Interest and Prices

CHAPTER 1

INTRODUCTORY

CHANGES in the general level of prices have always excited great interest. Obscure in origin, they exert a profound and far-reaching influence on the whole economic and social life of a country.

Relative variations in the exchange values of individual groups of commodities are a necessary and obvious result of changes in the conditions of production and of technical improvements. The damage which they cause to individual classes of producers and of consumers is, to a greater or lesser extent, adjusted as a result of changes in demand or of the movement of capital, labour, and land, from those spheres of production which are now less remunerative to those which have become more remunerative.

But it is a different matter when a rise or fall occurs in the money prices of all, or of most, commodities. Adjustment can no longer proceed through changes in demand or through a movement of factors of production from one branch of production to another. Its progress is much slower, being accomplished under continual difficulties, and it is never complete; so that a residue, either temporary or permanent, of social maladjustment is always left over.

A general rise in prices is, of course, to the disadvantage of all those who receive fixed money incomes, as is the case to-day with a constantly increasing number of social groups. It is also to the disadvantage of all those who derive the whole, or a large part, of their incomes by lending money capital of one kind or another. (These constitute a class which is, of course, in no way confined to the class of real capitalists.) This is at any rate the case so long as a corresponding rise in the rate of interest does not happen to offset the fall in the purchasing power of money. Lastly, a general rise in prices is to the disadvantage of labour, so long as it has not the power to enforce a corresponding rise in wages. But it must not be forgotten that a rise in wages may precede a rise in prices, acting as its direct cause. It will indeed appear later that this must be regarded as the most probable procedure whenever the rise in the price level is gradual and permanent, as opposed to those more fortuitous changes which are brought about by speculative buying and the like. That being so, it is not possible, without further qualification, to speak of a rise in prices as causing a general injury to labour. On the other hand, an upward movement of prices acts undoubtedly as a stimulus to the spirit of enterprise; though this advantage is possibly more apparent than real, for it is only too often associated with unhealthy speculation, based on what is a boom on paper rather than in actual economic fact, and culminates in over-expansion of credit, credit disturbances, and crisis.

A lasting fall in the prices of all commodities is generally recognised as no less significant an evil. While it is true that with the same wages the workers would be able to obtain more of the necessaries of life, this advantage is frequently outweighed by the other consequences of a fall in prices. Business is paralysed, and growing unemployment and falling wages result. Moreover, a low level of prices is often the effect of a previous reduction in wages; and it can then obviously do no more than offset this reduction. Lastly, and perhaps most important of all in this connection, direct and indirect taxation presses more heavily on the worker, and on the small man generally, when prices are low. Salaries of government and municipal officials seldom decrease in proportion to the cost of living. The state’s creditors, like all other creditors, claim the same interest as before (apart from the possibility of conversion), which means a correspondingly greater burden on the nation as a whole if the majority of its creditors are abroad. And if the amount of taxes and of other receipts collected by the state (or municipality) remains at its previous level in spite of the fall in prices, the temptation to some degree of government extravagance is generally inherent, and is seldom resisted with sufficient force.

In some cases, of course, there are considerable advantages to be gained by particular interests as a result of a rise or fall in the price level. But if advantages and disadvantages are weighed against one another there can be no doubt that the latter always preponderate; both because every disturbance to the social mechanism is an evil in itself and because the gain due to a fortuitous and unexpected increase in a man’s income is scarcely ever so significant as the injury caused by an unexpected decrease of equal magnitude.

It is, however, widely believed that what is most desirable of all is a state of affairs in which prices are rising slowly but steadily. Many, indeed, look upon the reduction in the value of money that has taken place in the course of centuries as a contrivance of providence, successful in particular in curtailing the fatal consequences of irresponsible borrowing and of the thoughtless saddling of posterity with burdens incurred in the interests of the current generation, though opinions differ as to the wisdom of governments of former times in assisting providence by debasing the currency. That is as may be. As men become accustomed to rely more on their own strength and foresight and less on the beneficent influences of nature, so of course will it become less necessary to pay attention to such remedies for past blunders. Moreover, if a gradual rise in prices, in accordance with an approximately known schedule, could be reckoned on with certainty, it would be taken into account in all current business contracts; with the result that its supposed beneficial influence would necessarily be reduced to a minimum. Those people who prefer a continually upward moving to a stationary price level forcibly remind one of those who purposely keep their watches a little fast so as to be more certain of catching their trains. But to achieve their purpose they must not be conscious or remain conscious of the fact that their watches are fast; otherwise they become accustomed to take the extra few minutes into account and so after all, in spite of their artfulness, arrive too late. . . .

It follows that if it were in our power to regulate completely the price system of the future, the ideal position, affording common advantage to the overwhelming majority of the various groups of interests, would undoubtedly be one in which, without interfering with the inevitable variations in the relative prices of commodities, the general average level of money prices—in so far as this conception can be assigned a definite meaning, a point to which we shall return in a moment—would be perfectly invariable and stable.

And why should not such regulation lie within the scope of practical politics? So far as relative values are concerned, their variations, as has already been mentioned, are dependent on natural causes, which in part elude all human control. Attempts by means of tariffs, state subsidies, export bounties, and the like, to effect a partial modification of the natural order of these values almost inevitably involve some loss of utility to the community. Such attempts must so far be regarded as opposed to all reason. Absolute prices on the other hand—money prices—are a matter in the last analysis of pure convention, depending on the choice of a standard of price which it lies within our own power to make. Yet this choice too is to some extent conditioned by certain natural circumstances. It is only necessary to think of the external factors which have, as it were, forced us to adopt the precious metals, and in recent times gold in particular, as the material of coins. But fundamentally these circumstances are of only secondary importance; or, more correctly perhaps, a more than secondary importance should never be attributed to them. For it is the part of man to be master, not slave, of nature, and not least in a sphere of such extraordinary significance as that of monetary influences.

Little success has been achieved up till the present in satisfying such an ideal. The progress of monetary theory and practice has not done much to secure the desired stability of the standard of value and of prices. Its failure is abundantly demonstrated by the history of prices of this last century, and particularly of its latter half. It is true that opinions differ as to the actual magnitude of the rise in the general level of prices (in terms of gold) that took place between the middle of the century and about the year 1873 and of the succeeding fall which has continued up till to-day1—about the magnititude, that is to say, of the corresponding changes in the exchange value or purchasing power of money. But this is easily to be understood. In the first place, there is no reason why these changes should have proceeded equally in the different countries. It is, in fact, certain that, for various reasons to which we shall return later, the changes will be unequal. (This is probably the explanation of the minor deviations between the tables of prices constructed by Sauerbeck and Soetbeer, to which Sauerbeck has himself called attention.2) Then we have the not unimportant difficulty of ascribing an unambiguous meaning to the conception of an average level of prices. Finally, there is the uncertainty as to which prices to take into account: whether to include only wholesale prices, as has usually been done up to the present, or also retail prices; whether to include only the prices of commodities or also the prices of services and, in particular, the wages of labour; and so on. In the next chapter we shall try to find a short answer to these questions.

In spite of these differences of opinion and in spite of the fact that the method which has hitherto been employed cannot be regarded as entirely unobjectionable, the substantial accuracy of its main results is not open to reasonable doubt. Examples of similar and even more violent oscillations of prices are provided in abundance by earlier periods of history, particularly for individual countries. But it has to be remembered that in those times a natural system of economy was in force to a very much more considerable extent than is the case to-day—over a wide range it was the rule in private as well as in public economy. Changes in the relative value of the precious metals or of money, even though very considerable, exerted a far smaller influence than does even the smallest movement of prices to-day, when a monetary system (in the widest sense of the term, including the credit system) has become almost universal.

It has already been pointed out that the prevention of these troubles by the provision of a constant measure of value cannot, in the present state of economic development, be regarded a priori as unthinkable. The difficulties of the problem are far more theoretical than practical. What is required is to be certain what is meant by the purchasing power of money and how it ought to be measured, and to obtain a clear view of the causes of changes in its value. There will then be no lack of practical means for converting theoretical judgments into appropriate measures. Of these two theoretical questions, it is the second, and by far the more difficult, that will mainly occupy our attention. But we will try in the first place to obtain as clear an answer as possible to the first.

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3 [1898.]

4 See the discussion in the Economic Journal, 1895 and 1896.

• 1]
• 2See the discussion in the Economic Journal, 1895 and 1896.
• 3Little success has been achieved up till the present in satisfying such an ideal. The progress of monetary theory and practice has not done much to secure the desired stability of the standard of value and of prices. Its failure is abundantly demonstrated by the history of prices of this last century, and particularly of its latter half. It is true that opinions differ as to the actual magnitude of the rise in the general level of prices (in terms of gold) that took place between the middle of the century and about the year 1873 and of the succeeding fall which has continued up till to-day—about the magnititude, that is to say, of the corresponding changes in the exchange value or purchasing power of money. But this is easily to be understood. In the first place, there is no reason why these changes should have proceeded equally in the different countries. It is, in fact, certain that, for various reasons to which we shall return later, the changes will be unequal. (This is probably the explanation of the minor deviations between the tables of prices constructed by Sauerbeck and Soetbeer, to which Sauerbeck has himself called attention.) Then we have the not unimportant difficulty of ascribing an unambiguous meaning to the conception of an average level of prices. Finally, there is the uncertainty as to which prices to take into account: whether to include only wholesale prices, as has usually been done up to the present, or also retail prices; whether to include only the prices of commodities or also the prices of services and, in particular, the wages of labour; and so on. In the next chapter we shall try to find a short answer to these questions.
• 4Little success has been achieved up till the present in satisfying such an ideal. The progress of monetary theory and practice has not done much to secure the desired stability of the standard of value and of prices. Its failure is abundantly demonstrated by the history of prices of this last century, and particularly of its latter half. It is true that opinions differ as to the actual magnitude of the rise in the general level of prices (in terms of gold) that took place between the middle of the century and about the year 1873 and of the succeeding fall which has continued up till to-day—about the magnititude, that is to say, of the corresponding changes in the exchange value or purchasing power of money. But this is easily to be understood. In the first place, there is no reason why these changes should have proceeded equally in the different countries. It is, in fact, certain that, for various reasons to which we shall return later, the changes will be unequal. (This is probably the explanation of the minor deviations between the tables of prices constructed by Sauerbeck and Soetbeer, to which Sauerbeck has himself called attention.) Then we have the not unimportant difficulty of ascribing an unambiguous meaning to the conception of an average level of prices. Finally, there is the uncertainty as to which prices to take into account: whether to include only wholesale prices, as has usually been done up to the present, or also retail prices; whether to include only the prices of commodities or also the prices of services and, in particular, the wages of labour; and so on. In the next chapter we shall try to find a short answer to these questions.