Before pausing for an interlude about the dueling reviews of Hayek and Hawtrey on each other’s works in the February 1932 issue of Economica, I had taken my discussion of the long personal and professional relationship between Hawtrey and Keynes through Hawtrey’s review of Keynes’s Treatise on Money. The review was originally written as a Treasury document for Hawtrey’s superiors at the Treasury (and eventually published in slightly revised form as chapter six of The Art of Central Banking), but Hawtrey sent it almost immediately to Keynes. Although Hawtrey subjected Keynes’s key analytical result in the Treatise — his fundamental equations, relating changes in the price level to the difference between savings and investment — to sharp criticism, Keynes responded to Hawtrey’s criticisms with (possibly uncharacteristic) good grace, writing back to Hawtrey: “it is very seldom indeed that an author can expect to get as a criticism anything so tremendously useful to himself,” adding that he was “working it out all over again.” What Keynes was working out all over again of course eventually evolved into his General Theory.
Probably because Keynes had benefited so much from Hawtrey’s comments on and criticisms of the Treatise, which he received only shortly before delivering the final draft to the publisher, Keynes began sending Hawtrey early drafts of the General Theory instead of waiting, as he had when writing the Treatise, till the book was almost done. There was thus a protracted period of debate and argument between Keynes and Hawtrey over the General Theory, a process that clearly frustrated and annoyed Keynes, though he never actually terminated the discussion with Hawtrey. “Hawtrey,” Keynes wrote to his wife in 1933, “was very sweet to the last but quite mad. One can argue with him a long time on a perfectly sane and interesting basis and then, suddenly, one is in a madhouse.” On the accuracy of that characterization, I cannot comment, but clearly the two Cambridge Apostles were failing to communicate.
The General Theory was published in February 1936, and hardly a month had passed before Hawtrey shared his thoughts about the General Theory with his Treasury colleagues. (Hawtrey subsequently published the review in his collection of essays Capital and Employment.) Hawtrey began by expressing his doubts about Keynes’s attempt to formulate an alternative theory of interest based on liquidity preference in place of the classical theory based on time preference and productivity.
According to [Keynes], the rate of interest is to be regarded not as the reward of abstaining from consumption or of “waiting”, but as the reward of forgoing liquidity. By tying up their savings in investments people forgo liquidity, and the extent to which they are willing to do so will depend on the rate of interest. Anyone’s “liquidity preference” is a function relating the amount of his resources which he will wish ot retain in the form of money to different sets of circumstances, and among those circumstances will be the rate of interest. . . . The supply of money determines the rate of interest, and the rate of interest so determined governs the volume of capital outlay.
As in his criticism of the fundamental equations of the Treatise, Hawtrey was again sharply critical of Keynes’s tendency to argue from definitions rather than from causal relationships.
[A]n essential step in [Keynes’s] train of reasoning is the proposition that investment an saving are necessarily equal. That proposition Mr. Keynes never really establishes; he evades the necessity doing so by defining investment and saving as different names for the same thing. He so defines income to be the same thing as output, and therefore, if investment is the excess of output over consumption, and saving is the excess of income over consumption, the two are identical. Identity so established cannot prove anything. The idea that a tendency for investment and saving to become different has to be counteracted by an expansion or contraction of the total of incomes is an absurdity; such a tendency cannot strain the economic system, it can only strain Mr. Keynes’s vocabulary. [quoted by Alan Gaukroger “The Director of Financial Enquiries A Study of the Treasury Career of R. G. Hawtrey, 1919-1939.” pp. 507-08]
But despite the verbal difference between them, Keynes and Hawtrey held a common view that the rate of interest might be too high to allow full employment. Keynes argued that liquidity preference could prevent monetary policy from reducing the rate of interest to a level at which there would be enough private investment spending to generate full employment. Hawtrey held a similar view, except that, according to Hawtrey, the barrier to a sufficient reduction in the rate of interest to allow full employment was not liquidity preference, but a malfunctioning international monetary system under a gold-standard, or fixed-exchange rate, regime. For any country operating under a fixed-exchange-rate or balance-of-payments constraint, the interest rate has to be held at a level consistent with maintaining the gold-standard parity. But that interest rate depends on the interest rates that other countries are setting. Thus, a country may find itself in a situation in which the interest rate consistent with full employment is inconsistent with maintaining its gold-standard parity. Indeed all countries on a gold standard or a fixed exchange rate regime may have interest rates too high for full employment, but each one may feel that it can’t reduce its own interest rate without endangering its exchange-rate parity.
Under the gold standard in the 1920s and 1930s, Hawtrey argued, interest rates were chronically too high to allow full employment, and no country was willing to risk unilaterally reducing its own interest rates, lest it provoke a balance-of-payments crisis. After the 1929 crash, even though interest rates came down, they came down too slowly to stimulate a recovery, because no country would cut interest rates as much and as fast as necessary out of fear doing so would trigger a currency crisis. From 1925, when Britain rejoined the gold standard, to 1931 when Britain left the gold standard, Hawtrey never stopped arguing for lower interest rates, because he was convinced that credit expansion was the only way to increase output and employment. The Bank of England would lose gold, but Hawtrey argued that the point of a gold reserve was to use it when it was necessary. By emitting gold, the Bank of England would encourage other countries to ease their monetary policies and follow England in reducing their interest rates. That, at any rate, is what Hawtrey hoped would happen. Perhaps he was wrong in that hope; we will never know. But even if he was, the outcome would certainly not have been any worse than what resulted from the policy that Hawtrey opposed.
To the contemporary observer, the sense of déjà vu is palpable.
Uneasy Money 