The Critics of Keynesian Economics

XIII

JACQUES RUEFF was born in Paris in 1896, and studied at the École Polytechnique. In 1927 he joined the League of Nations Secretariat as a member of the economic and financial section. In the following years he served as financial attaché to the French Embassy in London, as professor of economics at the École libre des Sciences politiques, as assistant director in the Ministry of Finance, and finally, in 1936, as head of the French Treasury. From 1939 to 1940 he was vice-governor of the Bank of France. He has since occupied many official positions for the French government and, under President de Gaulle, was the head of a commission appointed by Finance Minister Pinay which drew up the famous Rueff Plan for fiscal and economic reform. He is at present a judge at the Court of Justice of the European Coal and Steel Community. His works include: Des Sciences physiques aux Sciences morales, 1922; Théorie des Phénomènes monétaires, 1927; L’Assurance-chômage, 1931; L’Ordre social (in two volumes), 1945; and Epître aux dirigistes, 1949.

The following article appeared in The Quarterly Journal of Economies for May, 1947, pages 343-367, published by Harvard University Press.

THE FALLACIES OF LORD KEYNES’ GENERAL THEORY

JACQUES RUEFF

Lord Keynes’ theory, as expounded in his General Theory of Employment, Interest, and Money, dominates the economic thought of our time. Its author does not hesitate to declare that it demonstrates the futility of the classical theory and is destined to replace it:

I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.

But the new theory has not merely a philosophical significance. It leads to rules of action, notably in the struggle against the chief malady of modern society—chronic unemployment. Indeed, it is this aspect of it—the doctrine of “full employment”—that has been most influential. Explaining the evil and providing the means of curing it, it has brought great comfort to the world.

As a remedy for unemployment, it quickly expanded beyond economic science to become an instrument of government. It has led to the publication of white papers in England and Canada and to a proposed law in the United States, the Murray Full-Employment Bill, which undertake to bind governments to its prescriptions. The new French constitution obliges the government to present each year “a national economic plan designed to provide full employment of labor and the rational utilization of material resources.” The Economic Committee of the United Nations is called “Committee on Economic Questions and Employment.” Finally, the International Conference which is to deal with the problem of international trade and whose first session was held in London in October-November, 1946, is the Conference on Commerce and Employment.

The Keynesian philosophy is unquestionably the basis of a world policy today; and if the spectre of “under-employment” appears again in the world tomorrow, as is probable, it will be the universal recourse of peoples and governments. If it is true, it will be the salvation of the world; if it is false, it may lead to catastrophe by turning the world to ineffective remedies which may make the evil much worse.

For all those concerned with the future of human society there are, therefore, no questions more important at the present time than those raised by Lord Keynes’ theory, and no duty more pressing than that of passing judgment on the value of the explanations which it offers and the efficacy of the remedies which it suggests. This is the task which I am undertaking here.

In formulating the criticisms which seem to me to apply to the Keynesian theory, it is a source of great regret that I must do so after the author’s death. Fortunately, however, his supporters are so numerous, so active, and so powerful, that my scruples on this point are somewhat relieved. Moreover, I have already had the honor of a polemic with Lord Keynes. Far from avoiding discussion, he opened the columns of the Economic Journal to me for an article entitled, “The Ideas of Mr. Keynes on the Transfer Problem.” 1

1. THE KEYNESIAN THEORY

To avoid any possibility of misrepresenting the General Theory, I quote the résumé of its doctrine given in the work itself:

The outline of our theory can be expressed as follows. When employment increases, aggregate real income is increased. The psychology of the community is such that when aggregate real income is increased aggregate consumption is increased, but not by so much as income. Hence employers would make a loss if the whole of the increased employment were to be devoted to satisfying the increased demand for immediate consumption. Thus, to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level. For unless there is this amount of investment, the receipts of the entrepreneurs will be less than is required to induce them to offer the given amount of employment. It follows, therefore, that, given what we shall call the community’s propensity to consume, the equilibrium level of employment, i.e., the level at which there is no inducement to employers as a whole either to expand or to contract employment, will depend on the amount of current investment.

Thus, given the propensity to consume and the rate of new investment, there will be only one level of employment consistent with equilibrium. But there is no reason in general for expecting it to be equal to full employment . . . the economic system may find itself in stable equilibrium with N at a level below full employment. (Pages 27-30. Italics mine.)

Such is the fundamental basis of the whole Keynesian system, the explanation of “the remarkable inability of the classical theory to serve for scientific prediction,” and the demonstration of the baselessness of the “famous optimism of the traditional theory . . . founded on failure to recognize the obstacle to prosperity which may be raised by lack of effective demand.”

It is a question, then, of a revolution in economic theory and a profound modification of the rules of action suggested by it. The classical theory holds that no permanent equilibrium can exist as long as there is unemployment. The Keynesian theory, on the contrary, claims that a society can continue indefinitely with large numbers of unemployed, and on this basis offers itself as an explanation of this new phenomenon in the world—chronic unemployment.

The whole Keynesian analysis is based entirely on a psychological hypothesis, the producers’ insufficient propensity to consume. On this hypothesis the increase of income which might be produced by an increase of employment would not increase the demand for consumers’ goods in the same proportion.

With income not giving rise to demand for consumers’ goods, and in the absence of government initiatives stimulating investment expenditures of the same amount, the increment of production resulting from the increase in employment could not find a market. Lacking a market, the corresponding production would cease, and with it would disappear the increment of income which it might have engendered. Thus would be established, by the simultaneous limitation of production and of the income making possible its acquisition, the state of under-employment equilibrium whose explanation is given as the great discovery and the essential significance of the Keynesian theory.

There is one element in this explanation which will surprise all those familiar with the analyses of the classical economics: the idea that an economic society in which an unabsorbed offer of labor exists at all times can be, without expressly assuming any fixing of prices, a state of equilibrium.

But if this is the case, it is because it is impossible in the Keynesian hypothesis that this offer of labor should be accepted, because it does not give rise in any direction whatever to any demand capable of absorbing it. Unemployment, then, is the only solution offered to the workers from which it emanates. For anyone wishing to judge the General Theory, therefore, the question is, is it possible that an offer actually appearing in the market should not give rise to any demand of the same volume? If so, Keynes’ theory can explain equilibrium with under-employment, therefore chronic unemployment, and provide the means to deal with it. If not, the explanation which it offers needs to be reconsidered.

For Lord Keynes, the steps in the reasoning appear to be as follows. As a result of their insufficient propensity to consume, the workers able to take advantage of an increase in employment are not disposed to increase their expenditures on consumption in proportion to the additional income which they could obtain. Moreover, since they have no propensity to invest, they will therefore demand nothing for all the increment of resources which they do not devote to additional expenditures. I maintain that this analysis involves a serious error.

If there is really underemployment, it is not that certain workers can do more work, but that under the conditions offered by the market they wish to do more work. If they actually offer an increment of labor on the market, and if they do not intend to divert to consumption expenditure or investment the whole of the increment of income which an increment of labor makes possible, it is because they intend to increase their cash holdings by an amount equal to the increment of income which they do not spend. In proportion as they offer labor without demanding consumers’ goods or investment goods, they are, and must be, demanders of money. This is a fundamental conclusion whose necessity must be carefully understood; for we shall see that if it is admitted, it upsets the whole Keynesian construction.

If there is under-employment, it means that laborers desire to do more work. If they offer labor on the market, it is because they desire to obtain an increment of remuneration; and if they do not wish to devote their increment of resources to an increase of their expenditures on consumption or investment, it is because they intend to increase the amount of money which they keep on hand. If this were not so, their offer of labor would be purely platonic. There might be a possibility of more work, but there would be no desire for it, and there would not be under-employment.

This being so, I maintain that the demand for additional cash holdings is equivalent in its economic effects to demand for consumption goods or investment goods and, consequently, that it is able to provide a market for the labor forces offered, on the same conditions as the demand for such goods. To show this, I shall be obliged to study in detail the effect of the demand for money. This will be the purpose of the following section. It may perhaps seem out of proportion with the minor practical importance of the case with which it deals. There is no doubt that the increase of individual cash holdings could never amount to more than a limited sum, and that as soon as individuals have reached the limit of the holdings which they wish to have, they will divert any increment of resources to increasing their demand for consumers’ goods or investment goods. But since the hypothesis of the non-employment of this increment of resources in response to a corresponding demand is the very center of the Keynesian argument, it is indispensable, in order to judge the latter, to study the former with care.

2. THE EFFECTS OF THE DEMAND FOR CASH BALANCES

I maintain that Lord Keynes is mistaken in claiming that incomes which do not give rise to a demand for consumption goods or investment goods, that is, which give rise to a demand for additional cash balances, will be permanently lost to the mass of incomes required for the absorption of the production associated with them and consequently will create a permanent underemployment equilibrium. To show this simply, I shall first assume a regime where money is entirely metallic. Following that, I shall consider the general case.

If a worker enjoying an increase of employment increases his cash holdings, all other conditions, including the amount of cash holdings desired by the other members of the society, remaining unchanged, the increase in cash holdings realized by the owners of the incomes increased but not spent will necessarily have as a consequence a decrease in the cash holdings of other members of the society below the level of the holdings which they desire to maintain. To restore their cash holdings to the level desired, the latter will have no recourse but to offer without demanding. This will tend to bring about a fall in the whole system of prices.2

One price, however, remains stable amidst all these falling prices: the price of gold, automatically maintained at the legal parity by the purchases of the coinage authority. Hence the fall in the system of prices tends to bring about the transfer of productive resources from the products whose prices have fallen to the product whose price has not changed, a diminution in the production of the former and an increase in the production of gold. But the Bank of Issue buys all of the yellow metal offered and not demanded, and consequently supplies, by monetizing the increased production of metal, the additional cash holdings desired.

Since the fall of prices and the consequent transfer of productive resources continue as long as the cause which produced them persists—that is, the insufficiency of actual cash holdings relatively to those desired—this double movement cannot but result in bringing the former to the level of the latter by increasing the quantity of monetized metal and at the same time establishing between the price of gold, stabilized at the legal parity, and the other prices in the market the relations which formerly obtained.

Thus, the demand for additional cash holdings will have had the effect of diverting the labor forces offered in an increase in employment from the production of consumers’ goods or investment goods which would not have been wanted to the production of metal destined for monetization, and consequently providing the increases in cash holdings desired.

It is therefore impossible to accept Lord Keynes’ conclusion that, in the case assumed, the insufficiency of demand for consumers’ goods or investment goods constitutes an obstacle to the increase of employment. If there is really an offer of an increment of employment on the market, and if only increases in cash holdings are desired by the persons for whom the increase of employment will provide an increase of income, the labor forces offered will find themselves spontaneously but inevitably directed by the force of the price mechanism alone towards the production of the additional cash holdings desired. Thus, the increment of production associated with an increase of employment will not have lacked a market, since it will have taken the form in which the owners of the additional incomes wished to absorb it.

It is therefore not true that the limitation of the propensity to consume, if it is not compensated by investment expenditures of an appropriate amount, is the cause of a limitation of employment. It is still less true that it leads to an equilibrium with under-employment, since the forces spontaneously brought into being by every increase in labor offered tend to adapt the economic structure to the utilization which the newly employed workers wish to make of their additional income. An economic state in process of adaptation, whatever it is, cannot be a state of equilibrium. A theory which neglects the influences tending to produce these adaptations cannot be a general theory, still less a true theory.

The Keynesian faithful will, it is true, object that the preceding analysis is purely theoretical. They will point out, first of all, that it is solely by movements of prices that the adaptation required for the absorption of an increment of production tends to be stimulated, and that in the absence of these movements or in the absence of action by price movements on the structure of the productive system, no increase of employment could be expected. Therefore, in such a case, one would, in fact, be in a state of under-employment equilibrium.

This is true, but it is no less true that, in fact, in most of the economic systems which existed before the war, spontaneous movements of prices were able to develop, and that they effectively brought about the allocation of the factors of production. The considerable variations in the rate of gold production between periods of boom and periods of depression clearly showed the sensitiveness of the productive apparatus to price movements.

I shall consider in a later section the effects of price stabilization measures and the immobilization of the factors of production. But in no part of the General Theory are stabilization of prices and immobilization of the factors of production expressly indicated as fundamental conditions of under-employment equilibrium. If they were the fundamental conditions, it would have been indispensable that this be pointed out, for among the possible remedies it would have been necessary to count, alongside the interventions suggested by Lord Keynes, the suppression of the causes of economic rigidity. Even if this had been pointed out, however, a theory based upon such special hypotheses could not have been considered a “general theory.”

In any case, even in economies not very sensitive to the forces which tend to upset economic equilibria, these forces, as long as prices are not strictly stabilized, exist, and make it impossible to consider an economic structure subject to influences which tend to modify it a state of equilibrium.

It may be noted, however, that the preceding reasoning holds only so far as workable mines of gold exist in the society under consideration. However, the absence of accessible deposits only modifies the form of the regulatory apparatus; it does not destroy it, and it eliminates none of its consequences. The fall of prices brought about by the state of under-employment, if not checked by the absorption of the under-employed into the industries producing the yellow metal, tends to divert them to the production of goods capable of being marketed abroad.3 In this way it tends to bring about a favorable balance of payments for the country under consideration. It gives rise, as in the preceding case, to additional offers of metal on the market and consequently to additional monetizations. These latter furnish the additional cash holdings desired by the newly employed workers who do not apply their increments of income to consumption goods or investment goods.

Thus, in this case also, the fact that the workers available for an increment of employment are not disposed to devote more than a fraction of their increments of income to demand for consumers’ goods or investment goods does not create a lack of markets for the increments of production which these workers can supply. It merely diverts a part of the additional production to foreign markets, where it will procure, by way of exchange, the increments of metal which provide the additional cash holdings desired by the newly employed workers. In this case, again, the additional production will have been subjected to forces tending to provide it with a market. As long as prices and factors of production have not been stabilized, no state of under-employment equilibrium can exist.

The preceding analysis applies, it is true, only to a special case—that of a society using metallic money only. This leaves us with the general case of a society using inconvertible money or money which can be obtained both by the monetization of metal and the discount of commercial paper.

As in the preceding case, the non-utilization of a part of the increment of income arising from the increase of employment will lead the beneficiaries of the increments of income not utilized to increase their cash holdings. As a result, all other conditions remaining the same, the cash holdings of certain members of the society under consideration will prove to be less than they desire to hold. To bring their cash holdings back to the level they desire, they will have no other solution except to offer without demanding. It is the existence of these uncompensated offers which sets in motion a regulatory mechanism analogous in principle, if not in form, to that revealed by our study of a purely metallic regime.

The increment of offers may react either upon wealth in the strict sense or upon credit instruments. In the first case, it leads to a fall in prices; in the second, to an increase of money rates. If it affects wealth in the strict sense and credit instruments in the same proportion in which these enter into total offerings, the excess of offers resulting from the non-utilization of an increment of income will produce a fall in prices and a rise in money rates simultaneously. This preliminary statement shows the close relation which must exist between the two opposite movements. I shall next show—and this is essential for the argument—that they are inseparably bound together.

If the offer without demand reacts solely upon wealth in the strict sense, it affects cash markets to the exclusion of credit markets, since its object is the procurement of immediate increments of cash holdings. It therefore brings about a fall in cash prices. The fall in cash prices leads speculators to buy for cash with a view to sale on credit, obtaining by way of discount of the commercial paper derived from the second transaction the resources required to settle the first. The increase of the demand for discount brings about a rise in rates on the money market, a rise which does not come to an end until the general level of prices stops falling.4 Conversely, every increase in money rates leads speculators, other things remaining the same, to sell for cash with the intention of buying back on credit, investing in the market the funds derived from the first transaction until the settlement of the second. It therefore leads to a fall in the general level of cash prices.

The preceding analysis shows that the excess of offers resulting from the existence of non-utilized incomes gives rise in all cases, and simultaneously, to a fall in the general level of prices and a rise in money rates.

I know that the statement that such a relation exists will surprise certain readers who know that periods of boom, that is, periods of rising prices, are periods of high interest rates. However, the rise of money rates which has usually accompanied periods of boom in the past was caused by the increases in the discount rate decreed by the monetary authorities, almost always as a result of fears inspired by the decrease of their metallic reserves. In fact, in every country of the world, the periods of rising prices resulting from the budget deficits of recent years have been periods of very low money rates. Be it noted that in the absence of the relation stated above the functioning of an inconvertible monetary system would be simply inconceivable, since the need for cash holdings could not lead to the issue of new money. Moreover, and this seems to me the essential argument, the possibility that every excess of offers may react as well upon credit instruments as upon wealth in the strict sense suffices to make of this statement, which at first seems paradoxical, a truth of common sense.

If, in the light of this proposition, we follow the unfolding of the phenomena which result from the insufficiency of cash holdings, we observe that in the first phase the fall in the general level of prices furnishes, by reducing the cash holdings required for the carrying on of transactions, the increments of cash holdings desired.

Now the rate of discount of the bank of issue is always very close to the market rate. When the rising market rate reaches the rate of discount, it stops increasing, since at this rate the bank accepts all paper offered and not demanded. From this moment on, all the excess of offers above the demand for short-term paper is diverted from the market to the bank of issue. The latter monetizes the paper which it has bought, and in this way supplies the increments of cash holdings desired. Commercial paper, however, is representative of wealth of the same value, wealth which is either stored up or, more generally, on its way through the process of production.

Everything goes on, therefore, as if the rights which contained this wealth, instead of being thrown upon the market, were disposed of outside the market in the assets of the bank of issue, the latter clothing them in the monetary garb which makes them reappear in the form of additional cash holdings.

Thus, in a regime of inconvertible money, as in a metallic regime, the non-ultilization of certain incomes does not give rise to a lack of markets. Wealth of the same value as that not demanded is spontaneously diverted from the market to the bank of issue. There it is ultilized for the manufacture of the increments of cash holdings demanded by the owners of the additional incomes which were not consumed and not invested. Thus, as long as the increase in cash holdings continues, the increments of production will find a market. The abstinence of the owners of the additional incomes will not have brought about under-employment.

The preceding analysis shows that in a regime of inconvertible money the process is analogous in principle, if not in form, to that characteristic of a metallic regime; but as a result of the great flexibility of interest rates, the first process is evidently more sensitive than the second. It will therefore act more easily and more promptly. In this way, it will assure a smoother adaptation of the productive apparatus to the opportunities offered it by the market. In a mixed regime—where money is obtainable both by the coinage of gold and by the monetization of commercial paper, the two processes may act simultaneously. The conclusion, from the point of view which interests us here, is not modified.

There is a case, however, where money and credit instruments do not represent wealth of equal value: when they are issued against engagements which draw their value only from a governmental act, obliging the bank of issue to buy them at a nominal rate entirely different from that at which they could be sold in the market—the situation characteristic of every regime with a deficit financed by recourse to the bank of issue. In such a case, however, the rights which contain the false credits are added, when their owners wish to turn them into real wealth, to those from which the wealth offered on the market has been derived. The demand is increased in proportion. It is impossible, therefore, to imagine that the purchasing power impinging upon the market should not be sufficient to absorb the wealth offered there.

The preceding analysis shows that in all cases the demand for liquidity implies a demand for wealth of equal value. This wealth can, according to circumstances, be metal or credits, themselves representatives of goods stored or sold on credit. We are therefore not entitled to conclude that “liquidity preference” diminishes proportionately the purchasing power impinging on the market. This always remains determined, everything remaining the same, by the value of the production offered there. The demand for liquidity—like every demand, whatever its nature—simply sets forces in motion which tend to stimulate in the productive apparatus the adaptation capable of satisfying it.

To demand money is not, as Lord Keynes believes, to demand nothing. It is to demand wealth capable of being monetized within the framework of the existing monetary system. Hence, the preference for liquidity offers, like any other demand, an outlet for the labor forces offered on the market. Contrary to the Keynesian conclusion, it cannot be, at least so far as prices and the factors of production are not entirely immobilized, a cause of under-employment in the society which it affects.

3. THE ORIGINS OF THE KEYNESIAN ERROR

The Keynesian theory of permanent under-employment equilibrium rests, then, essentially on an erroneous idea—the idea that all income not spent on consumers’ goods or investment goods involves an inadequate absorption of the production of which it is the result. This idea is itself the consequence of two fundamental errors which characterize Lord Keynes’ thought in the monetary sphere.

The first is based on the over-simplified idea that money and credit instruments are nothing but empty symbols with no value. This, one might say, is the effect of a monetary nominalism with which the General Theory is thoroughly impregnated. The most characteristic passage from this point of view is the one dealing with financial provisions:

But when the financial provision exceeds the actual expenditure on current upkeep, the practical results of this in its effect on employment are not always appreciated. For the amount of this excess neither directly gives rise to current investment nor is available to pay for consumption.

Thus sinking funds, etc., are apt to withdraw spending power from the consumer long before the demand for expenditure on replacements (which such provisions are anticipating) comes into play; i.e. they diminish the current effective demand and only increase it in the year in which the replacement is actually made. (Pages 99, 100.)

Nothing shows more clearly that, for Lord Keynes, to accumulate reserves—that is to say, to accumulate money or short-term credit instruments—involves a proportionate diminution in the effective current demand, and therefore, the creation of under-employment.

The fallacy of this thesis appears immediately when the accumulation is in the form of metal. I have shown in the preceding section that the process characteristic of a circulation made up entirely of gold is general, and that the Keynesian thesis is just as untenable when the holdings consist of inconvertible money or short-term credit instruments.

At the beginning of Chapter 16, Sundry Observations on the Nature of Capital, our author presents the thesis even more clearly:

An act of individual saving means—so to speak—a decision not to have dinner today. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing today’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand—it is a net diminution of such demand.

Here there is no question that, for Lord Keynes, to save is to demand nothing. He does not realize that to accumulate money or credit instruments is to demand the values of which the money or credit instruments are a representation, and that to diminish one’s cash holdings is to liberate the same values, causing them to be offered on the market.

The regulatory process thus neglected is, however, an essential one, indispensable to a comprehension of the monetary mechanism. If it is not granted, it goes without saying that, as Keynes believes, preference for liquidity, that is to say, the accumulation of monetary reserves, tends to destroy the equilibrium of the market by inadequacy of demand, just as their utilization destroys it by excess. Every variation in reserves and holdings would, therefore, preclude the maintenance of economic equilibrium.

If, on the contrary, we grant it, the increase of reserves and holdings tends merely to divert to the fabrication of money the productive forces previously devoted to the production of the goods which are no longer demanded, while the utilization of these holdings tends to free the productive forces which were utilized for the production of the wealth represented by the money and orient them towards the production of the newly demanded goods.

I believe, moreover, that the process of monetary regulation, if it is generally admitted so far as metallic money is concerned—though not always very conscientiously—is ignored by most monetary theorists, so far as inconvertible monetary systems are concerned. For my part, I have found it difficult to disentangle it and to show its generality.5 I now believe it to be unquestionably established, and I believe, moreover, that it is the keystone of the whole theory of money.

In particular, I cannot see how one could explain the bond which must exist between the total amount of individual cash holdings and the quantity of money in circulation without making use of the theory of regulation. Every individual fixes freely, more or less consciously, the amount of his cash holdings. He generally ignores the existence of the procedures by which money can be created, and yet, in order that his desire for cash holdings may be satisfied, it is necessary that he be able by his decision to bring about variations in the quantity of money in circulation, in a regime of inconvertible money as well as a regime of metallic money. Only the theory of monetary regulation, based upon the mechanism which I have analyzed above, seems to me able to furnish the indispensable explanation and to show how each individual, in fixing the amount of his own cash holdings, helps to determine the total amount of money issued.

The problem of the bond between the amount of individual cash holdings and the total amount of money in circulation did not escape Lord Keynes, but since he ignores and denies the process of monetary regulation, he elaborates, to resolve it, an obscure explanation of the mechanism by which

. . . the liberty, which every individual possesses, to change, whenever he chooses, the amount of money he holds [is harmonized] with the necessity for the total amount of money, which individual balances add up to, to be exactly equal to the amount of cash which the banking system has created. (Page 84. Italics mine.)

Thus, for Keynes, the quantity of money which the banking system has created is a datum. The total amount of individual cash holdings has to be adapted to it. I am convinced, on the contrary, that it is the total of cash holdings desired by individuals which, thanks to the mechanism of regulation, determines the quantity of money in circulation. But I have also shown that the mechanism of regulation, if we admit that it exists, excludes the possibility of equilibrium with under-employment and, consequently, destroys the foundation of the Keynesian theory.

It is not only the paragraphs which I have cited but the whole General Theory which leads to the conclusion that Lord Keynes’ position is entirely dominated by the idea that the quantity of money in circulation is a datum arbitrarily fixed by the monetary authorities, upon which the market demand exercises no influence. His theory of interest (Chapter 13) in particular, rests upon this foundation:

It is the “price” which equilibrates the desire to hold wealth in the form of cash with the available quantity of cash—

And the quantity of money is not determined by the public. All that the propensity of the public towards hoarding can achieve is to determine the rate of interest at which the aggregate desire to hoard becomes equal to the available cash.

Furthermore, Lord Keynes believes that the monetary authorities can cause the quantity of money in circulation to vary. “If we have to govern the activity of the economic system by varying the quantity of money,” he writes. Can a more outmoded and over-simplified conception be imagined? Among men who have reflected on monetary questions, are there any considerable number today who believe that a bank of issue fixes the quantity of money in circulation? All those who, from near or far, have participated with their eyes open in the management of a bank of issue are well aware that the open market can modify the cover of the outstanding circulation, can substitute to the great profit of the bank, treasury bills for an advance to the state, and lower the rate of interest, but cannot directly modify the quantity of money in circulation.

As Directeur du Mouvement General des Fonds, I have known periods of equal deficit where the circulation increased and others where it decreased, without the monetary authorities having taken any action to bring about these changes and in spite of everything they could do to prevent them. As Deputy Governor of the Bank of France, I witnessed the vain attempts of the central bank to resist the increase of note issue.

Thus, the quantity of money in circulation, contrary to popular belief, is not fixed by the authorities of the market, and the fundamental error of Lord Keynes seems to me to result from the wholly superficial views which he holds concerning the monetary mechanism.

If we admit the existence of the mechanism of monetary regulation which I think I have demonstrated, under-employment cannot be a permanent state of equilibrium, since the mechanism of regulation tends to bring about those very transfers of the factors of production which are capable of making it disappear, even in the case where, as a result of liquidity preference, the demand of workers newly employed is exercised only in part upon consumers’ goods and investment goods. Thus, either the quantity of money in circulation is a datum—and the theory of Keynes can be true—or the quantity of money is fixed by the size of the cash balances which the users of money desire to hold, and the Keynesian explanation of permanent under-employment equilibrium falls to pieces.

4. THE GENERAL THEORY, IMPERFECT PHILOSOPHY OF UNSPECIFIED RIGIDITY

It will be pointed out, to be sure, that the tendencies resulting from an increase of unutilized incomes, i.e., neither consumed nor invested, will not prevent unemployment unless they effectively divert productive forces from the production of wealth in the strict sense to wealth susceptible of being monetized, gold or commerical paper. Until the transfer has occurred, new production will throw upon the market wealth not demanded, and in this way will condemn to unemployment those who were disposed to devote themselves to such production. Under-employment will simply be the expression of the refusal of the owners of incomes to accept what they do not want.

Thus, at the moment when the increase of employment takes place, if it is not directed into a channel which permits it to furnish the increments of money desired by the beneficiaries of the unspent increments of income, the situation may be that envisaged in, and explained by, the Keynesian theory. The only difference will be that while Keynes considers this situation a position of under-employment equilibrium, I regard it as a temporary state which the forces arising from the mechanism of regulation tend to modify.

If the action of these forces were rendered ineffective, however, if they were incapable of diverting factors of production, Keynes’ theory could then be considered a faithful explanation of reality. Thus, the theory of employment which Keynes calls “general” is valid only for very special cases, for economies which are entirely insensitive to movements of prices and of interest rates.

Moreover, in this case, if the theory is really to take account of reality, it would have to be the object of a profound generalization. If permanent unemployment can exist in an entirely rigid economy, it is not merely because the demand for investment goods may not be sufficient to offset the excess of a given increment of income above the increment of consumption which it is capable of causing, but because it might happen in various ways that the increase of production which an increase of employment might make possible in the channels where it is practically feasible would not consist of products which the beneficiaries of corresponding increases of incomes would wish to obtain.

An example will make my thought clearer. I assume a state of general under-employment; in other words, a state in which important segments of the labor force are either unemployed or employed less than they would like to be. Keynes says that in the absence of a systematic increase in investment this state might be a permanent state of equilibrium, because if employment increased, a part of the increments of income associated with the new production would not give rise to any demand, as a consequence of the psychological disposition of individuals to devote only a part—varying with their propensity to consume—of their increments of income to increased consumption.

I have shown that in such a case individuals who do not consume demand money, and that the increments of cash holdings which their attitude leads them, consciously or not, to desire could be furnished them only by a suitable orientation of production—an orientation which the mechanism of monetary regulation tends to bring about. Hence, under the assumption which implicitly underlies Keynes’ theory—a rigid economy and a propensity to consume not offset by an increase of investment—under-employment is permanent only because, while the owners of increments of income are not disposed to accept anything but increments of cash holdings, the increments of production which an increase of employment might afford them are only wealth in the strict sense—consumers’ goods or investment goods.

Let the unemployed laborers apply themselves to the production of what is demanded, namely, gold in a country capable of producing it, exportable goods in a country possessing no gold deposits, or goods capable of being absorbed in a process giving rise to commercial paper, and employment can increase. Thus, in the Keynesian hypothesis, unemployment will result only from the incapacity of the productive apparatus to adapt itself to the market demand.

But this defect of adaptation—essentially temporary, since no one, it seems obvious, is disposed to hoard increments of income indefinitely—is only a very special and very exceptional form of the defects of adaptation possible. Under-employment is not caused only by an insufficient propensity to consume. It also results from every divergence between the increments of production which an increment of employment might supply and the increments of demand which the corresponding increment of incomes could give rise to.

Let us suppose, for example, that the situation in which Keynes sees the essential cause of under-employment does not exist, every owner of increments of income being disposed to demand consumers’ goods for the totality of his new resources. Now in such a situation, where the propensity to consume would be 100 per cent, any increase in employment would be impossible if the workers capable of being newly employed were adapted only to the manufacture of investment goods or consumers’ goods other than those which the owners of increments of income desired. The state of under-employment would exist despite a total propensity to consume.

Conversely, in a society where the unemployed workers were not ready to produce anything except consumers’ goods—the case, in particular, of unemployed workers specialized in agricultural production—every demand for investment goods, however important, would have no effect upon employment. The Keynesian remedy would be wholly ineffective.

Thus, Lord Keynes has taken account, among all possible causes of under-employment attributable to economic rigidity, only one very special case, that of unemployment due to incapacity of the economic organism to furnish the increments of cash holdings or of short-term credit instruments which are temporarily demanded of it. He has given to this cause of under-employment an importance which it does not in general deserve, since unemployment can result from any defect of adaptation between production and the demand capable of absorbing it, and can last until this adaptation has been effected. He has, furthermore, failed to note that the complete economic rigidity required, if his theory is to be partially true, is not a general characteristic of economic societies but, on the contrary, a very exceptional state, which only special measures of immobilization or control could engender.

The omission in the general theory of the essential effects of economic rigidity is evidently an extremely serious matter, since it conceals the true character of the Keynesian explanation and brushes aside some of the remedies for under-employment which it should have suggested.

The considerations developed in the present section lead to a general view of the mechanism of unemployment. Contrary to Keynes’ view, it does not result from an insufficiency of income. Income is never insufficient to absorb existing production; for, apart from special circumstances which I cannot consider in detail here, it is engendered by this production and its amount at every period is identically equal to the value of the said production.6

On the other hand, if the products offered are not those desired by the market, their value may be reduced to zero at the same time as the income of the producers to whose activity they are due. Thus the total income is not rendered incapable of absorbing the production, for the value of the latter is reduced in the same degree as the total of the former. But if the production of unwanted goods comes to an end, the state of unemployment to which it gave rise is not a state of equilibrium, for it engenders forces which tend to modify it with a view to restoring to the factors of production their normal productivity. It is only when these forces are systematically paralyzed that under-employment can become a permanent characteristic of the society in question.

5. THE POLITICAL CONSEQUENCES OF THE GENERAL THEORY

The preceding analysis will enable us to form an opinon concerning the efficacy and probable consequences of the remedies for unemployment which the Keynesian theory suggests.

These remedies all rest upon the central idea that underemployment is due to an inadequate propensity to consume. To increase employment, therefore, it is sufficient either to increase the propensity to consume or to offset the inadequacy of the demand for consumption goods by a systematic increase of investment. In order to increase the propensity to consume, Lord Keynes recommends a redistribution of income designed to discourage the deplorable instinct to save:

Thus our argument leads towards the conclusion that in contemporary conditions the growth of wealth, so far from being dependent on the abstinence of the rich, as is commonly supposed, is more likely to be impeded by it. (Page 373.)

He also contemplates appropriate fiscal and interest-rate policies. If the level of investment is fixed, total income depends entirely on the propensity to consume, therefore on measures tending to develop it. “So long as the marginal propensity to consume out of wages is greater than that out of profits,” says one of his disciples, “any rise in wage rates at the expense of profits will raise the aggregate marginal propensity to consume . . . thus raising the level of income that can be supported by a given level of investment and federal expenditure.” (Econometrica, July, 1946, p. 227.)

The preceding analysis shows that these remedies cannot have any permanent effect on the level of employment, which is indifferent to the utilization made of the incomes to which it gives rise. It also shows that the corresponding interventions will reduce the temporary unemployment arising from economic rigidity only in the exact degree to which the increase in the propensity to consume arouses demand for the goods which the under-employed labor forces are capable of producing. If the latter are unable or unwilling to offer anything but investment goods, the increase in the propensity to consume will leave them unemployed. In any event, their adaptation to the new markets afforded them by a given increase in the propensity to consume would be neither less difficult nor less painful than that which would have made possible the absorption of unemployment by adaptation to the utilization which the owners of incomes intended to make of them, whether it responds to a desire to save or a desire to hoard.

But the fundamental and quasi-universal remedy of the Keynesian theory is the investment expenditure undertaken by the state with a view to warding off the alleged inadequacy of private demand. For each level of investment there is supposed to be a corresponding level of income, and hence of employment. If employment declines, it is because the volume of investment required to sustain the existing employment has not been achieved. To do away with unemployment, it is necessary and sufficient that the state assume the investment expenditures which private initiative is unwilling to undertake.

The whole preceding analysis shows that this conclusion is false. The level of investment expenditures, whether public or private, does not define the level of employment, since with every level of employment there is associated an income capable of absorbing the corresponding production, under the one condition that the latter be adapted, in its nature, to the effective demand of the owners of incomes. Even if we admit “as a permanent characteristic of human nature” the existence of a consumption function analogous to that assumed in the Keynesian analysis, it does not lead to the conclusion that investment expenditures are necessary in order to insure full employment; for every demand which is not exercised upon the market for consumers’ goods will reappear in the form of demand for investment goods or for hoarding.

It should be noted further that a demand for additional cash holdings will always be of limited amount, and that when it is satisfied, the corresponding demand will reappear upon the market for investment goods or consumers’ goods.

It is true, however, that investment expenditures can bring relief to a temporary unemployment crisis, though only to a limited extent. They can furnish a market for unemployed labor forces available for the production of the investment goods for which they produce the demand. Every increment of investment expenditure can increase employment in the investment industries and in these alone. Moreover, we should not consider the investment industries as a whole. It is only the factors of production specialized in the industries which benefit from the additional demand which will be afforded an additional market by the investment expenditures, relieving them from the unemployment which would have led them to make the adjustment required by the conditions of market demand.

However, though investment expenditures can in this way reduce temporary unemployment in the industries affected by them, they entail secondary effects which must be taken into account if we wish to arrive at a decision on balance concerning the consequences which the full-employment policy will bring in its train when it becomes the object of generalized application. These secondary effects will vary according to whether the investment expenditures are achieved within the framework of a treasury in equilibrium or with a deficit; in other words, according to whether they are financed by taxes and loans or by the issue of treasury bills rendered eligible for discount because the market has not of its own accord assured the absorption of them.

In the first case, there is a levy on the society of the resources devoted to the financing of the investment program. If the purchasing power thus taken away from individuals is that which they intended to spend on wealth not offered in the market (for example, in the Keynesian hypothesis, additional cash holdings), and if the increment of demand arising from the investment program impinges on wealth which the unemployed factors of production are capable of producing, the investment program will increase employment, but it need not turn out this way. It is probable that in large measure the demand for articles not produced—for example, increments of cash holdings—will persist and that the levies accomplished will, to the extent of an important fraction of their total, reduce the demands which were impinging upon the other segments of the market.

Consequently, the program will have augmented the amplitude of the adjustments required for spontaneous reabsorption of the unemployed and delayed the moment when the latter will be able to come to pass. Under the (improbable) assumption that the public investment program has absorbed all the unemployed productive resources—that is, to the degree in which it has achieved its purpose—it would have brought about the disappearance of every force capable of assuring an ultimate spontaneous recovery of the market.

But, furthermore, if the investment expenditures imply the utilization of raw materials or goods demanded in the market, they will, by increasing the demand and hence the price of these goods, help to reduce the outlets spontaneously afforded them by the market. So far as they have served to absorb this wealth, the investment expenditures will not have helped to increase the employment in the market. Finally, so far as the investment program diverts means of production from the areas where they are more desired to less useful employments, it will reduce the standard of living of the society.

However, it is unlikely that a large investment program following a period when economic depression has seriously reduced government revenues should ever be financed within the framework of a balanced budget. In the majority of cases, if not in all, resources will be obtained by the issue of treasury bills eligible for discount.

In the situation foreseen by the Keynesian hypothesis—a depression caused by the refusal of certain workers to utilize the increment of income afforded them by an increment of employment—inflation can supply them with the increments of cash holdings which they wish to obtain. In this way, so far as the offer of employment is accepted by the under-employed workers, whether it corresponds to their previous specialization or they accept the modifications in activity which it implies, an investment program financed by inflation can bring about an increase of employment.

However, individuals, other things remaining the same so far as prices go, cannot be supposed to increase their cash holdings indefinitely. The moment will necessarily arrive when the newly issued monetary tokens will not be wanted. Then they will produce, along with a rise in the general level of prices, all the economic and social disorders associated with inflation. If we wish to avoid the latter without abandoning the investment program which has given rise to them, there will be no other solution but to limit demand by a system of general rationing.

Thus, the inauguration of a vast program of public works, if it is carried out over a prolonged period, will revive in the world an economic regime invented by Hitler, from which victory was supposed to free us. We shall see the restraints progressively tightening and expanding, and the steady unfolding of the familiar process of inflation will again bring about the suppression of all human liberties. In this way it will be demonstrated once more that the governments of human societies have a choice between only two solutions: to allow the apparatus of production to adapt itself to the structure which, by the movements of prices, the will of the consumers tends to impose upon it, or to adapt the desires of consumers by authoritative regulation to the structure of the productive apparatus which we do not propose to change.

The preceding analysis illuminates the phenomena which we have observed during the past decade and explains why the development of war industries caused unemployment to disappear, while investment plans applied in peace time seem incapable of accomplishing it. The war-time programs created a practically unlimited demand. They reabsorbed unemployment because the workers available were transferred, voluntarily or under compulsion, into the employments which this demand brought into being. As for financing, it was assured, so far as it was not covered by taxation or by loans, by recourse to the bank of issue. The inflation thus engendered was in large measure neutralized by rationing, that is, by the suppression of the freedom of the demanders in the utilization of their purchasing power.

The new activities obviously restricted the previous production by the utilizations of material and of energy which they implied, but no one thought of complaining about it, because at the same time taxation, borrowing, and rationing restricted the power of buying.

Can the same result—unsatisfactory as it is, since it implies and requires the suppression of all economic liberty—be hoped for in time of peace? I do not think so. In the first place, it is improbable that the administrative authorities will be able to impose in time of peace the transfers of labor power which such a program implies. These transfers will probably be neither less extensive nor less painful than those which would have assured the spontaneous reabsorption of the under-employed; and since the latter are considered unacceptable, it is improbable that the former would be any more acceptable, even if the public authorities had a mind to impose them. Moreover, the inauguration of a large investment program will appreciably diminish, by the utilization of raw materials and of energy which it requires, the production of articles really demanded. Public opinion will be reluctant to give up what it wants for the production of what it does not want.

The privations which the investment program will cause will be much more appreciable than in time of war, for it will not be possible to raise the tax revenues to the level which they had attained during hostilities, or to obtain voluntary loans of such large amounts, or to impose, by means of rationing, a sufficient neutralizing of purchasing power. For all these reasons, an unsatisfied demand will persist in the market and this will give rise more or less rapidly, according to its relative magnitude, to all the troubles of inflation.

In spite of these prospects, it is probable that the next period of depression will see a general application in the world of the policy suggested by Lord Keynes. I am confident that this policy will not reduce unemployment, except to a very limited extent, but that it will have profound consequences upon the evolution of the countries in which it is applied. Through the economic disorders to which it will give rise, it will re-establish in the world a regime of general planning analogous to the regime of war time and based upon the suppression of all individual liberty. Thus, the next economic crisis seems likely to be the occasion for profound political changes, welcome to some people, dreaded by others. In any event, being based on a false theory, the remedies, which will be adopted will give rise to repercussions very different from those they were designed to produce. Their ineffectiveness will be, for a great part of public opinion, one more reason for urging the suppression of a regime which, by denying itself, will have destroyed itself.

Whom Jupiter wishes to destroy, he first makes mad.

1 Economic Journal, September, 1929, Revue d’Economie Politique, July-August, 1929.

2 I have analyzed in detail, in Chapter 4 of my L’Ordre Social, the mechanism by which this fall is brought about.

3 This mechanism, too, is analyzed in detail in Volume 1 of my L’Ordre Social (p. 383).

4 The rate does not depend upon the absolute level of prices, but only on variations in it. Mathematicians would say that it is a function of the derivative of the general level of prices with respect to time. (L’Ordre Social, Vol. I, p. 61.)

5 L’Ordre Social, Vol. I, Chs. 17–20.

6 L’Ordre Social-Ch. 10.