Prices and Production

CHAPTER 5

Unsettled Problems of Trade Cycle Theory

I

So much has already been said (in chapter 3, sections 4 and 6) about the most important of the outstanding problems of monetary influences on economic phenomena, that only a brief supplement is needed at this point. With regard to the problems of monetary theory in the narrower sense I may restrict myself chiefly to what has been said above, as I hope to publish the results of a separate investigation concerning this problem elsewhere.117 A few remarks may, however, be ventured merely as a summing-up of what has already been said, and in doing this we shall touch on a number of other important problems. The most significant result of our investigation must be the grasp of the elementary fact that we have no right to assume that an economic system with an “elastic” currency will ever exhibit those movements that can be immediately deduced from the propositions of static theory. On the contrary, it is to be expected that movements will arise which would not be possible under the conditions usually assumed by that theory. It is particularly important to realize that this proposition is true whether the changes in the volume of money also effect changes in the so-called “general value of money” or not. With the disappearance of the idea that money can only exert an active influence on economic movement when the value of money (as measured by one kind of price level) is changing, the theory that the general value of money is the sole object of explanation for monetary theory must fall to the ground. Its place must, henceforth, be taken by an analysis of all the effects of money on the course of economic development. All changes in the volume of effective monetary circulation, and only such changes, will therefore rank for consideration as changes in economic data capable of originating “monetary influences.”

The next task of monetary theory is, therefore, a systematic investigation of the effects of changes in the volume of money. In the course of this approach, relationships will inevitably be contemplated that do not have the permanence of the equilibrium relationships. All these results, however (and this must be emphasized to prevent misunderstanding), will be reached by the aid of the methods of static analysis, for these are the only instruments available to economic theory. The only difference is that these methods will be applied to an entirely new set of circumstances that have never, up till now, received the attention they deserve. It is vitally necessary that such an investigation should keep clear of the notion that the adjustment of the supply of money to changes in “money requirements” is an essential condition for the smooth working of the equilibrating process of the system, as presented in equilibrium theory.118 It must always start from the assumption that the natural determining factors will exert their full effect only when the effective volume of money remains unchanged, whatever may be the actual changes in the extent of economic activity.

Precise propositions as to the effects of changes in the volume of money can be laid down only when accurate information is available both as to the genesis of the change and the part of the economic system where it took place. For this reason little can be said about changes resulting from the decumulation of hoarded treasure or the discovery of new gold deposits. The way in which an individual will elect to spend money coming to him as a gift or as a result of other non-economic motives cannot be determined from deductive considerations. Similarly, little can be said a priori about bank credit granted to the state, so long as we have no information as to how they are to be used. The situation is different, however, when we are dealing with productive credit granted by the banks to industry—which constitute the most frequent form of increase in the volume of circulating media. This credit is only given when and where its utilization is profitable, or at least appears to be so. Profitability is determined, however, by the ratio of the interest paid on this credit to the profits earned by their use. So long as the amount of credit obtainable at any given rate of interest is limited, competition will ensure that only the most profitable employments are financed out of a given amount of credit. The uses to which the additional money can be put are thus determined by the rate of interest, and the amount that can be said about those uses will therefore depend, in turn, on how much is known about the importance and the effects of interest. Whatever may have been written or thought on this old problem of theoretical economics, it is undeniable that those particular aspects of interest theory that are important for our analysis have so far received less attention and even less recognition than is their due. It is not practicable to work out, within the limits of this essay, the supplementary analysis that seems to me to be necessary in this field; but I should like, at least, to indicate, before I conclude, some angles of approach that appear to have been unduly neglected hitherto. Needless to say, the sections that follow have even less claim than their predecessors to be regarded as comprehensive.

II

In the economic system of today, interest does not exist in the form in which it is presented by pure economic theory. Not only do we find, instead of one uniform rate, a great number of differing rates, but, beyond this, none of the various rates of interest existing is entitled to rank as the rate of interest described by static theory, on which all other rates depend, differing only to the extent to which they are affected by special circumstances. The process of interest fixation, which is at the basis of pure theory, never in fact follows the same course in a modern credit economy; for in such an economy the supply of, and the demand for, savings never directly confront each other.

All existing theories of interest, with a few not very successful exceptions, restrict themselves to the explanation of that imaginary rate of interest that would result from such an immediate confronting of supply and demand. The fact that the rate of interest that these theories explain is one never found in practice does not mean that they are of no importance, or even that any explanation of the actual rates can afford to ignore them. On the contrary, an adequate explanation of that “natural rate” is the indispensable starting point for any realization of the conditions necessary to the achievement of equilibrium, and for an understanding of the effects that every rate of interest actually in force exerts on the economic system. It is true that it does not suffice to explain all empirically observed rates since it takes into consideration only one of the factors determining those rates (though that factor is, of course, the one that is always operative); but any consideration of ruling interest rates that did not relate its analysis to that of the imaginary interest rate of static theory would hang entirely in the air. For the most part, however, no solution has been found to the wider problem of building up on the basis of the theory of an equilibrium rate of interest, which can be deduced from the creditless economy, the structure of different rates that can be simultaneously observed in a modern economy. The solution of this particular problem should provide a most valuable contribution to a deeper insight into cyclical fluctuations.

But before we set out to explore on the one hand the difference between the natural rate of interest and the actual rate, and on the other hand that between the various kinds of the latter, we must say something about the importance of changes in the equilibrium rate itself, since some very confused ideas prevail as to the function of the equilibrium rate of interest in a dynamic economy. This is not very surprising since, as we have seen above, an insufficient appreciation of the role of interest is the cause of most misunderstanding in trade cycle theory. Perhaps it is not too much to say that the importance an economist attaches to interest as a regulator of economic development is the best criterion of his theoretical insight. It is therefore all the more regrettable that recent economic literature has been quite fruitless so far as the theory of interest is concerned.119 This too is perhaps due in part to the fact that the earlier economists, to whom we owe our present knowledge of interest theory, stopped short in their investigations and never came to the point of explaining the actual rates.

III

Under the rubric of pure interest theory (by which we understand the explanation of that rate of interest which is not modified by monetary influences, although paid, of course, on capital reckoned in money terms) we shall have to deal briefly with the question of the effect of transitory fluctuations in the natural rate of interest, conditioned by “real” factors. This question is of great importance, taking as it does a decisive place in some of the best-known trade cycle theories of our day. In particular Professor Cassel’s view (mentioned above, p. 39) that the real cause of cyclical fluctuations lies in an overestimate of the supply of new capital, is based on the assumption that a temporary fall in the rate of interest conditioned by real causes can bring about overinvestment in the same way as a rate of interest artificially lowered by monetary factors. This view, which seems to be supported by a considerable body of experts, has to be judged quite differently according to the changes that elicit fluctuations in the rate of interest originate on the demand or the supply side. Fluctuations caused by changes on the demand side, which Professor Cassel uses as an explanation in his trade cycle theory, certainly cannot be regarded as an adequate explanation of the cycle; for, as Professor Amonn has already pointed out,120 this is no reason why entrepreneurs should (assuming an unchanged rate of interest) expect to obtain more credit in the future than they can now. However there can be no doubt that violent fluctuations in savings and the consequent temporary changes in the equilibrium rate of interest act similarly to an artificial lowering of the money rate of interest in causing an extension of capital investments that cannot be maintained later owing to the diminished supply of savings.121 In this case, therefore, it is permissible to speak of non-monetary cyclical fluctuations. This differs, however, from the conception of cyclical fluctuations employed hitherto, in that the passage from boom into depression is not a necessary consequence of the boom itself, but is conditioned by “external circumstances.” A downward turn of this sort can occur just as well in a hitherto stationary economy or during a depression as at the end of a boom; and it should therefore be regarded less as an example of a cyclical movement than as a particularly complicated case of the direct process of adjustment to changes in data. In any case, for reasons given above, such an explanation, as compared with an endogenous theory, would only come into play when the latter had proved insufficient to explain a given concrete phenomenon.

But there can be no doubt that such fluctuations in the natural rate, conditioned by changes in the rate of saving activity, present some very important problems in interest theory, the solution of which would be an important aid in estimating the effect of fluctuations conditioned by monetary changes. We have entirely disregarded the circumstances determining the supply of savings and the fluctuations in this supply; and the examination of these is a promising field for future research. It might even be possible to show that fluctuations in saving activity are a necessary concomitant of economic progress, and thus to give a firm basis to the theories we have mentioned. This is, perhaps, not very probable.

In direct relation to the above problem stands the question of the effects of alterations in the rate of interest on the price system as a whole. An examination of this subject should throw light on the point of view, emphasized by Professor Fetter,122 that the height of interest rate at any given moment expresses itself in the whole structure of price relationships, while every change in that rate must pari passu bring about changes in the relation between particular prices and thus in the quantitative relationships of the whole economy.

But here we must content ourselves with drawing attention to the problems arising out of the changes in the natural rate of interest, without contributing further to their solution. We shall only venture a further remark on a question concerning not the consequences but the causes of these changes, since this is important in what follows. This is the question of whether the rate of interest at any moment depends on the total amount of capital existing at that moment or only on the amount of free capital available for new investment.123 We mention this here only in order to emphasize the untenability of the widespread view that the determining factor, on the supply side, is the whole existing stock of capital. If that were so it would hardly be possible to explain any large fluctuations of the rate of interest, since the relative changes that the existing capital stock undergoes within brief periods and under normal circumstances is insignificant. A thorough investigation of the interconnections in this field must show that the actual rate of interest depends (apart from the demand for loan capital) only on the supply of newly produced or reproduced capital. The existing stock of fixed capital affects only the demand side, by determining the yields to be expected from new investments. This explains how, in a country that is well equipped with fixed capital, the rate of interest can temporarily rise higher than that obtainable in a country that is poorly equipped, provided that there is relatively more free capital available for new investment in the latter than in the former. This fact has some significance in connection with the phenomenon of enforced saving with which we shall deal later.

IV

As regards the relationship of the natural or equilibrium rate of interest to the actual rate, it should be noted, in the first place, that even the existence of this distinction is questioned. The objections, however, mainly arise from a misunderstanding that occurred because K. Wicksell, who originated the distinction, made use in his later works of the term “real rate” (which to my mind is less suitable than “natural rate”) and this expression became more widespread than that which we have used.124 The expression “real rate of interest” is also unsuitable, since it coincides with Professor Fisher’s “real interest,”125 which, as is well known, denotes the actual rate plus the rate of appreciation or minus the rate of depreciation of money, and is thus in accordance with common usage, which employs the term “real wages” or “real income” in the same sense. Unfortunately Wicksell’s change in terminology is also linked up with a certain ambiguity in his definition of the “natural rate.” Having correctly defined it once as “that rate at which the demand for loan capital just equals the supply of savings,”126 he redefines it, on another occasion, as that rate which would rule “if there were no money transactions and real capital were lent in natura.”127 If this last definition were correct, Dr. G. Halm128 would be right in raising, against the conception of a “natural rate,” the objection that a uniform rate of interest could develop only in a money economy, so that the whole analysis is irrelevant. If Dr. Halm, instead of clinging to this unfortunate formula, had based his reasoning on the correct definition, which is also to be found in Wicksell, he would have reached the same conclusion as Professor Adolf Weber—the distinguished head of the school of which he is a member: that is, that the natural rate is a conception “which is evolved automatically from any clear study of economic interconnections.”129 In accordance with this view, Wicksell’s conception must be credited with fundamental significance in the study of monetary influences on the economic system; especially if one realizes the practical importance of a money rate of interest depressed below the natural rate by a constantly increasing volume of circulating media. Unfortunately, although Wicksell’s solution cannot be regarded as adequate at all points, the attention it has received since he propounded it has borne no relation to its importance. Apart from the works of Professor Mises, mentioned above, the theory has made no progress at all, although many questions concerning it still await solution.130 This may be due to the fact (on which we have touched already) that the problem had become entangled with that of fluctuations in the general price level. We have already stated our views on this point (pp. 105–06), and indicated what is necessary for the further development of the theory. Here we shall try to restate the problem in its correct form, freed from any reference to movements in the price level.

V

Every given structure of production—i.e., every given allocation of goods as between different branches and stages of production—requires a certain definite relationship between the prices of the finished products and those of the means of production. In a state of equilibrium, the difference necessarily existing between these two sets of prices must correspond to the rate of interest, and at this rate, just as much must be saved from current consumption and made available for investment as is necessary for the maintenance of that structure of production. The latter condition necessarily follows from the fulfillment of the former, since the prices paid for the means of production, plus interest, can only correspond to the prices of the resulting products when, at the given prices and rate of interest, the supply of producers’ goods is exactly adequate to maintain production on the existing scale. The price margins between means of production and products, therefore, can only remain constant and in correspondence with the rate of interest so long as the proportion of current income, which at the given rate of interest is not consumed but reinvested in production, remains exactly equal to the necessary capital required to carry on production. Every change in this proportion must begin by impairing the correspondence of price margins and the interest rate; for it influences both in opposite directions, and so leads to further shifts in the whole structure of production, representing an adjustment to altered price relationships. These resulting changes in the structure of production will not always be the same; they will vary according to whether the change in the proportions of the social income going respectively to consumption goods and investment goods corresponds to real changes in the decisions of individuals as to spending and saving, or whether it was brought about artificially, without any corresponding changes in individual saving activity.

Apart from individual saving activity (which includes, of course the savings of corporations, of the state, and of other bodies entitled to raise compulsory contributions) the proportions between consumption and capital creation can only change as a result of alterations in the effective quantity of money.131 When changes in the division of the total social dividend, in favor of capital creation, result from changes in the saving activity of individuals, they are self-perpetuating. This is not true of such variations between “consumption and accumulation” (if we may use for once the terminology of Marxian literature) as are due to additional credit granted to the entrepreneurs; these can be assumed to persist only so long as the proportion is kept artificially high by a progressively increasing rate of credit creation. Such an injection of money into circulation acts only temporarily—until the additional money becomes income. At that moment, the proportion of capital creation must relapse to the level of voluntary saving activity, unless new credit is granted bearing the same relation to the new total of money incomes as the first injection bore to the former total.132

It is clear that such a process of progressive increase in the supply of money cannot be maintained under our existing credit system, especially since, as it proceeds, more extensive use will be made of cash. On the other hand, a mere cessation of further increases—not, therefore, a reversal of credit policy, toward deflation—is sufficient to bring back the proportion of total income available for capital formation to the extent of voluntary savings.

The differences in the effects of these two kinds of variation between consumption and capital formation manifest themselves first of all on the price system, and thus on the natural or equilibrium rate of interest. The first effect of a diminution of the rate on loans arising from increased saving activity—so long as the structure of production remains unchanged—is to bring that rate below the margin between the prices of means of production and of products. The increased saving activity, however, must soon cause on the one hand a falling off in the demand for consumption goods, and hence a tendency for their prices to fall (a tendency that may merely find expression in decreasing sales at existing prices) and, on the other hand, an increase in the demand for investment goods and thus a rise in their prices. The extension of production will have a further depressing effect on the prices of consumption goods, as the new products come on the market, until, finally, the difference between the respective prices has shrunk to a magnitude corresponding to the new, lower, interest rate. If, however, the fall in the rate of interest is due to an increase in the circulating media, it can never lead to a corresponding diminution in the price margin, or to a readjustment of the two sets of prices to the level of an equilibrium rate of interest that will endure. In this case, moreover, the increased demand for investment goods will bring about a net increase in the demand for consumption goods; and therefore the price margin cannot be narrowed more than is permitted by the time lag in the rise of consumption goods prices—a lag existing only as long as the process of inflation continues. As soon as the cessation of credit inflation puts a stop to the rise in the prices of investment goods, the difference between these and the prices of consumption goods will increase again, not only to its previous level but beyond, since, in the course of inflation, the structure of production has been so shifted that in comparison with the division of the social income between expenditure and saving the supply of consumption goods will be relatively less, and that of production goods relatively greater, than before the inflation began.133

VI

There have recently been increasingly frequent objections to this account of the effects of an increased volume of currency, and the artificial lowering of interest rates conditioned by it, on the grounds that it disregards certain supposedly beneficial effects that are closely connected with this phenomenon. What the objectors have in mind is the phenomenon of so-called “forced saving,” which has received great attention in recent literature.134 This phenomenon, we are to understand, consists in an increase in capital creation at the cost of consumption, through the granting of additional credit, without voluntary action on the part of the individuals who forgo consumption, and without their deriving any immediate benefit. According to the usual presentation of the theory of forced saving, this occurs through a fall in the general value of money, which diminishes the consumers’ purchasing power; the volume of goods thus freed can be used by the producers who obtained additional credit. We must, however, raise the same objection to this theory that we raised against the usual account of the effects of an artificial lowering of the money rate of interest, i.e., that in principle, forced saving takes place whenever the volume of money is increased, and does not need to manifest itself in changes in the value of money.135

The “depreciation” of money in the hands of the consumer can be, and frequently will be, only relative, in the sense that those diminutions in price that would otherwise have occurred are prevented from occurring. Even this causes a part of the social dividend to be distributed to individuals who have not acquired legitimate claim to it through previous services, nor taken them over from others legitimately entitled to them. It is thus taken away from this part of the community against its will. After what has been said above, this process needs no further illumination.

Nor do we need to adduce further proof that every grant of additional credit induces “forced saving”—even if we have avoided using this rather unfortunate expression in the course of our argument. There is only one further point—the effect of this artificially induced capital accumulation—on which a few remarks should be added. It has often been argued that the forced saving arising from an artificially lowered interest rate would improve the capital supply of the economy to such an extent that the natural rate of interest would have to fall finally to the level of the money rate of interest, and thus a new state of equilibrium would be created—that is, the crisis could be avoided altogether. This view is closely connected with the thesis, which we have already rejected, that the level of the natural rate of interest depends directly upon the whole existing stock of real capital. Forced saving increases only the existing stock of real capital goods, but not necessarily the current supply of free capital disposable for investment—that portion of total income that is not consumed but used as a provision for the upkeep and depreciation of fixed plant. But any addition to the supply of free capital available for new investment or reinvestment must come from those of the investments induced by forced savings which already yield a return—a return large enough to leave over, after providing for supplementary costs connected with the new means of production, a surplus for depreciation and for interest payments on the capital. If the capital supply from this source is to lower the natural rate of interest, it must not, of course, be offset by a diminution elsewhere—resulting from the decline of other undertakings confronted with the reinforced competition of those newly supplied with capital.

The assumption that an artificial increase of fixed capital (i.e., one caused by additional credit) tends to diminish the natural rate of interest in the same way as one effected through voluntary savings activity presupposes, therefore, that the new capital must be incorporated into the economic system in such a way that the prices of the products imputed to it shall cover interest and depreciation. Now a given stock of capital goods is not a factor that will maintain and renew itself automatically, irrespective of whether it is in accordance with the current supply of savings or not. The fact that investments have been undertaken that cannot be “undone” offers no guarantee whatever that this is the case. Whether capital can be created beyond the limits set by voluntary saving depends—and this is just as true for its renewal as for the creation of new plant—on whether the process of credit creation continues in a steadily increasing ratio. If the new processes of production are to be completed, and if those already in existence are to continue in employment, it is essential that additional credit should be continually injected at a rate that increases fast enough to keep ahead, by a constant proportion, of the expanding purchasing power of the consumer. If a new process of roundabout production can be completed while these conditions still hold good, it can contribute temporarily to a lowering of the natural rate of interest; but this provides no final solution of the difficulty.

For “eventually” a moment must inevitably arrive when the banks are unable any longer to keep up the rate of inflation required, and at that moment there must always be some processes of production, newly undertaken and not yet completed,136 that were only ventured because the rate of interest was kept artificially low. It does not follow, of course, that these processes in particular will be left unfinished because of the subsequent rise in that rate; on the other hand, their existence does cause the rate of interest to be higher than it would be in their absence, when capital would be required only by processes made possible by voluntary saving without any competing demand arising from processes which were only enabled to start by “forced saving.” The capital invested in new and not yet completed processes of production will thus merely intensify the demand for further supplies by calling for the capital necessary to complete them—an effect that will be the more pronounced the greater the ratio of capital invested to capital still required. It may therefore quite easily come about that, in order to complete these newly initiated processes, capital may be diverted from the maintenance of complete and old-established undertakings, so that a new plant is put into operation and an old plant closed down, although the latter would have been kept up, and the former never put in hand, if it had been a question of building up the whole capital equipment of the economy from the start. This does not merely mean that the total return comes to less than it otherwise would; it also means, primarily, that production is forced into channels to which it will only keep for as long as the new and spuriously produced stock of fixed capital can remain in use. The value of capital invested in processes that can be continued, and, still more that in processes where continuance is impracticable, will shrink rapidly in value—this shrinkage being accompanied by the phenomena of a crisis. Thus on purely technical grounds it will become uneconomic to maintain them. It should be particularly remarked that, from the point of view of the fate of individual enterprises, capital invested in a fixed plant, but raised by borrowing, is of precisely the same importance as working capital, i.e., the loss of value does not merely necessitate writing down; it generally makes it impossible to carry on at all.

The cause of this development is, evidently, that an unwarranted accumulation of capital has been taking place; though people may regard it (under the alluring name of “forced saving”) as a thoroughly desirable phenomenon. After what has been said above it is probably more proper to regard forced saving as the cause of economic crises than to expect it to restore a balanced structure of production.

VII

There remains one problem of interest theory, in the wider sense of the word, that we need to examine more closely than we have yet done—in order to exhibit a problem of first-class importance to the progress of trade cycle theory. This is the problem of the varying height and independent movements of rates of interest ruling at the same place and at the same time. We are not thinking, of course, of differences conditioned either by the unequal standing of borrowers or by the fact that, under the name of interest, payments are also made for the services or costs connected with the granting of credit. We are interested only in the problem of variations arising within the pure or net rate of interest, as they can be observed between varying durations of credit—the problem usually known in economic literature as the problem of interest rates, in the money, and in the capital (investment) market, respectively.

In this respect we may repeat what we have already said at the beginning of this chapter—that the theoretical investigations of interest have been broken off at far too early a stage to afford much understanding of the rates actually ruling at any given moment. It is very remarkable that none of the great theorists to whom we owe our insight into the fundamental factors determining the equilibrium rate of interest made the slightest attempt to explain these differences between interest rates. Systematic investigation of this problem came much later and then characteristically the investigation related chiefly to the question of the “external order of the capital or money market”; and it is only recently that Dr. G. Halm137 has treated the simultaneous existence of varying interest rates “as a problem of interest theory.” Although Dr. Halm deserves full credit for the undeniable service he has rendered in putting the problem in the proper form for discussion, his attempt at solution can hardly be regarded as fully successful. Thus we still stand at the beginning of a crucially important development of a special theory of money rates of interest.

The clearing up of these interconnections is of primary importance to trade cycle theory, since the discrepancies between the expected yields of existing means of production and the actual yield obtainable from the available liquid capital must necessarily arise in the course of the cycle. Given a sufficient insight into the influences determining the yields of both types of investment, the simultaneous changes in the height of both kinds of interest rates should afford extraordinarily valuable material for the diagnosis of any actual situation, and thus the growth of this part of interest theory would provide an important basis for the development of empirical research and forecasting. A particularly promising approach might consist of an examination of the question from the point of view of an equalization of the time differences between the rates of interest that would prevail if the whole supply of capital at any time had to be invested for a longer period. Such an equalization would be brought about by a kind of arbitrage for which, naturally, only money lent at call or at short notice could be considered.

In this field, too, the extension of equilibrium analysis to successively occurring phenomena, which I have attempted in another work,138 may prove fruitful. At any rate, an explanation of this arbitrage could also explain why the rates on short-term credit can be temporarily lower, or on the other hand higher, than the long-term rate, since both borrower and lender would find such an arbitrage to their advantage. This view cannot be refuted by the objection that the rates on short-term credit not only change earlier but also change to a greater degree than those in the capital market; for it may be economically entirely justifiable to pay higher rates or obtain lower ones, for a short term, than one expects for a long term, since the expectation of getting better terms at a later period, under more favorable conditions, may compensate for the relative disadvantages suffered in the short run.

VIII

Finally, we should like to point out quite briefly certain tasks in the field of statistical research that according to our theoretical analysis seem likely to be particularly fruitful. In connection with the last question dealt with, we should draw attention to the statistics of the money market, which are still, unfortunately, in a very elementary stage, partly for technical reasons but mainly because of difficulties of interpretation. These latter arise largely from the fact that the statistical determination of the absolute height of the interest rate, or even of its movements, discloses almost nothing as to its bearing on the economic system.139 The same rate of interest that at one moment may be too low in relation to the whole economic situation may be too high at the next, or vice versa. Misunderstandings on this point may be responsible for certain erroneous views, concerning the alleged insignificance of the height of interest rates, that are often held by statistical economists. The innumerable attempts to minimize the significance of interest rates by means of statistical investigations, which abound in the United States140 (where they do not even shrink from such absurdities as an attempt to find an explanation [!] of interest by way of statistical investigation) would be impossible but for the complete confusion persisting as to the limits of statistical research. Here again we have to repeat what was asserted at the beginning of this book: statistics can never prove or disprove a theoretical explanation; they can only present problems or offer fields for theoretical research.

For precisely this reason—viz., that the absolute height of interest rates tells us nothing of their significance—an examination of the extent and regularity of shifts between various interest rates offers a promising field for statistical technique. An interesting first attempt in this direction is the famous “Three Market Barometer” of the Harvard Economic Service, which uses the trend of the long-term interest rate as a baseline in plotting the curve of the money market rates. Such an empirical consideration of the differences between interest rates does not, of course, exhaust the lines of approach that a complete theoretical explanation of these rates might indicate as suitable for empirical research. The fact that theoretical research itself can be stimulated and awakened to new problems to an important degree from the application of our sketchy knowledge to statistical investigations is amply demonstrated by the investigations of Donner and Hanau, which we have already mentioned.

It is in the statistics of private banking, however, that the heaviest task presents itself. In Europe we are still worse supplied with these than with those of the money market proper. In the United States, on the other hand, some pioneer work has been done in this field,141 since the ample statistical material available there provided is itself a sufficient incentive for such investigations. In Europe, the lack of any kind of material makes even a first step in this direction impossible.

In many respects the most remarkable of these enquiries are those of Mr. Holbrook Working. Using the data concerning the state of deposits in the “National Banks,” which are available for many years past and at intervals of only a few months, he succeeds in establishing a far-reaching parallelism between the movements of deposits and the fluctuations of the wholesale price level. Like most theoretical investigations in the same field, however, his results are distorted by the superficial assumption that monetary influences can only manifest themselves in movements of the price level, while those changes in the volume of bank credit that are just sufficient to prevent changes in the price level are supposed, on this assumption, to exercise no active influence on the trade cycle. It should be mentioned—as having particular bearing upon the views developed in this essay—that, according to Mr. Working’s calculations, before the war a yearly increase in deposits of more than 5 percent would have been necessary in order to keep the price level steady; that is to say, additional credit would have had to be created to an extent that must have caused considerable changes in the structure of production.

If the results of our theoretical analysis were to be subjected to statistical investigation, it is not the connection between changes in the volume of bank credit and movements in the price level that would have to be explored. Investigation would have to start on the one hand from alterations in the rate of increase and decrease in the volume and turnover of bank deposits and, on the other, from the extent of production in those industries that as a rule expand excessively as a result of credit injection.142 Every increase in the circulating media brings about the same effect, so long as each stands in the same proportion to the existing volume; and only an increase in this proportion makes possible a further increase in investment activity. On the other hand, every diminution of the rate of increase in itself causes some portion of existing investment, made possible through credit creation, to become unprofitable. It follows that a curve exhibiting the monetary influences on the course of the cycle ought to show, not the movements in the total volume of circulating media, but the alteration in the rate of change of this volume.143 Every upturn of this curve would show that an artificial lowering of the money rate of interest or, if the curve was already rising, a further lowering of the money rates, was making possible additional investments for which voluntary savings would not suffice; and every downturn would show that current credit creation was no longer sufficient to ensure the continuance of all the enterprises it originally called into existence. It would be of great interest to correlate this presentation of the influence causing an excessive production of capital goods with actual changes in the production of these goods, on the basis of available data.

The possible contributions of banking statistics to trade cycle research are by no means exhausted by the chance they offer of observing the immediate connection between the granting of credit and the movements of production, though these may some day constitute the most important basis of business forecasting. No less important would be an investigation into the volume, at any given moment, of those factors that determine credit expansion, under the other headings of bank balance sheets, and in particular an examination of the relation between the total amount of earning assets and the current accounts, the relation between these and the cash circulation, and so on. Such an investigation, if it were not merely to exhibit their movements in time but also to analyze the deeper connections between them—and most especially if it were to clear up the relationship between interest rates, profits, and the liquidity of the banks—would further our insight into the factors determining credit expansion as well as our knowledge of their limits, and thus make it possible to forecast movements in the factors determining the total development of the economic situation.

It is very unfortunate that such inquiries, especially on the continent of Europe, are almost impossible owing to the lack of necessary data in the form of returns showing the state of the banks, and published at short intervals; insofar as they are possible at all it is only in a few countries and for a very short period. As soon as it is realized that, owing to the existence of banks, the equilibrating forces of the economic system cannot bring about that automatic adjustment of all its branches to the actual situation, which is described by classical economic theory, it is justifiable even from a liberal point of view that the banks should be subjected to degrees of publicity as to the state of their business which is not necessary in the case of other undertakings; and this would by no means imply a violation of the principle of business secrecy, since it would be quite sufficient for this purpose if the authorities were to adopt the United States’s plan of publishing summary returns for all banks at frequent intervals. Our reflections thus yield the conclusion that an alleviation of cyclical fluctuations should be expected preeminently from a greater publicity among business enterprises, and particularly among the banks. The example of the United States, which is far ahead in this respect in all the branches of its economic system, will not only silence in time the objections raised against such publicity, but sooner or later will force us to follow in their path.