The Monetary Problem Of The Scandinavian Countries1

THE MONETARY PROBLEM OF THE SCANDINAVIAN COUNTRIES1

NOT long ago I was asked by Professor Davidson to write something about the recent rise in the Danish and Norwegian exchange rates. I am afraid that I consented rather too hastily; for starting off with the whole question of the rise and fall of prices during and after the War, I soon became assailed by very strong misgivings as to the completeness, if not the validity, of the explanations usually provided with such unanimous conviction by economists, especially here in Sweden. I began further to wonder whether practical men of affairs, in spite of some obviously wrong and illogical conclusions, have not in some directions advanced further than we have towards an understanding of these phenomena. The consequence is that my treatment of this side of the question has become disproportionately extensive. For this I have to apologise.

The main question at issue has referred on the one hand to the relation between a scarcity of commodities and the rise of prices and on the other hand to the relation between the cessation of such a scarcity and the subsequent fall in prices. That commodities were scarce during the War cannot be denied. In the belligerent countries this was due to the fact that a large percentage of productive workers were called to arms or to the production of munitions. At the beginning of the War the deficiency of ordinary commodities could in part be made good by drawing on stocks, of which Germany in particular had large quantities, or they could be replaced, as in the case of the Entente countries, by imports. But as the War went on and covered a wider field these sources were of course no longer adequate. In the neutral countries the scarcity of commodities was more indirect in origin, taking the form partly of obstacles to import, partly of an unduly large export of goods to belligerent countries. Nevertheless, it is a well-known fact that a very marked scarcity made itself felt even in neutral countries. By what means, and in what order, this scarcity was first alleviated on the conclusion of the War, and was finally eliminated, is a matter far more difficult to ascertain (and one to which I shall return). There is, however, no doubt that in most countries the degree of scarcity which existed during the War has been alleviated, or even more than alleviated.

It is the scarcity of commodities that business men have regarded as the chief if not the sole cause of the rise in prices, at any rate in those countries whose exchanges did not entirely collapse during the War; and similarly it is increased supplies which provide their explanation of the marked post-War fall in prices. The expansion and subsequent contraction in the medium of exchange would according to them be merely the consequence, indeed the almost inevitable consequence, of the rise and fall in prices which had already taken place. The theorists, on the other hand, have tried to prove that a scarcity of commodities in itself can cause at the most a proportionate rise in prices, whereas in most cases the rise was very much greater. The theorists would argue that if the total quantity of money in circulation had decreased pari passu with the decline in supplies of commodities, no rise in prices would have taken place; if the quantity had remained stationary, there would have been no more than a proportionate rise in prices, which in the countries least affected would amount to 10 or 20 per cent. But the actual rise in prices amounted to several hundred per cent. The main cause is, therefore, to be sought in the monetary sphere, in an over-liberal credit policy on the part of the note-issuing banks, and above all in a too great benevolence toward the demands of governments. Even in the country where such a measure was least to be expected, namely, England, the government took it upon itself to issue notes.

The most pregnant formulation of the arguments on the two sides is perhaps to be found in Professor Cassel’s well-known Money and Foreign Exchange after 1914 (March 1922). I take the liberty of quoting the following passage:2

Whenever this suggestion has been made [that the driving force in the rise in prices has been what is termed inflation], the usual answer from the central banks has been that they could not suppress the demand. When the scarcity of commodities became aggravated, the public clung as long as possible to their claims upon life, and bought, in spite of the fact that prices rose. It was commonly imagined that the public were by no means limited in this buying up of goods by the amount of their current incomes, but that they could draw on their balances at the banks for as much as they wanted, and could thus procure the purchasing power they needed in order to supply themselves with goods at however high a price. This reasoning is rather alluring,3 and it may not be out of place to say a few words in explanation of where the error really lies. The public’s deposits at the banks are, as a rule, loaned out to industry and trade. If the public withdraws any part of its deposited funds in order to gain extra purchasing power, then a corresponding amount of funds must be withheld from industry and trade. In consequence of this the purchasing power of enterprises, and ultimately also that of the workers, is diminished, and therefore no increase takes place in the total purchasing power which the community has at its disposal. This is only the case if the banks create fresh bank currency in order to be able to pay back the deposited funds which the public demands to withdraw, and therefore do not make the reduction in their granting of credit to industry which this consumption of the savings should rightly have required. But thereby we find ourselves involved in a regular process of inflation, with a rise in prices as the inevitable consequence.

The weakness in Professor Cassel’s argument, as well as in the argument of those whose opinions he opposes, seems to me to lie in the lack of a clear conception of the term purchasing power. It is only money purchasing power which here comes into question. It therefore stands to reason that a general rise in the market prices of both goods and services itself creates the purchasing power required for meeting the higher prices. If the rise in prices were absolutely uniform, then each individual, whether it was goods or services that he had for sale, would obtain exactly the amount of purchasing power which he needed in his capacity of buyer. Should the rise in prices be less uniform (in the War it was far from uniform), then some naturally get more and others less for their goods and services; but the sum total of purchasing power is still sufficient for the purpose and does not need to be supplemented by the banks. This monetary purchasing power will not, of course, no matter how great it becomes, be sufficient to procure the quantity of goods which each individual would like to consume; for if it were, everybody, taken together, would obtain more goods than the amount actually on the market, and that is an absurdity. But it is this very scarcity which causes the rise in prices; and the monetary purchasing power so created is adequate to pay the sum actually demanded for the available goods and services.

What is needed is an increase in volume of the medium of exchange. If all payments were made on a cheque basis this increase would, of course, take place quite automatically. All drafts on banking accounts, with the resultant transfers from one account to another, would constantly increase in amount as prices rose. At first, however, there would be no increase either in the average amount or in the aggregate of these accounts. In the course of time they would become inconveniently small in proportion to the increased volume of monetary payments. They would consequently need to be adjusted upwards. In the final analysis this presupposes an increase in bank credit. But as prices rose, bank deposits and bank loans would swell more or less automatically

Again, if other instruments of exchange, such as bank notes (and coin) are employed, then a general rise in prices will cause the banks of issue to increase their issue of notes (and coin). Should these banks flatly refuse to expand their circulation, they would doubtless cause an embarrassing shortage of the medium of exchange, and as a result the rise in prices would meet with difficulties and might perhaps be hindered. But it does not seem likely that these banks could actually prevent the rise or force prices down to their original level. For in the first place, resort could be had to payment by cheque to almost any desired extent—as happened in the United States during the crisis of 1907; secondly, if an extension of credit were refused by the private banks as well, an increase in the velocity of circulation of notes and cheques might roughly compensate for the insufficiency in quantity. According to a statement by Bortkiewitch in the Schriften des Vereins für Sozialpolitik, 1924: 170, the rise of prices in Germany eventually amounted, if I remember rightly, to 37 times the increase in the circulation of bank notes. The conditions, it is true, were extraordinarily abnormal, but a doubling or trebling of the normal velocity of circulation of money ought not, even during fairly stable conditions, to meet with insurmountable difficulties.

The quantity theory is, of course, entirely based on the thesis that the velocity of circulation of money at any given time is approximately constant, a thesis based in its turn on the supposed conservatism of our habits of payment. Such conservatism cannot be denied, but our deeply ingrained habits of consumption are far more conservative, and if the two come into conflict, it should be fairly obvious which will get the upper hand, in spite of the fact, or rather for the very reason, that our habitual requirements can no longer be satisfied.

It should a fortiori prove futile to prevent a rise in prices merely by raising interest rates so as to make it more difficult to obtain credit. A rise in the rate of interest is certainly an almost infallible means of restricting the demand for credit on the part of all producers, but it can hardly have a similar effect on those who merely desire to strengthen their cash position in view of the increase in the volume of exchange.

It is clear that this premise, namely, the shortage of goods, regarded as the primary cause of the rise in prices, leads us to an entirely different presentation of the problem from the one on which monetary theory has hitherto been based.4 Under normal conditions, when production and consumption proceed in almost unchanged proportions, a rise in prices (apart from a rise due to an abnormal increase in the production of gold) can actually be caused only by too liberal a credit policy on the part of the banks, making it possible for speculators to obtain an increase in money purchasing power which no longer corresponds to such increase as may be simultaneously brought about by voluntary saving. In this case the remedy is obviously to be found in a tightening of credit, brought about for instance by raising the rates of interest on advances and deposits. This would lessen the demand for credit and possibly encourage saving. In the present case, however, it is not a question of additional purchasing power (for this, as we have seen, is provided automatically by the rise in prices). Here too a relative shortage in the means of payment can at a time of high prices make payments more or less difficult, but it cannot entirely prevent them so long as purchasing power exists.

Suppose that there were a real market in the physical sense, for instance, a yearly fair at which the population of the neighbouring communities exchanged their produce. A rumour that there would be a shortage of goods in the future would unquestionably cause an increased demand for goods, and a general rise in prices. For this to happen it would not, of course, be necessary to suppose that the amount of legal tender on the market increases, but only that on the last day of the market, when all business transactions are finally settled, claims and debts are cleared on a larger scale than usual, and at the same time that the available money circulates somewhat more rapidly, which does not alter the fact that the money brought to market is generally in proportion to the expected amount of business.

It is indeed true (and this would to a certain extent seem to strengthen Professor Cassel’s argument) that the intimate relationship between the money market and the capital market means that every measure on the part of the banks which tends to restrict the quantity of means of payment has a very restraining influence on producers’ demand for credit (and encourages saving), with the obvious result that prices tend to fall pro tanto. The strength of such influences as may be brought about in this way should not, however, be exaggerated. It is certain that if such measures for checking the demand for credit are to have any effect whatever, they must be taken in hand at the very commencement of the rise in prices. Once prices have started to rise, it is too late for these factors to play any rôle. What is the significance of a rise in the rate of interest of a few per cent, per annum in checking the demand for credit when producers may already reckon with a progressive rise in prices of perhaps as many per cent, a month?

On the other hand, the bankers were definitely illogical when they gave as their reasons for not raising rates of interest during the War, firstly, that such a rise would not have been able to check the rise in prices, and secondly, that higher rates of interest would be harmful to “legitimate business enterprise”. It is obvious that the two sections of this argument are mutually contradictory. Just to the extent that a rise in rates of interest would have failed entirely to check the rise in prices it would not have been harmful either to legitimate or to illegitimate business enterprise—at the most it would have served as a slight check on the enormous profits which were being made.

But it might be asked, granting the above-mentioned premise (I should like to emphasise that I do not personally guarantee its validity but have accepted it as a hypothesis on the strength of the opinion of practical men of business), how, apart from a return to normal conditions in regard to production and consumption, could stabilisation of prices be at all possible? This question is not easily answered. If new credit is entirely withheld, then prices will naturally become stable when the tension between the price level and the amount of available medium of exchange has become so great that it entirely counteracts the tendency towards a rise in prices. If on the other hand the banks offer capital, though at higher rates of interest, then theoretically at least the rise in prices might be expected to continue, for it cannot cease until a balance has been attained between the supply and the demand of goods, and this never takes place so long as there is a general endeavour to maintain a degree of consumption which it is physically impossible to meet. But such an attempt must eventually cease. When scarcity is permanent, people will at last resign themselves to the inevitable and give up the attempt to maintain the normal standard of living to which they had been accustomed. Thus demand and supply will again correspond to each other on a lower plane, and there will be no cause for a further rise in prices. If, however, the scarcity of goods extended to the necessities of life, this transition could not, under conditions of free competition, take place without entailing great suffering for the poorer classes, as the better situated classes would, despite the scarcity, be able naturally to satisfy their needs for these goods. It follows, in my opinion, that rationing was a blessing, and that it should have been applied on an even larger scale, so as to have included such things as fuel (which would indirectly have had the effect of rationing housing, so that the laws regulating the letting of houses and flats—which did not entail rationing—would perhaps have been superfluous). However, anybody who tried during the War to procure—sometimes perhaps illegally—an extra pound of butter or coffee or a sack of potatoes, will be able to testify to the difficulty of resigning to the inevitable. And, in fact, prices did not cease to rise until the armistice, and not definitely even then.

Through force of habit I have been writing as though I were treating mainly of Swedish conditions. But the above description, in so far as it is correct, applies pre-eminently to the belligerent countries, where the rise in prices must in any case be presumed to originate. It was, as I have pointed out, their governments’ heavy demands for goods and services for the purposes of war which directly brought about the scarcity of raw materials and labour necessary to the production of goods for civilian purposes, and this, on our hypothesis, should of itself have caused a general rise in prices.5 There is no doubt that this rise in prices was very much strengthened because the various governments (who had no goods for sale and consequently were in constant need of new purchasing power) did not from the beginning procure such purchasing power from the public, either by way of taxes or through loans at suitable rates of interest—say twelve to fifteen per cent.—but instead procured it partly (as in England) directly by issuing bank notes, partly by loans from the note-issuing banks at nominal rates (as in France, Germany, etc.), and only in the second instance tried to procure it from the public, first of all from the War profiteers, and even this at rates that had been artificially lowered by previous manipulations.

In neutral countries, especially in the Scandinavian countries, prices did indeed rise as much as, or more than, in belligerent countries (such as England and America), but this rise was a secondary and derivative phenomenon. This is easily demonstrated: it was in all probability only by prohibiting the import of gold (February 1926) and by forcing the rate of foreign exchange below par that we were able to prevent our price level from rising yet further. If the Scandinavian countries had simply maintained the gold standard during the War—a thing which they unquestionably would have been capable of doing and which in fact Norway is said to have proposed at the beginning of the War—then it would have been impossible to prevent a further rise in prices,6 and by sending us gold foreign countries would then have been able at their pleasure to draw notes from the Bank of Sweden, thereby assuring themselves of our goods (unless there had been a complete embargo on all exports). In this way we should have obtained a great deal of gold, but the maintenance of the gold standard after the War would have been made harder rather than easier, for the deflation necessary to bring this about would have been still more comprehensive. To avoid it we might have been forced in the end to cancel payments in gold, precisely on account of the superfluity of gold, and at the present moment all three Scandinavian countries might have had a depreciated paper currency, as is the case in Spain in spite of the enormous amount of gold which she acquired during the War. Our financial and political leaders are therefore at the most to be blamed for having refrained from preventing the rise in prices, not for having actually brought it about; and if our theory is correct, prevention might have proved impossible, although our leaders should have been able to manage considerably better than they did.

We know that in regard to all these questions Professor Cassel is of the opposite opinion. But his views, especially in his Money and Foreign Exchange after 1914, are so vaguely expressed that I am unable to grasp their real meaning. Professor Cassel was one of those who recommended the exclusion of gold in 1916, and he is even said to have been the author of the very sensible plea for this measure which was originally intended to be placed before the Diet. Professor Cassel regrets—as I do, and, I believe, the majority of Swedish economists with me—that the exclusion of gold was not carried out more radically, and with a clearer conception of its aim. This failure was partly due to the fact that the agreement of Denmark and Norway to the measure was only half-hearted, and that they subsequently thwarted the intentions of the Bank of Sweden by sending their gold into this country. Nevertheless, Professor Cassel subsequently claims in his book that it would have been better if we had not declared the exclusion of gold,7 and he claims further (p. 271)8 that the economists who during the summer of 1918 continued to urge a more energetic enforcement of the exclusion of gold were “badly informed”, because at this time, according to Professor Cassel, the value of our currency was “considerably below its gold value”. He praises the “clearer insight” of the practical bankers “who on the same occasion pointed out that it would be desirable if the Bank of Sweden were less averse than heretofore to the influx of gold, and expressed the opinion that the status of our country might be such (after the War) as to necessitate the export of gold on a large scale”.

Up to the present date the Bank of Sweden has scarcely been obliged to export gold. What it actually has exported it has no doubt been only too pleased to get rid of. I therefore find it hard to see where the “clearer insight” of these bankers comes in. On the other hand, it would have been very advantageous from a purely business point of view to increase the supply of gold at the expense of the supply of foreign exchange if it had been possible to foresee that certain currencies would subsequently depreciate; but as a matter of fact there was nothing to prevent the private banks from importing gold for their own needs instead of buying foreign currencies, a procedure that, as far as I know, was never adopted. For that matter, if Professor Cassel’s theory were valid, the advice of the private bankers to the Bank of Sweden would have been as vain as the contrary advice of the economists. If the value of Swedish currency was below its gold value, the Bank of Sweden could in any case only import gold at an excessive price. But how does this tally with Professor Cassel’s statement? The fact is, as Davidson points out, that the dollar rate at that time was 91 öre, i.e. more than 20 per cent, below parity. It follows that, according to Professor Cassel, dollar notes would have been still lower, say 30 per cent, below their gold parity, a thing very difficult to imagine, for shortly afterwards, without any deflation either previously or subsequently, they could be redeemed in gold.

What Professor Cassel probably means to say is that Swedish prices during the War were forced to such a high level by internal inflation (principally as a result of “official” waste) that if the trade balance had been level, our currency would have proved to be considerably below the dollar, and therefore also below gold parity. But it was difficult for us to import, and as a result our balance of trade and of payments was “favourable”—Professor Cassel has not gone into this matter in detail. Consequently our currency (and also to a lesser extent that of our neighbours) was valued abroad above its real domestic worth and even above its parity with the dollar. This is not impossible; but if it had really been so, it would, in the case of Sweden, prove difficult to explain why the inferiority of our notes was not disclosed as soon as a free gold market was established in America through the resumption of the redeemability of the dollar and the free export of gold, and why furthermore the Swedish crown, after a temporary depreciation, resumed its parity in relation to the dollar as early as December 1922 without our taking any drastic measure to raise its value. This contingency Professor Cassel obviously did not foresee (see p. 276), in spite of his oft-vaunted prophetic powers.

I see the matter in a different way. The abnormally high level of prices in Sweden during the War is to be ascribed to three factors, which would have made themselves felt to an equal, if not to a greater, degree even if we had remained entirely passive and had accepted all the gold that was offered us. The first factor was the general inflation, to the extent to which it extended over a gold-standard country such as the U.S.A. The second factor would have led to European prices rising higher than American prices even if currencies had been kept at their parities. This factor took the form of the very excessive exports of American goods (during and after the War), which caused the already enormously high freight rates to rise considerably more for eastward than for westward trade.9 The result was indirectly to raise the prices of our imports, in spite of the fact that our direct imports from America during the last years of the War were insignificant (they grew in volume later on). Finally, we have the well-known restrictions on imports, which for certain reasons made themselves more felt in Sweden than in the other Scandinavian or neutral countries, and which obviously had the same effect that high or prohibitive import tariffs would have had, viz. of raising the general price level. Even this rise in prices would have taken place on a full gold standard; indeed, the rise would have become even sharper, until perhaps it would eventually have prevented any excess of exports. Instead, we refused to accept gold and the rates of exchange perforce fell below parity. This no doubt inclined exporters and their financial backers, the banks, to extend credit at cheap rates abroad, or, if it was stipulated that payment must be in Swedish currency, it induced the foreign buyer to seek credit, even on onerous terms, in the hope of a future profit on the exchange. This inducement would have been lacking if we had received our payments in gold. It is quite possible—and this is not denied by Professor Davidson—that the tension between the exchange rate and the price level would not then have become quite as great as it actually did become—for instance, during the autumn of 1917. I naturally do not venture to claim that every detail of this explanation would tally with the truth, but it seems to dispense with the necessity of presupposing an “internal inflation”—it depends only on the absence of any internal deflation, which if it had come to pass would have caused the dollar exchange to sink yet further. Wherein then lies “the fatal miscalculation” which Professor Cassel ascribes to the above-mentioned economists?

III

As to the period after the War, with its irrational and often puzzling price fluctuations, I am loth to confess that I would far sooner listen to somebody who could express an authoritative opinion on these matters than essay an explanation myself. I feel that some very general remarks are all I have to offer.

We (and the other neutral countries) were now able to import freely, and the trade balance, instead of showing an excess of exports, showed a very decided excess of imports (principally from America). It is clear that the discrepancy between a dollar rate which was far below parity and a price level, or rather price index, which was more than 50 per cent, higher than in America, had soon to disappear; 10 whether this would come about by a sudden fall in our commodity prices or by a rise in the dollar exchange rate to far above parity, would of course depend on circumstances. If Professor Cassel had had his way in the spring of 1919, when the dollar first rose above parity, and had induced us to re-establish a full gold standard with free export of gold, then we should obviously have chosen the former alternative. Whether this would have been to the benefit of our country is a question into which I shall not enter.

Even at as late a date as March 1922, Professor Cassel regards his advice in this matter as having been sound, and claims that if it had been followed “no violent fluctuations need have taken place.” 11 The result, so far as I can see, would have been that our price level would have behaved in the same way in terms of crowns as it actually behaved in terms of gold, i.e. divided by the dollar exchange rate’s ratio to parity. In other words, from an index number of 369 in January 1919 we should have fallen to 246 in January of the following year, after which our index would have risen again to about 296 in July 1920 and then have fallen to 150 in October 1921. The absence of fluctuations would have been, to say the least, relative. Towards the end of his book (p. 351) Professor Cassel warns us in the strongest terms against any attempt to make our notes redeemable in gold until the price level has been “brought into conformity with the gold standard one intends to introduce”, and in this connection hints that it would be advisable to “procure more sensible managers for the central banks”. As far as I know, however, nobody has ever proposed anything so risky as he did in 1919, when he was opposed by the Governors of the Bank of Sweden. How is it possible that such contradictions can emanate from the same brain?

Professor Cassel had for that matter come to the conclusion that (p. 352) “it was hardly possible for a small European country independently to resume the redemption of notes with gold”. The lack of relation to the facts may be left on one side; but how does this statement tally with Professor Cassel’s adherence to the point of view which he first put forward in 1919?

The fall in our prices was at first gradual, and was actually interrupted in 1920 by a fresh rise, mainly confined, however, to wholesale prices.12 On the other hand, the dollar rate rose almost continuously, until in December 1920 it reached its maximum (37 per cent, above parity)—though only after deflation in America had been going on for several months.

This severe deflation, in which many countries—though not all—were gradually involved, is undoubtedly a unique phenomenon in monetary history. It seems futile to try to find a purely monetary explanation of the whole, or of the major part, of this deflation, as being due to “deflationist policy” of the Federal Reserve Board and other Central Banks. It must, in-deed, be admitted that a high rate of interest, ceteris paribus, renders all sellers anxious to sell for cash, and all buyers less anxious to buy for cash, and that it therefore has a certain tendency to force down cash prices, i.e. the actual price level. And I think that I may also safely maintain that a rate of interest which permanently either exceeds or falls below the actual earnings on capital invested in productive enterprise would have a cumulative influence on prices.13 But that an increase of a few per cent, per annum (it has never been a question of more) would be able in itself to lower prices as much as 5 per cent, a month, as happened during the memorable year 1921, seems a priori unplausible, and I cannot see how such a causation can be theoretically maintained. If, on the other hand, such a catastrophic fall in prices should be due to other causes, it seems equally futile to attempt to check it by a more liberal credit policy, unless the banks are simply to lend money without demanding interest or repayment—a thing which doubtless did actually occur on a considerable scale (vis-à-vis the State) in those countries, such as Austria, Russia, Germany, and to some extent also Italy and France, which did not participate in the general deflation.

Here too it is tempting to adopt the view of those who lay most stress on the “side of goods”, and on the closely related “psychological factor”. The deflation in the United States was, as we know, preceded by a severe rise in prices (far more severe than that in Sweden) during the latter part of 1919 and the beginning of 1920. The cause is doubtless to be sought in the relative shortage of goods brought about by the enormous excess of exports (amounting to over four billion dollars) from America during the year 1919. The fall in prices which followed was at first, as is often observed, in the nature of a recovery, of a reaction against the preceding sharp rise in prices. But such an explanation does not carry much weight. If a rise in prices, caused by a scarcity of goods, had already been checked by the reluctance of the banks to provide the means for their payment, then even if the scarcity of goods were to cease, the downward tendency would obviously get the upper hand, and prices would fall. But if, as has generally been the case, the means of payment keep fairly well in step with the rise in prices, one could hardly expect more than that the rise in prices would cease—and not that it would be followed by a decline—when the supply of goods had risen to normal.

There may, however, in this connection be another factor to consider. When there is a persistent shortage of goods, the tendency for prices to rise must eventually cease, even without any restriction of credit on the part of the banks. This will occur when people in general have become accustomed to, and resigned to, the restriction in consumption to which they have year after year been forced to adapt themselves. When this has become the case, then a more normal supply of goods will have the effect of abundance, of a surplus supply, for which no corresponding demand has as yet made itself felt. We should then witness the same phenomenon that I described in my introduction, only reversed. However vague this explanation of the phenomenon of deflation may seem, it is probably nearer to reality than the usual explanation of the process of deflation “that there was an abundance of goods but that people were too poor to buy them”. For, broadly speaking, that is impossible. It is impossible, at one and the same time, to be both rich and poor, to have goods to sell and yet lack the means wherewith to buy other goods. One nation can, of course, have an abundance of goods while another lacks the barest necessities; whether, however, this would lead to a rise or fall in the international price level is not clear. Goods always set up a demand for other goods, as J. B. Say long ago demonstrated.

Finally, it is fairly obvious that the severe deflation which set in a year and a half to two years after the end of the War had all the characteristics of a phenomenon caused by a crisis. The cessation of the War did not immediately bring an abundance of goods in its wake. While it greatly facilitated the exchange of goods between most countries, production did not rise to anywhere near its pre-War volume. Furthermore, the importers, aided by credits, held their expensive imports in stock, in order to prevent the market from becoming glutted and to assure for themselves a profit. Professor Cassel points to the alleged abundance of goods during the years 1919-20 : it must, he says, “cause some embarrassment to a theory which wanted to make the scarcity of commodities the true ground of explanation for the rise in prices”.14 This argument, however, hardly carries as much weight as might at first be supposed. Gradually the further holding of goods in stock became too inconvenient and risky, partly, no doubt, on account of the high rate of interest, but mainly as a result, in all probability, of the increased production and supply of goods, particularly (as Professor Cassel himself points out) after the belligerent countries had begun to sell off their enormous supplies of war materials. In particular, England’s military stocks exceeded anything one had been able to foresee; among other things, England had during the War bought the whole Australian wool clip for several years in advance. Another important factor that had a bearing on this matter was the much discussed purchasers’ strike.15 When prices began to fall, everyone postponed his purchases as long as possible in the hope that prices would fall still further; at the same time, merchants tried to force their sales, fearing too that prices might fall still more. This kind of purchasers’ strike is quite a usual phenomenon, if I am not mistaken, during every crisis, and to some extent it strengthens my argument as to the reason for a fall in prices. A person who postpones an otherwise desirable purchase makes a sacrifice which is less onerous to the extent that he has been forced, by the previous shortage of goods, to lower his standard of living. (In some cases, and in respect to some commodities, the tendency may be in the opposite direction.)

Suppose then (although it must be granted that this is not very plausible) that the effect on prices of a shortage of goods is, so to speak, compensated by the subsequent restoration of normal output. There would still remain a very considerable residual rise in prices,16 and this would have to be looked upon as the cumulative result of that inflation which in the meanwhile would be caused on the “side of money” through too liberal a granting of credit. It can scarcely be questioned that bank rates, both during the War and during the first years after the armistice (even in those countries which, relatively speaking, were foremost in protecting their currencies), were too low in relation to the real rate of interest, which must have been forced up by the lack of liquid capital caused by the War. It is unfortunately true that these last-mentioned conceptions are extremely difficult to define and outline, but this does not alter the fact that they constitute the bedrock foundation of economic phenomena, to which a thorough study will amply testify.

Looking upon the matter in this way, it seems to me that the lack of understanding between practical men of business and economists might dissolve into a higher unity; and since there is hardly any reason, short of another world war, to fear that a sudden shortage of goods will occur, a wise and foreseeing bank policy should, under normal conditions, be all that is needed to give all possible desirable stability to the level of prices and to the purchasing power of money.

In turning to the Scandinavian countries, we find that whereas Sweden, like two other neutral countries, Holland and Switzerland, and even at an earlier date than these countries, without taking any special measures and without any other difficulties than those involved in lowering the price level, was able to bring her currency to parity with the dollar and with gold, Denmark and Norway, in spite of diverse measures, have not yet been able to attain this end. It is obvious that the cause of this disparity is to be found in the less favourable external circumstances of these countries—the U-boat warfare with ensuing losses for Norway, and miscalculated transito transactions and the financing of Sönderjylland, etc., in the case of Denmark—and not in any superhumanly clever measures on the part of our bankers and financiers. Nevertheless, it is legitimate to say that ever since the exclusion of gold in 1916 the Swedish currency has been more rationally managed than those of our neighbouring countries. If the prevailing wholesale price level of the three countries is divided by the dollar rate of exchange, it will be found, as a Norwegian writer has pointed out,17 that the purchasing power of the dollar was lower in Sweden than in Norway, and highest in Denmark. This would seem to prove that the rise of prices in Sweden was principally due to external circumstances, and when these circumstances were removed the currency regained its parity value as against the dollar; on the other hand, the rise of prices in Norway and Denmark, at least after the War, was partly due to internal inflation, which became continuous and even accentuated, and made it impossible to bring the values of these currencies up to that of the dollar and of the Swedish crown. During recent years the values of these currencies have fallen as low as 60 öre for the Danish crown and 50 for the Norwegian, reckoned in Swedish currency.

Since then, however, as we know, there has bean a change for the better, both currencies having risen by over 50 per cent. According to the latest quotations the Danish crown is so near parity that one may assume that in all probability it will regain parity, especially as the Danish price level (if the figures given by Finanstidende are otherwise reliable) was already by October of this year very close to the Swedish one. (It is to be noted, however, that it is not a question of the actual price level but rather of the index numbers obtained by using the price level as it was twelve years ago as a basis.) Conditions in Norway are unfortunately not nearly so favourable, the exchange rate with Sweden at present being 76 öre, whereas Norway’s price level (index number) compared with ours would barely correspond to an exchange rate of 72 öre. In this respect, however, a considerable improvement has set in since 1924.

As this development has taken place principally during the year 1925 I have not any detailed commentaries available. It is, however, generally attributed, at least in part, to a factor that we have hitherto only lightly touched on, but which has no doubt during the whole period in question played a considerable part, namely, foreign bull speculation in the currencies of the two countries. This type of speculation has come into disrepute since the War. It has been practised on an enormous scale but has led to enormous losses for the speculators, simply because the country in question did not, as it proved, at ail wish to improve its currency but on the contrary lived—as long as it could—on its successive depreciations.18 But even under and normal conditions bull speculation, whether in commodities or in securities, has the disadvantage, where the bull movement is supported only by the speculation itself, that when profits are realised and the object of speculation is sold, the price falls again on account of the increase in supply. In a case, however, like the one we are speaking of, the speculators have been supported by the obvious wish, and officially expressed intention, of both countries to regain the parity value of the crown. They have been able to count upon the fact that if the exchange rose and remained for any length of time at a higher level as a result of their manipulations, the government of the country would not wish it to fall again and would exert themselves to maintain it at this level. If speculators, for instance, have bought bills or other securities from Denmark, this implies that Danish imports have partly been obtained on credit (or that its exports have been paid for in advance), in which case one may foresee that a foreign loan will be issued to consolidate the floating debt instead of letting this debt again bring the exchange rate down. Unfortunately, speculators do not find it to their advantage to let the exchange remain at a constant level, and if they try to harvest their gains at too early a date, the exchange may be lowered again. This form of speculation, which after all is nothing else but a temporary foreign loan, unquestionably produces a good lever for facilitating attempts at deflation; imports are stimulated, import goods become more abundant and cheaper, the whole procedure runs more smoothly and pleasantly than if it is to be entirely based on measures taken within the country itself, tightening of credit and domestic borrowing.

In his above-mentioned article, Schumpeter remarks in regard to England, probably rightly, that when England announced her intention of returning to gold parity, and the whole world knew the weighty reasons for this step, speculators generally became bullish of sterling and in this way supplied England with capital, which in a marked degree facilitated her endeavour. Schumpeter seems to fear that this would give rise to a troublesome discrepancy between exchange rate and price level in England, but this fear seems to have been unfounded. On the whole the fluctuations of the exchange rate and of the price level seem to influence one another in the same and not in the opposite direction, which would indicate that both have a common source—as Schumpeter himself points out.

But everything costs something; an increased consumption of import goods is obtained at the price of a foreign debt, and added to this the country has, on account of the rise in its exchange, to pay a sort of secret rebate on capital corresponding to the speculators’ gain on the exchange.

The most advisable thing, therefore, especially in regard to Norway, seems to me immediately to resume payments in gold at approximately the present rate of exchange. This would not hinder, but would rather facilitate, the Government’s consideration of the advisability of granting the compensation that might justifiably be claimed both from the State and from the individual on account of the fall in the value of the currency. This matter, as I have pointed out in an address given before the Society for Political Economy, cannot be regarded as settled even in the countries that have been able to redeem their notes at gold parity, because the value of gold is still far below what it was before the War.

However, as far as I can see, there is no immediate necessity for adopting a new monetary unit. The notes at present in use can simply be exchanged for new notes of a somewhat lower value, which could be directly redeemable in gold at the former parity. In this way the re-establishment of the monetary union between the three Scandinavian countries would, inter alia, be very much facilitated. I, for my part, firmly believe in such a union. This monetary union—with such further regulations as were added to it either by express agreement or by the force of established practice, and which led to the three countries having essentially the same monetary system—may be said to have constituted a small-scale pattern for that future regulation of the world’s monetary system on a uniform basis which so long has been a favourite idea of economists. Now that the realisation of these plans seems to be within reach, it would indeed be a great pity if the failure of the pattern should be used as an argument by those who, as a result of prejudice and mental sloth, are driven to oppose all new departures.

Let me end with these simple remarks.

I understand very well that on this occasion I have called for the indulgence of my readers more than I usually do. What I have written has principally been an attempt to clarify my own thoughts on a difficult and involved question. It would be a great satisfaction to me if I could dare to think that I have induced the reader to attempt a similar process, even if he should in this way reach conclusions very different from my own.

_____________

19 Ekonomisk Tidskrift, 1925.

20 English edition, p. 65.

21 [These two words are translated from the Swedish edition. The English edition reads “quite false”.]

22 It is the more remarkable that this fact has been overlooked—if indeed it has—inasmuch as all economists are familiar with the phenomenon that scarcity of any given commodity, say grain, may lead to a much more than proportionate rise in its price. In such a case it is generally supposed that the money prices of other commodities fall to a corresponding degree, but I know of no instance where this has actually happened.

23 The matter can be simplified by assuming that every single member in turn of the population who can serve at the front or work at home has for some weeks every year to go soldiering on his own provisions and work at the munitions factories without pay; in this way a proportionately lessened supply of labour power (and to some extent of capital) would remain over for the production o£ ordinary goods.

24 In the Netherlands, where the Central Bank at least claimed to be prepared to accept at par all gold offered—although certain restrictions no doubt were in force—the wholesale price index during the last years of the War rose above our own, notwithstanding the fact that their import difficulties were hardly greater than ours.

25 He says (English edition, p. 94) : “ After the end of the War Sweden would have had an effective gold currency, and the former parity between the Swedish krona and the dollar might at any rate approximately have been maintained.” Can anyone believe such a statement? Why, then, did Holland (not to mention Spain) let her currency drop far below the dollar and, from 1921 onwards, below the Swedish currency as well?

26 [Henceforth references are to the Swedish edition, unless otherwise stated.]

27 This phenomenon probably became more noticeable when the United States shipped her armies and war materials to Europe, and less so when the return movement set in.

28 Our price level, as expressed in gold, remained higher than the American level until the end of December 1922.

29 Op. cit., p. 280.

30 It would be hard to deny that this rise was caused—as pointed out by Davidson—in part at least by the premature lowering of the discount rate by the Riksbank. Judging merely by Cassel’s comments (p. 275 ff.), the uninitiated reader would hardly be able to draw any conclusion other than that Cassel himself had opposed this step. As it happened, however, barely a week had elapsed since he recommended a still more thoroughgoing lowering of the discount rate, for the strange reason that the dollar had already risen above its parity. This, to Bay the least, was an original way of introducing his simultaneous recommendation that the export of gold be resumed.

31 This point of view is, strangely enough, opposed by Professor Cassel, although it would seem in itself considerably to strengthen his own argument. On this point Schumpeter (“Kreditkontrolle”, Archiv für Sozialwissenschaft, 1925, no. 1, p. 295) goes even further than Cassel; he holds that a permanently high bank rate, though at first it brings about a lowering of prices, must finally lose all effect, as it tends to decrease production and thereby to increase the scarcity of goods. For my own part, I have assumed that the volume of production—leaving out those phenomena which are caused by a crisis—will, on the whole, remain constant as long as the real factors of production, land, labour, and real capital, remain unaltered. Bank rate affects only the competition between producers for the possession of these factors, causing their prices, and other prices, steadily to sink, or to rise, as long as an abnormally high or low bank rate is in force. If Cassel’s view, and still more that of Schumpeter, were correct, it would be possible for the banks to raise or lower their rates ad libitum withont risking anything more than a once-and-for-all rise or fall in prices. This seems absurd. The extreme complication of the whole question becomes apparent when it is remembered that high bank rate, especially if it also depresses prices, should stimulate voluntary saving and should thereby increase the amount of real capital, whereas low bank rate, with a resultant rise in prices, will force people with fixed incomes to save, and this should also tend to increase the amount of capital. It is for future investigations to unravel this tangle.

32 Op. cit., English edition, p. 54.

33 An analogous War-time phenomenon was the underhand withholding of goods.

34 This can probably be best measured by the cost of living index, which includes both retail prices and rents.

35 Emil Diesen, “Price Level, Currency, Exchange Rates, etc.”, Stalsök. Tidskr., 1922. As far as I can see, his figures for Sweden do not quite tally with those given by Davidson in Ekonomisk Tidskrift, 1925, no. 1.

36 During the War and the first years of the ensuing peace, speculation in low-value currencies was probably on the whole bullish, as it was believed and hoped that they would improve in the future. As, however, this hope was in regard to certain countries frustrated, it was only natural that bull speculation should eventually be replaced by bear speculation—a continued deterioration of the currency was taken for granted; and as the measures adopted by the governments to counteract this new trend of speculation either were inadequate or failed altogether to materialise, the bear speculation, as has been the case in France during recent years, led to a sharp decline in the currency and thereby indirectly in commodity prices, without any corresponding internal inflation taking place (cf. articles by A. Aftalion in the Revue d’économie politique, 1924). In Germany it went finally so far that the domestic currency ceased to function as a measure of value—apart from immediate exchange transactions—and was instead transformed, so to speak, into an independent object of wealth, which under the constant pressure of bear speculation was forced down until its value was nil.

THE END

1See, for instance, his preface to the German edition of his Vorlesungen, II.: Geld und Kredit, 1922.
2Lectures, II.: On Money and Credit, 3rd Swedish ed., p. 197.
3See the following papers in the Ekonomisk Tidskrift: (i) Davidson, “On the Concept of the Value of Money”, 1906; (ii) Wicksell, “The Stabilisation of the Value of Money, a Means of Preventing Crises”, 1908; (iii) Davidson, “On the Stabilisation of the Value of Money”, 1909; (iv) Wicksell, “Money Rate of Interest and Commodity Prices”, 1909. Cf. also Brinley Thomas, “The Monetary Doctrines of Professor Davidson”, Economic Journal, March 1935.
4Loc. cit., 1908, p. 211.
5Loc. cit., pp. 65, 66.
6An analysis of these questions is to be found in my Swedish book, Monetary Policy, Public Works, Subsidies and Tariffs as Remedies for Unemployment, 1934. A revised English version will appear in 1936 under the title The Theory of Expansion.
7Preface.
8Ibid., p. 198.
9Lectures, 2nd Swedish ed., p. 202. See also Cassel, Theory of Social Economy, § 48.
10Ibid., p. 393.
11In Wicksell’s opinion the money rate should be raised to ensure equilibrium on the capital market and prevent a rise of the price level; see Wicksell’s answer.
12“The Monetary Problem of the Scandinavian Countries,” Ekonomisk Tidskrift, 1925; translated below, p. 199 ff.
13Pp. 201, 202, below.
14P. 210, below.
15Loc. cit., 1909, p. 64.
16Statsökonomisk Tidskrift, Oslo, 1917.
17In an article on “Der Bankzins als Regulator der Warenpreise”, Jahrbücher für Nationalōkonomie und Statistik, vol. 68, 1897, I may have expressed myself rather too hastily. At any rate I had as yet failed to take account of the considerations which follow above.
18An Inquiry into the Currency Principle, p. 123; History of Prices, vol. vi., Appendix xv., p. 636. The italics are mine.
19Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory. Moreover, he always regarded his own contribution as a doubtful hypothesis and never became as convinced of its tenability as did some of his pupils. He explicitly rejected the idea that his theory provided an explanation of the business cycle. He was critical of Mises’ idea that mistaken credit policy is the origin of the tendencies towards booms and depressions. A brief quotation will indicate his position: “Our conclusion is, therefore, that although the changes in the purchasing power of money, caused by credit policy, are under present conditions intimately bound up with the business cycle and without any doubt also influence the latter, above all by giving rise to crises, yet it does not seem essential to assume that there is, by the nature of things, any necessary connection between these two phenomena. The main cause of the business cycle, and a sufficient cause, seems to be the fact that technical and commercial progress cannot by its very nature give rise to a series which proceeds as evenly as the growth in our time of human needs—due above all to the organic increase in population—but is now accelerated now retarded. In the former case ... a mass of circulating capital is transformed into fixed capital, a process which, as I have said, accompanies every rising business cycle: it seems as a matter of fact to be the one really characteristic sign, or one in any case which it is impossible to conceive as being absent.”. . . “If the banks already at the beginning of a rising period sufficiently raised their interest rates, but on the other hand reduced them energetically when the depression was about to set in”, then the price level would probably remain stable, although raw materials for fixed capital would rise in price during periods of good trade and fall during times of bad trade. “Under such circumstances the chief crises-causing factor would probably have disappeared, and what remained would be only a quiet wave movement between periods of accelerated formation of fixed capital and periods when the new capital assumed . . . other forms.” . . . “Increase in commodity stocks is probably the most important form of real investment during so-called bad trade.”
20Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory. Moreover, he always regarded his own contribution as a doubtful hypothesis and never became as convinced of its tenability as did some of his pupils. He explicitly rejected the idea that his theory provided an explanation of the business cycle. He was critical of Mises’ idea that mistaken credit policy is the origin of the tendencies towards booms and depressions. A brief quotation will indicate his position: “Our conclusion is, therefore, that although the changes in the purchasing power of money, caused by credit policy, are under present conditions intimately bound up with the business cycle and without any doubt also influence the latter, above all by giving rise to crises, yet it does not seem essential to assume that there is, by the nature of things, any necessary connection between these two phenomena. The main cause of the business cycle, and a sufficient cause, seems to be the fact that technical and commercial progress cannot by its very nature give rise to a series which proceeds as evenly as the growth in our time of human needs—due above all to the organic increase in population—but is now accelerated now retarded. In the former case ... a mass of circulating capital is transformed into fixed capital, a process which, as I have said, accompanies every rising business cycle: it seems as a matter of fact to be the one really characteristic sign, or one in any case which it is impossible to conceive as being absent.”. . . “If the banks already at the beginning of a rising period sufficiently raised their interest rates, but on the other hand reduced them energetically when the depression was about to set in”, then the price level would probably remain stable, although raw materials for fixed capital would rise in price during periods of good trade and fall during times of bad trade. “Under such circumstances the chief crises-causing factor would probably have disappeared, and what remained would be only a quiet wave movement between periods of accelerated formation of fixed capital and periods when the new capital assumed . . . other forms.” . . . “Increase in commodity stocks is probably the most important form of real investment during so-called bad trade.”
21As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. In 1906 Davidson, whom Wicksell held in the highest esteem, suggested that during periods of rapid technical progress and increasing productive efficiency a greater stability of business would be ensured if commodity prices fell in proportion to the increase in output than if they remained stable. Davidson asserted that if the money rate of interest and business profits (Wicksell’s natural rate) stood in a normal relation to one another before the increase in efficiency, then they would continue to do so if prices fell in proportion to the latter. There would be no need for a change in the money rate of interest. If it were reduced to prevent a fall in the price-level, it would be too low in relation to profits, and a process of an inflationary character would start. To this Wicksell replied: “In the case which Davidson has chosen it may appear that the increase in profits due to increased productivity and the reduction in profits due to the fall in prices, caused on his assumption by the former, would offset one another. But surely this would only happen if the price movement could be anticipated beforehand and estimated, or if it were so even and had lasted for so long that it had come to be generally regarded as something constant? In general, however, the individual business man will make his calculations for the future, and so fix his demand for labour, raw materials, and credit on the basis of current prices.” Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.
22As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. In 1906 Davidson, whom Wicksell held in the highest esteem, suggested that during periods of rapid technical progress and increasing productive efficiency a greater stability of business would be ensured if commodity prices fell in proportion to the increase in output than if they remained stable. Davidson asserted that if the money rate of interest and business profits (Wicksell’s natural rate) stood in a normal relation to one another before the increase in efficiency, then they would continue to do so if prices fell in proportion to the latter. There would be no need for a change in the money rate of interest. If it were reduced to prevent a fall in the price-level, it would be too low in relation to profits, and a process of an inflationary character would start. To this Wicksell replied: “In the case which Davidson has chosen it may appear that the increase in profits due to increased productivity and the reduction in profits due to the fall in prices, caused on his assumption by the former, would offset one another. But surely this would only happen if the price movement could be anticipated beforehand and estimated, or if it were so even and had lasted for so long that it had come to be generally regarded as something constant? In general, however, the individual business man will make his calculations for the future, and so fix his demand for labour, raw materials, and credit on the basis of current prices.” Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.
23In his rejoinder Wicksell admitted that this case required more attention than he had so far given to it. Davidson’s reasoning depended, however, on “the tacit assumption that the supply of real capital has been increased in the same proportion as productivity. Davidson is obviously of the opinion that money wages remain unaltered; thus if commodity prices have fallen, real wages would have been subject to an increase, but how can they be raised without an increased supply of real capital?” Making reference to Böhm-Bawerk’s theory of capital, Wicksell asserted that this is impossible, and continued: “If the quantity of real capital is increased the real rate of interest will fall even if prices remain unaltered and thus money wages rise. . . . Naturally, however, my assumption is that ‘other things remain equal’; i.e. that real capital and real wages are not subject to any change. . . . An increase in productivity when the supply of real capital is unaltered must necessarily mean a rise in the real rate of interest, and equilibrium on the market can never exist unless the money rate is made to coincide with the latter, i.e. unless it is in this case raised.” Although it was possible that prices might temporarily fall, a tendency for a cumulative rise in prices would set in unless the money rate was raised.
24I have come to regard this side of the Wicksellian theory as more important than his other attempt to combine price theory and monetary theory—by his identification of the rate of interest which would maintain the price level constant with the rate as determined in the theory of pricing and distribution, the latter being termed alternatively natural rate, i.e. the marginal productivity of capital, and normal rate, i.e. the rate which equalises supply and demand of savings. The general theory of pricing and distribution is, after all, static in character and its concepts are not likely to lend themselves to the more dynamic analysis of, say, problems of inflation. Rather than build monetary theory on this static analysis, it would seem more natural to pursue the monetary analysis of the actual determinants of the various rates of interest in a dynamic world and then, in the light of such analysis, to revise the theory of distribution. Work along this line seems to me to be the natural consequence of the first-mentioned innovation of Wicksell’s. It would bring monetary theory into harmony with price theory by making the latter more dynamic and would probably give up not only concepts like the natural rate of interest but the whole idea of a monetary equilibrium and thus also the concept of a normal rate of interest defined in equilibrium terms.
25Let me return now to the third modification, introduced by Wicksell in the first Swedish edition of his Vorlesungen (1906). It concerns the influence of gold production on prices: “I had formerly, in close accordance with the opinion of the classical school, imagined that this influence is mainly exercised chiefly through the intervention of the rate of interest; gold production in excess of needs ought in the first place to cause an increase in the gold stocks of banks and thereby a reduction of their interest rates, which in its turn should cause a rise in prices. . . . After further reflection I have, however, come to the conclusion that the main emphasis ought rather to be placed on the demand for commodities from the gold-producing countries; if this demand is not offset by an equally large supply of goods from other countries—in other words, by a need for new gold—it must necessarily lead to a rise in prices, and this immediately; thus the money rate of interest is perhaps not at all affected or possibly affected even in the opposite direction.” “The increasing gold stocks would then serve as a sort of ‘hook’ behind the price movement, preventing it from receding again . . . i.e. not as the first cause of the rise in prices but as a foundation which has been inserted after the beginning of the price movement. ... I mention this only in passing as a conceivable hypothesis. ... A similar treatment seems to be called for by the rapid reduction of the value of money which is as a rule the consequence of successive issues of paper currency.” “In this case, too, the rise in prices is, strictly speaking, the primary factor, the increase in the quantity of means of payment the secondary factor, and it is at least conceivable that under such conditions no real surplus of paper currency and consequent fall in the rate of interest emerges.” Two years later, however, in a discussion with Davidson, Wicksell seems to have returned to his old position; he made an attempt to deal with the case of gold production as a mere special instance of a discrepancy between the normal rate and the money rate of interest. “In so far as the new gold does not exercise a depressing influence on the interest rates of the banks, it will instead increase business profits, by enabling business men to sell in a market with higher prices after having bought in one with lower prices; in this way the discrepancy between the two factors, the money rate and the natural rate, will remain about the same.”
26Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory. Moreover, he always regarded his own contribution as a doubtful hypothesis and never became as convinced of its tenability as did some of his pupils. He explicitly rejected the idea that his theory provided an explanation of the business cycle. He was critical of Mises’ idea that mistaken credit policy is the origin of the tendencies towards booms and depressions. A brief quotation will indicate his position: “Our conclusion is, therefore, that although the changes in the purchasing power of money, caused by credit policy, are under present conditions intimately bound up with the business cycle and without any doubt also influence the latter, above all by giving rise to crises, yet it does not seem essential to assume that there is, by the nature of things, any necessary connection between these two phenomena. The main cause of the business cycle, and a sufficient cause, seems to be the fact that technical and commercial progress cannot by its very nature give rise to a series which proceeds as evenly as the growth in our time of human needs—due above all to the organic increase in population—but is now accelerated now retarded. In the former case ... a mass of circulating capital is transformed into fixed capital, a process which, as I have said, accompanies every rising business cycle: it seems as a matter of fact to be the one really characteristic sign, or one in any case which it is impossible to conceive as being absent.”. . . “If the banks already at the beginning of a rising period sufficiently raised their interest rates, but on the other hand reduced them energetically when the depression was about to set in”, then the price level would probably remain stable, although raw materials for fixed capital would rise in price during periods of good trade and fall during times of bad trade. “Under such circumstances the chief crises-causing factor would probably have disappeared, and what remained would be only a quiet wave movement between periods of accelerated formation of fixed capital and periods when the new capital assumed . . . other forms.” . . . “Increase in commodity stocks is probably the most important form of real investment during so-called bad trade.”
27In the second Swedish edition of the Lectures (1915), Wicksell introduced a modification of more far-reaching character, although he did not himself regard it as important. In the Preface he writes: “I have not found myself called upon to modify my general standpoint, if one does not count as such a certain concession to my critics concerning the mutual effect on one another of the money rate and the natural rate of interest”. This concession reads as follows: “It has been objected that a reduction of the money rate ought to have a depressing effect on the real (natural) rate; thus, the stimulus to a further rise in prices would disappear. This possibility cannot in general be denied. A reduction of the real rate requires, other things being equal, new real capital, i.e. increased savings.” Wicksell admits that the tendency towards an increase in savings may be much stronger than the opposite tendency, so that the rise in prices which has begun may stop. However, he regards this reaction between savings and the real rate of interest as a “secondary factor”.
28In my opinion, the bearing of this objection is much wider than Wicksell supposed. The analysis of Lindahl and of Myrdal has demonstrated that the existence of “credit and of money rates of interest are included as elements in the construction by which the natural rate is determined”. “It is impossible to conceive of relative barter terms whose development is independent of the absolute monetary units in which credit contracts are concluded.” In other words, Wicksell’s concept of a natural rate of interest proves to be of little use in dynamic analysis.
29As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. In 1906 Davidson, whom Wicksell held in the highest esteem, suggested that during periods of rapid technical progress and increasing productive efficiency a greater stability of business would be ensured if commodity prices fell in proportion to the increase in output than if they remained stable. Davidson asserted that if the money rate of interest and business profits (Wicksell’s natural rate) stood in a normal relation to one another before the increase in efficiency, then they would continue to do so if prices fell in proportion to the latter. There would be no need for a change in the money rate of interest. If it were reduced to prevent a fall in the price-level, it would be too low in relation to profits, and a process of an inflationary character would start. To this Wicksell replied: “In the case which Davidson has chosen it may appear that the increase in profits due to increased productivity and the reduction in profits due to the fall in prices, caused on his assumption by the former, would offset one another. But surely this would only happen if the price movement could be anticipated beforehand and estimated, or if it were so even and had lasted for so long that it had come to be generally regarded as something constant? In general, however, the individual business man will make his calculations for the future, and so fix his demand for labour, raw materials, and credit on the basis of current prices.” Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.
30During his last years Wicksell came more and more to doubt the solidity of what had been regarded as the cornerstone of his monetary theory:—the idea that if the money rate coincided with a normal rate of interest, which brought about equality between savings and investment, the commodity price level would remain constant. To what extent his earlier discussion with Davidson influenced him we cannot say. To judge from his last paper, it was discussions with business men on the causes of war inflation, especially the influence of a reduction in the supply of commodities, which caused the alteration in his views.
31Briefly expressed, Wicksell’s doctrine—which on this point coincided on the whole with Cassel’s—amounted to this: if more money is lent to investors, and used by them for real investment, than is saved, then total purchasing power is increased, and prices rise. But if equilibrium is maintained between savings and investment, purchasing power is kept constant and prices cannot rise, at least not more than in proportion to any reduction in the available volume of commodities. Discussing the influence of war-time scarcity of commodities, Wicksell observed that in this kind of reasoning is reflected a “lack of a clear conception of the term purchasing power. It is only money purchasing power which here comes into question. It therefore stands to reason that a general rise in the market prices of both goods and services itself creates the purchasing power required for meeting the higher prices.” In addition is needed only “an increase in volume of the medium of exchange. If all payments were made on a cheque basis this increase would, of course, take place quite automatically.” The velocity of means of payments of every kind would increase, for most people are more conservative in regard to their habits of consumption than in regard to their habits of making payments. Besides, a new demand for credit would arise from people who wanted to increase their holdings of cash. It cannot be regarded as certain that credit restrictions will keep down such a demand for credit. “A rise in the rate of interest is certainly an almost infallible means of restricting the demand for credit on the part of all producers, but it can hardly have a similar effect on those who merely desire to strengthen their cash position in view of the increase in the volume of exchange.”
32Wicksell was, of course, quite right in pointing out that the fundamental concepts, not only of purchasing power or income, but also among others of savings and investment, had not been defined sufficiently clearly. When that has been done, it will, in my opinion, be possible to use the Wicksellian approach to the study of price movements with greater advantage. Although Wicksell’s tools were deficient, his scientific genius led him to an insight into the character and morphology of the movements of the price system which will, I think, always be regarded as a great scientific achievement, even when such concepts as his natural or normal rate of interest have long since been discarded. Nobody would have rejoiced more than Wicksell at the present questioning of the very fundamentals of monetary theory, his own contributions included, had he lived to witness it. His truly scientific and humble attitude towards monetary problems is well revealed in one of the concluding remarks, intended very seriously, in his last paper: ‘As to the period after the War, with its irrational and often puzzling price fluctuations, I am loth to confess that I would far sooner listen to somebody who could express an authoritative opinion on these matters than essay an explanation myself ”.
33In his rejoinder Wicksell admitted that this case required more attention than he had so far given to it. Davidson’s reasoning depended, however, on “the tacit assumption that the supply of real capital has been increased in the same proportion as productivity. Davidson is obviously of the opinion that money wages remain unaltered; thus if commodity prices have fallen, real wages would have been subject to an increase, but how can they be raised without an increased supply of real capital?” Making reference to Böhm-Bawerk’s theory of capital, Wicksell asserted that this is impossible, and continued: “If the quantity of real capital is increased the real rate of interest will fall even if prices remain unaltered and thus money wages rise. . . . Naturally, however, my assumption is that ‘other things remain equal’; i.e. that real capital and real wages are not subject to any change. . . . An increase in productivity when the supply of real capital is unaltered must necessarily mean a rise in the real rate of interest, and equilibrium on the market can never exist unless the money rate is made to coincide with the latter, i.e. unless it is in this case raised.” Although it was possible that prices might temporarily fall, a tendency for a cumulative rise in prices would set in unless the money rate was raised.
34Wicksell’s opinion of the character of the business cycle is perhaps most clearly presented in his paper “The Riddle of Crises”. Here he pointed out that there are two entirely different methods of explaining the comparatively regular ups and downs of business. One is to assume that some extraneous forces work intermittently and so cause oscillations. The other makes use of the hypothesis that the present economic system will, by its very nature, react in an oscillatory manner to any irregular forces which tend to make it move. It might be imagined to be like a rocking-horse. Wicksell undoubtedly inclined towards the latter view, while maintaining that intelligent credit policy—at least under most conditions—could prevent the rocking tendency from growing violent.
35But so long as business continues to be conducted on normal lines, it is not to be supposed that there will be any cumulative movement of prices in the manner of an avalanche. Through its influence on supply and demand, an expectation of a rise in prices in the future is by its very nature capable in itself of bringing about only a somewhat smaller rise than is actually expected. For a buyer could not obtain any profit if the whole of the expected rise were included in the actual price, and the seller will almost always prefer a smaller but more secure profit to a profit which is somewhat larger but less certain.
36“That a reduced rate of interest has no necessary tendency to raise the prices of commodities. On the contrary, it is a cause of diminished cost of production, and consequently of cheapness.”

Interest and Prices