absolute level of prices and the relationship between the total amount of money in nominal terms and the total amount of income.

In chapter 3, Hawtrey introduces the idea of credit money and banks, and the role of a central bank.

In chapter 4, Hawtrey discusses the organization of production, the accumulation of capital, and the employment of labor, explaining the matching circular flows: expenditure on goods and services, the output of goods and services, and the incomes accruing from that output.

Having laid the groundwork for his analysis, Hawtrey in chapter 5 provides an initial simplified analysis of the effects of a monetary disturbance in an isolated economy with no banking system.

Hawtrey continues the analysis in chapter 6 with a discussion of a monetary disturbance in an isolated economy with a banking system.

In chapter 7, Hawtrey discusses how a monetary disturbance might actually come about in an isolated community.

In chapter 8, Hawtrey extends the discussion of the previous three chapters to an open economy connected to an international system.

In chapter 9, Hawtrey drops the assumption of an inconvertible paper money and introduces an international metallic system (corresponding to the international gold standard then in operation).

Having completed his basic model of the business cycle, Hawtrey, in chapter 10, introduces other sources of change, e.g., population growth and technological progress, and changes in the supply of gold.

In chapter 11, Hawtrey drops the assumption of the previous chapters that there are no forces leading to change in relative prices among commodities.

In chapter 12, Hawtrey enters into a more detailed analysis of money, credit and banking, and, in chapter 13, he describes international differences in money and banking institutions.

In chapters 14 and 15, Hawtrey traces out the sources and effects of international cyclical disturbances.

In chapter 16, Hawtey considers financial crises and their relationship to cyclical phenomena.

In chapter 17, Hawtrey discusses banking and currency legislation and their effects on the business cycle.

Chapters 18 and 19 are devoted to taxation and public finance.

Finally in chapter 20, Hawtrey poses the question whether cyclical fluctuations can be prevented.

After my series on Hawtrey and Keynes, I condensed those posts into a paper which, after further revision, I hope will eventually appear in the forthcoming Elgar Companion to Keynes. After I sent it to David Laidler for comments, he pointed out to me that I had failed to note that it was actually Hawtrey who, in Good and Bad Trade, introduced the term “effective demand.”

The term makes its first appearance in chapter 1 (p. 4).

The producers of commodities depend, for their profits and for the means of paying wages and other expenses, upon the money which they receive for the finished commodities. They supply in response to a demand, but only to an effective demand. A want becomes an effective demand when the person who experiences the want possesses (and can spare) the purchasing power necessary ot meet the price of the thing which will satisfy it. A man may want a hat, but if he has no money [i.e., income or wealth] he cannot buy it, and his want does not contribute to the effective demand for hats.

Then at the outset of chapter 2 (p. 6), Hawtrey continues:

The total effective demand for all finished commodities in any community is simply the aggregate of all money incomes. The same aggregate represents also the total cost of production of all finished commodities.

Once again, Hawtrey, in chapter 4 (pp. 32-33), returns to the concept of effective demand

It was laid down that the total effective demand for all commodities si simply the aggregate of all incomes, and that the same aggregate represents the total cost of production of all commodities.

Hawtrey attributed fluctuations in employment to fluctuations in effective demand inasmuch as wages and prices would not adjust immediately to a change in total spending.

Here is how Keynes defines aggregate demand in the General Theory (p. 55)

[T]he effective demand is simply the aggregate income or (proceeds) which the entrepreneurs expect to receive, inclusive of the income which they will hand on to the other factors of production, from the amount of current employment which they decide to give. The aggregate demand function relates various hypothetical quantities of employment to the proceeds which their outputs are expected to yield; and the effective demand is the point on the aggregate demand function which becomes effective because, taken in conjunction with the conditions of supply, it corresponds to the level of employment which maximizes the entrepreneur’s expectation of profit.

So Keynes in the General Theory obviously presented an analytically more sophisticated version of the concept of effective demand than Hawtrey did over two decades earlier, having expressed the idea in terms of entrepreneurial expectations of income and expenditure and specifying a general functional relationship (aggregate demand) between employment and expected income. Nevertheless, the basic idea is still very close to Hawtrey’s. Interestingly, Hawtrey never asserted a claim of priority on the concept, whether it was because of his natural reticence or because he was unhappy with how Keynes made use of the idea, or perhaps some other reason, I would not venture to say. But perhaps others would like to weigh in with some speculations of their own.


9 Responses to “Uneasy Money Marks the Centenary of Hawtrey’s Good and Bad Trade”

  1. 1 andrew lainton September 11, 2013 at 2:42 am

    Wicksells 1898 Interest and Prices was not translated into English until many years after, Wicksell had a lecture outlining his theory published in the Economic Journal in 1907 but this does not use the term ‘natural rate’. Wicksell and Hawtry probably picked up the term from earlier English Political Economy, probably Ricardo, though the term is much older dating from at least 1750 (Joseph Massey), though the theory in the form we know it today was derived by Thorton in 1810, (which Wicksell did not know until 15 years after Interest and Prices) and it Wicksells reading of Ricardos summary of Thortons ideas was probably his inspiration,
    Humphry http://richmondfed.org/publications/research/economic_review/1986/pdf/er720303.pdf
    Interestingly Thorton’s version, and the version presented in the 1907 lecture, did not depend on an unobservable ‘natural rate’ but an observable rate of profit from goods and services (not money) – what the classical’s referred to as the ‘mercantile rate of profit’ – without the Austrian contamination of a natural rate under barter which Sraffa rightly criticised.

    Did Hawtry originate the theory of ‘effective demand’? He may have idependently discivered it but equivalent versions can be found in Johannsen 1908 http://archive.org/stream/neglectedpointin00joha#page/102/mode/2up, and in in John P. Nortons Statistical Studies in the New York Money Market (1902) http://archive.org/details/cu31924032510962
    Of course the term originates from Smith ‘effectual demand’ though the first use in the manner close to what to Keynes meant I can find is in Edward West https://andrewlainton.wordpress.com/2011/06/01/every-hand-in-motion-edward-wests-classical-theory-of-demand-and-employment/ from 1826


  2. 2 Blue Aurora September 11, 2013 at 6:54 am

    Actually, didn’t the term “effective demand” go farther back than Hawtrey or Wicksell? IIRC, Thomas Robert Malthus did use the term “effective demand”, but whether he meant it the same way as other economists meant it is another question (and I don’t know the answer to that question, actually).


  3. 3 David Glasner September 11, 2013 at 9:16 am

    Andrew, Thanks for providing the useful historical background information on the usage of the term “natural rate of interest.’

    I recall now that Johansen had used the term effective demand before Keynes, but I didn’t know about Nortons or West. I think that Smith’s usage of “effectual demand” was in a more micro context than that it which it was used by Hawtrey and Keynes, i.e., as a measure of aggregate nominal spending, so it is probably not appropriate to credit him as an early discoverer of the concept.

    Blue Aurora, I vaguely recall that Malthus used the term “effective demand.” In his biographical essay on Malthus (see Keynes’s Essays in Biography) Keynes wrote favorably about Malthus and lamented that British economists followed Ricardo rather than Malthus after Ricardo and Malthus clashed about the possibility of general gluts and Say’s Law. But I don’t remember if Keynes actually mentioned that Malthus used the term “effective demand.”


  4. 4 andrew lainton September 12, 2013 at 6:09 am

    I dont know of any use of the term ‘effective demand’ in Mathus, in ‘definitions in political economy’ he uses a very ricardian definition – i.e. the quanity demanded when the price is equal to cost of production.

    Malthus does though use a monetary definition – ‘gven demand’
    ‘A given demand, in regard to price, is a given quantity of money intended to be laid out in the purchase of certain commodities in a market; and a given demand, in regard to value, is the command of a given quantity of labour intended to be employed in the same way.’
    Keynes definition of aggregate demand – though presented in more moden langauge – is essentially the same


  5. 5 Ray Newton September 14, 2013 at 7:16 am

    When discussing the supply/demand factor, which is the very basis of economics, it is not only important, but absolutely essential to understand that while these were a natural phenomena in the earlier stages of human life, they are not always (rarely?) so today.

    Of course there is almost always a natural basis present, but both sides of the equation, unlike in maths, can be manipulated to varying degrees, even though over sufficient time may correct. However, timing is an essential factor in many endeavors, and, therefore, must always be taken into account.

    There is nothing sinister, in manipulation of systems it has been with us for centuries. It is just that we have been conditioned to see it that way. We are all endowed with the seven deadly sins in varying degrees. Sometimes there is good reason for the manipulation,sometimes not.

    I am confident, for example, that if the gold price was not ‘manipulated’ (controlled) our current system could not exist.

    I know, from experience, it is not something which Academia cares to take into account. They preach to the followers as though it doesn’t exist.

    This, perhaps more than anything else is what leads, what may, perhaps, be otherwise good economists into bad ones. It is like the naivety of law that assumes swearing on oath ensures the truth. Consequently, they become willing pawns to be used by those who have a better grasp of the system. (they should, they built it) over centuries.

    No, of course, none of you will agree, certainly of the ones who post. Your writing denotes your thinking – as does mine.

    My suggestion is, if you like fantasy, and a world that conforms to it, then become a fiction writer, I, like many, enjoy it when it does not purport to be anything but fantasy.

    If you want me to cite examples of how it is done, I will be happy to show you many. But I do not enjoy proving the world is roundish and not flat to those who genuinely, or try to kid me, they believe otherwise.


  6. 6 sumnerbentley September 14, 2013 at 8:15 am

    Slightly off topic, but a question about demand. Hawtrey defines it as nominal GDP, which seems fine. What I can’t figure out is how textbooks define it. Sometimes they seem to define it as real GDP. The real output demanded at a given price level. At other times as NGDP, as they say “If the AS curve is vertical a rise in AD might merely lead to higher prices, with no rise in output.” Obviously the distinction is related to a shift in a curve versus a movement along the curve, but I don’t see that distinction in the textbooks. The terms seem the same for both types of changes. Am I missing something?


  7. 7 Ray Newton September 20, 2013 at 7:55 am

    As Marcus Aurelius said around 2000 years ago, along with a touch of Sir Arthur Conan Doyle, via Holmes more recently, but with a slight tweak to both – “It is not what we ‘see’, but what we observe, and how we learn, and USE, from what we learn, which is important.”


  8. 8 David Glasner September 29, 2013 at 9:43 am

    Andrew, Thanks for the lesson on Malthus. However, I am not sure that “given demand” quite corresponds to Keynesian or Hawtreyan “effective demand,” which refers to total income (or expenditure) rather than “a given quantity of money intended to be laid out in the purchase of certain commodities.” Not sure what “certain commodities” refers to.

    Ray, you wrote:

    “I do not enjoy proving the world is roundish and not flat to those who genuinely, or try to kid me, they believe otherwise.”

    Then why do you keep trying?

    Scott, I haven’t looked at a textbook discussion of AD in decades, but I agree with you that, unless you are explicitly assuming a fixed price level, the analysis should be done in nominal terms.


  9. 9 Ray Newton September 30, 2013 at 3:49 am


    You, seem, like so many who make a decision to start a blog, and open it to comment, and fail to comprehend that the internet reaches out, without influence from race, religion, culture, or nationality – even standard of education, to all corners of our world – even the top of Mnt, Everest, I believe, if you have the required hand held set, and invites them to ‘look in’. That is why the great mind of Mr William Gates called it ‘Windows’ I presume.

    It should be logically assumed, therefore, that far more people ‘surf’ the site, and peer in the window, than the few who bother to grace you with ‘feedback’. I would say, considerably more.

    Some will share my view, some won’t, some will seek to pay more attention to their own observations of our economic system, built over centuries, long before even Adam Smith wrote his treatise to the subject, some won’t.

    Whatever is the result, we stir men’s (and women’s, got to be careful these days) minds. Well, those capable of being stirred. Stagnant minds, are like stagnant water.

    If one ever believes that something tiny in the greater scheme of things, cannot move a mass, let him think of a tiny mosquito buzzing around in a great hall full of people.

    (Yes, I know, it is likely to get swatted or sprayed, in the end, but not before making its presence felt in taking it seriously by many – c’est la Vie.)


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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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