Posts Tagged 'central banks'

Keynes v. Hawtrey on British Monetary Policy after Rejoining the Gold Standard

The close, but not always cozy, relationship between Keynes and Hawtrey was summed up beautifully by Keynes in 1929 when, commenting on a paper by Hawtrey, “Money and Index Numbers,” presented to the Royal Statistical Society, Keynes began as follows.

There are very few writers on monetary subjects from whom one receives more stimulus and useful suggestion . . . and I think there are few writers on these subjects with whom I personally feel more fundamental sympathy and agreement. The paradox is that in spite of that, I nearly always disagree in detail with what he says! Yet truly and sincerely he is one of the writers who seems to me to be most nearly on the right track!

The tension between these two friendly rivals was dramatically displayed in April 1930, when Hawtrey gave testimony before the Macmillan Committee (The Committee on Finance and Industry) established after the stock-market crash in 1929 to investigate the causes of depressed economic conditions and chronically high unemployment in Britain. The Committee, chaired by Hugh Pattison Macmillan, included an impressive roster of prominent economists, financiers, civil servants, and politicians, but its dominant figure was undoubtedly Keynes, who was a relentless interrogator of witnesses and principal author of the Committee’s final report. Keynes’s position was that, having mistakenly rejoined the gold standard at the prewar parity in 1925, Britain had no alternative but to follow a policy of high interest rates to protect the dollar-sterling exchange rate that had been so imprudently adopted. Under those circumstances, reducing unemployment required a different kind of policy intervention from reducing the bank rate, which is what Hawtrey had been advocating continuously since 1925.

In chapter 5 of his outstanding doctoral dissertation on Hawtrey’s career at the Treasury, which for me has been a gold mine (no pun intended) of information, Alan Gaukroger discusses the work of the Macmillan Committee, focusing particularly on Hawtrey’s testimony in April 1930 and the reaction to that testimony by the Committee. Especially interesting are the excerpts from Hawtrey’s responses to questions asked by the Committee, mostly by Keynes. Hawtrey’s argument was that despite the overvaluation of sterling, the Bank of England could have reduced British unemployment had it dared to cut the bank rate rather than raise it to 5% in 1925 before rejoining the gold standard and keeping it there, with only very brief reductions to 4 or 4.5% subsequently. Although reducing bank rate would likely have caused an outflow of gold, Hawtrey believed that the gold standard was not worth the game if it could only be sustained at the cost of the chronically high unemployment that was the necessary consequence of dear money. But more than that, Hawtrey believed that, because of London’s importance as the principal center for financing international trade, cutting interest rates in London would have led to a fall in interest rates in the rest of the world, thereby moderating the loss of gold and reducing the risk of being forced off the gold standard. It was on that point that Hawtrey faced the toughest questioning.

After Hawtrey’s first day of his testimony, in which he argued to a skeptical committee that the Bank of England, if it were willing to take the lead in reducing interest rates, could induce a world-wide reduction in interest rates, Hawtrey was confronted by the chairman of the Committee, Hugh Macmillan. Summarizing Hawtrey’s position, Macmillan entered into the following exchange with Hawtrey

MACMILLAN. Suppose . . . without restricting credit . . . that gold had gone out to a very considerable extent, would that not have had very serious consequences on the international position of London?

HAWTREY. I do not think the credit of London depends on any particular figure of gold holding. . . . The harm began to be done in March and April of 1925 [when] the fall in American prices started. There was no reason why the Bank of England should have taken ny action at that time so far as the question of loss of gold is concerned. . . . I believed at the time and I still think that the right treatment would have been to restore the gold standard de facto before it was restored de jure. That is what all the other countries have done. . . . I would have suggested that we should have adopted the practice of always selling gold to a sufficient extent to prevent the exchange depreciating. There would have been no legal obligation to continue convertibility into gold . . . If that course had been adopted, the Bank of England would never have been anxious about the gold holding, they would have been able to see it ebb away to quite a considerable extent with perfect equanimity, and might have continued with a 4 percent Bank Rate.

MACMILLAN. . . . the course you suggest would not have been consistent with what one may call orthodox Central Banking, would it?

HAWTREY. I do not know what orthodox Central Banking is.

MACMILLAN. . . . when gold ebbs away you must restrict credit as a general principle?

HAWTREY. . . . that kind of orthodoxy is like conventions at bridge; you have to break them when the circumstances call for it. I think that a gold reserve exists to be used. . . . Perhaps once in a century the time comes when you can use your gold reserve for the governing purpose, provided you have the courage to use practically all of it. I think it is possible that the situation arose in the interval between the return to the gold standard . . . and the early part of 1927 . . . That was the period at which the greater part of the fall in the [international] price level took place. [Gaukroger, p. 298]

Somewhat later, Keynes began his questioning.

KEYNES. When we returned to the gold standard we tried to restore equilibrium by trying to lower prices here, whereas we could have used our influence much more effectively by trying to raise prices elsewhere?


KEYNES . . . I should like to take the argument a little further . . . . the reason the method adopted has not been successful, as I understand you, is partly . . . the intrinsic difficulty of . . . [reducing] wages?


KEYNES. . . . and partly the fact that the effort to reduce [prices] causes a sympathetic movement abroad . . .?


KEYNES. . . . you assume a low Bank Rate [here] would have raised prices elsewhere?


KEYNES. But it would also, presumably, have raised [prices] here?

HAWTREY. . . . what I have been saying . . . is aimed primarily at avoiding the fall in prices both here and abroad. . . .it is possible there might have been an actual rise in prices here . . .

KEYNES. One would have expected our Bank Rate to have more effect on our own price level than on the price level of the rest of the world?


KEYNES. So, in that case . . . wouldn’t dear money have been more efficacious . . . in restoring equilibrium between home and foreign price . . .?

HAWTREY. . . .the export of gold itself would have tended to produce equilibrium. It depends very much at what stage you suppose the process to be applied.

KEYNES. . . . so cheap money here affects the outside world more than it affects us, but dear money here affects us more than it affects the outside world.

HAWTREY. No. My suggestion is that through cheap money here, the export of gold encourages credit expansion elsewhere, but the loss of gold tends to have some restrictive effect on credit here.

KEYNES. But this can only happen if the loss of gold causes a reversal of the cheap money policy?

HAWTREY. No, I think that the export of gold has some effect consistent with cheap money.

In his questioning, Keynes focused on an apparent asymmetry in Hawtrey’s argument. Hawtrey had argued that allowing an efflux of gold would encourage credit expansion in the rest of the world, which would make it easier for British prices to adjust to a rising international price level rather than having to fall all the way to a stable or declining international price level. Keynes countered that, even if the rest of the world adjusted its policy to the easier British policy, it was not plausible to assume that the effect of British policy would be greater on the international price level than on the internal British price level. Thus, for British monetary policy to facilitate the adjustment of the internal British price level to the international price level, cheap money would tend to be self-defeating, inasmuch as cheap money would tend to raise British prices faster than it raised the international price level. Thus, according to Keynes, for monetary policy to close the gap between the elevated internal British price level and the international price level, a dear-money policy was necessary, because dear money would reduce British internal prices faster than it reduced international prices.

Hawtrey’s response was that the export of gold would induce a policy change by other central banks. What Keynes called a dear-money policy was the status quo policy in which the Bank of England was aiming to maintain its current gold reserve. Under Hawtrey’s implicit central-bank reaction function, dear money (i.e., holding Bank of England gold reserves constant) would induce no reaction by other central banks. However, an easy-money policy (i.e., exporting Bank of England gold reserves) would induce a “sympathetic” easing of policy by other central banks. Thus, the asymmetry in Hawtrey’s argument was not really an asymmetry, because, in the context of the exchange between Keynes and Hawtrey, dear money meant keeping Bank of England gold reserves constant, while easy money meant allowing the export of gold. Thus, only easy money would induce a sympathetic response from other central banks. Unfortunately, Hawtrey’s response did not explain that the asymmetry identified by Keynes was a property not of Hawtrey’s central-bank reaction function, but of Keynes’s implicit definitions of cheap and dear money. Instead, Hawtrey offered a cryptic response about “the loss of gold tend[ing] to have some restrictive effect on credit” in Britain.

The larger point is that, regardless of the validity of Hawtrey’s central-bank reaction function as a representation of the role of the Bank of England in the international monetary system under the interwar gold standard, Hawtrey’s model of how the gold standard operated was not called into question by this exchange. It is not clear from the exchange whether Keynes was actually trying to challenge Hawtrey on his model of the international monetary system or was just trying to cast doubt on Hawtrey’s position that monetary policy was, on its own, a powerful enough instrument to have eliminated unemployment in Britain without adopting any other remedial policies, especially Keynes’s preferred policy of public works. As the theoretical source of the Treasury View that public works were incapable of increasing employment without monetary expansion, it is entirely possible that that was Keynes’s ultimate objective. However, with the passage of time, Keynes drifted farther and farther away from the monetary model that, in large measure, he shared with Hawtrey in the 1920s and the early 1930s.

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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