Prosperity and Depression

CHAPTER 4 CHANGES IN COST, HORIZONTAL MALADJUSTMENTS AND OVER-INDEBTEDNESS AS CAUSES OF CRISES AND DEPRESSIONS

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§ 1. INTRODUCTION

In this chapter we shall discuss certain factors which have sometimes been put forward as the causes of the periodic recurrence of crises and depressions. The argument, however, goes too far. It is not in this case a question of elaborate theories embodying a full explanation of the business cycle comparable to the monetary explanation or the over-investment theory, but of certain particular factors which contribute something to the explanation of certain phases of the cycle. To recognise that these factors may sometimes, or frequently, play a rôle in shaping the course of the cycle is by no means incompatible with acceptance of the monetary or over-investment theory of the cycle, though of course all members of these two schools would not attribute much importance to the factors in question.

§ 2. CHANGES IN COST OF PRODUCTION AND EFFICIENCY OF LABOUR AND PLANT

In a competitive business economy, the statement that a restriction in industrial activity is due to the fact that production cost has risen above selling price does not add much to the mere statement that industrial activity has been reduced—at any rate, if “price” is interpreted (as it obviously should be) as the expected future price and “cost” as marginal cost at the expected volume of activity. This statement is compatible with any explanation of the crisis and depression. Whether a series of crop failures, over-investment, monetary deflation, under-consumption or anything else is ultimately responsible for the breakdown of the boom and for the depression, the proximate cause of the reduction in industrial output is the fact that expected prices do not cover production cost. All these factors must finally find their expression somewhere in a disappearance of the profit margin. (There are other formulæ which are as vague and unhelpful as the cost-of-production formula—e.g., the assertion that the breakdown is due to the fact that demand has fallen short of supply, to a disequilibrium between production and consumption, or to over-production in certain lines of industry and so on.)1

Mitchell on the cyclical movements of production cost.

The rise of production cost during the prosperity phase and the reduction of production cost during the depression play a prominent rôle in the explanation of the cycle by Professor W. C. MITCHELL. The following is his description of the process: “The decline in overhead cost per unit of output (which was brought about by the first increase in production after the trough of the depression) ceases when enterprises have once secured all the business they can handle with their standard equipment, and a slow increase of these costs begins when the expiration of the old contracts makes necessary renewals at the high rates of interest, rent and salaries which prevail in prosperity. Meanwhile, the operating costs rise at a relatively rapid rate. Equipment which is antiquated and plants which are ill located or otherwise work at some disadvantage are again brought into operation. The price of labour rises, not only because the standard rates of wages go up, but also because of the prevalence of higher pay for overtime. Still more serious is the fact that the efficiency of labour declines, because overtime brings weariness, because of the employment of ‘undesirables’, and because crews cannot be driven at top speed when jobs are more numerous than men to fill them. The prices of raw materials continue to rise faster, on the average, than the selling prices of products. Finally, the numerous small wastes incident to the conduct of business enterprises creep up when managers are hurried by a press of orders demanding prompt delivery.”2

A corresponding process of cost reduction is going on during the depression and prepares the ground for a revival.

Elements contained in other theories.

In the passage quoted, the operation of a number of factors is very luminously described. But, analytically, the various forces making for higher unit cost, partly in real terms, partly only in terms of money, are very different in nature.

That cost of production in terms of labour rises because inefficient workers and undesirables must be employed and because antiquated equipment must be brought into operation when production is expanded is quite natural. This is simply a way of expressing the law of decreasing returns. The supply price rises, and this “obviously limits the extent to which production expands in response to a given rise in demand; and, since the whole process takes time, it is natural that we should find expansion carried forward continuously up to a point, and then stopped”3 This does not, however, explain why expansion is followed by a breakdown and depression.

That money wages rise during the upswing (and fall during the downswing) has been shown in connection with the theories reviewed earlier in this book. This rise (and fall) in wages is a consequence of credit expansion (and contraction). It does not explain anything, unless it is possible to show why efficiency wages must rise, or are likely to rise (or fall) more (or less) rapidly than prices—that is to say, if a time-lag can be established between the movement of wages and prices.

The rise in interest rates is, as the monetary over-investment theory has shown, a symptom of a vertical maladjustment in the structure of production. It works out in an increase in money costs, but affects the higher stages of production more severely. As a link in the analysis of the over-investment theory or a purely monetary theory à la HAWTREY which explains the breakdown by an act of hoarding or credit-restriction, the rise in interest rates adds something to the explanation of the business cycle; but it is not very helpful if regarded only as contributing to the increase of the money cost of production.

Movements in efficiency.

A new point, not so far mentioned in our analysis, is the argument that efficiency tends to fall during the upswing, because waste crops up everywhere (and efficiency tends to increase during the downswing because of the elimination of waste). Since money wages generally rise during the upswing (and fall during the downswing), this is equivalent to saying that efficiency wages rise faster than money wages during the upswing (and fall faster during the downswing). This is probably a factor which affects all branches and all stages of production alike; or, if it does not, the differences are due to accidental circumstances, and there is no tendency for higher and lower stages—i.e., the production of durable capital goods and of perishable consumers’ goods—to be affected in a different degree.

This tendency of efficiency wages to rise during the upswing—the reader will easily make the necessary adjustments for the application of the argument to the downswing—is surely a factor which must unfavourably affect the whole situation. Other things being equal, the breakdown would at least be postponed if this lowering of efficiency could be avoided. But the avoidance of waste and the maintenance of the level of efficiency attained during the depression would not in themselves mean the avoidance of vertical and horizontal maladjustments in the structure of production. If, on the other hand, there is no horizontal or vertical misdirection of investments, the influence of an all-round lowering of efficiency may be compensated by an increase in prices or a reduction of money wages.

It cannot, however, be denied that, theoretically, a heavy fall in efficiency, unaccompanied by a corresponding fall in money wages and not compensated by a rise in prices, may produce a general depression.

The same effect may perhaps be brought about by a rise in money wages, induced from the supply side, unaccompanied by a rise in efficiency or a general increase of prices. There are reasons to believe that something of this sort happens during the later phase of the upswing of an ordinary business cycle. The decrease in efficiency alone, on the other hand, is probably not of the same order of magnitude as the rise in general prices.

But this involves a quantitative estimate and calls for statistical investigation; and it is not easy to find a statistical measure for the changes in the efficiency of labour. The well-established fact that, in a number of industries, output per head of the employed labourers rises sharply during the depression and falls during the upswing of the cycle is not a sufficient proof, because it may be entirely due to the fact that antiquated plants, etc., are put into operation during the upswing and are closed down during the downswing, and that less efficient workers are engaged during the upswing and discharged during the downswing. In technical parlance, the change of efficiency which we have in mind must be represented by a shift of the productivity curve, while the statistically observed changes in the output per head of the labour employed may be due—and to a certain but unknown degree undoubtedly are due—to a movement along the curve.

§ 3. HORIZONTAL MALADJUSTMENTS

Capable of explaining a general depression.

The distinction between “horizontal” and “vertical” maladjustments in the structure of production was explained above. We have seen that, according to the over-investment theory, a vertical maladjustment is normally the cause of the collapse of the boom; and the exponents of the monetary form of the over-investment theory especially seek to show that such a vertical maladjustment (of which the outstanding symptom is capital shortage and a sharp rise in the interest rate) does not arise by pure chance, but develops as the natural and necessary consequence of the inflationary forces which are at work during the upswing, falsifying certain essential price relationships by distorting the rate of interest.

Even if one accepts this theory as fundamentally correct, it does not follow that horizontal maladjustments are not equally likely to arise, or in certain cases to be responsible for the breakdown.

It is true, a horizontal maladjustment alone (that is to say, an over-development of a particular branch of industry) can explain only a partial—as opposed to a general—depression for the reason that, if industry A is over-developed, there must be an industry B which is under-developed and, if A is depressed, B must prosper. But the same is true, as we have seen, of a vertical maldistribution of the factors of production.

In order to explain a general depression, it is necessary to recognise that a deflationary cumulative process can be set in motion by partial dislocation of the productive process. If this is accepted, there is no difficulty in assuming that such a vicious spiral of contraction may be started by a horizontal, as well as by a vertical, maladjustment in the structure of production.

“Error theories.”

Such horizontal maladjustments can be brought about by a great number of circumstances which may be classified as (1) shifts in demand and (2) shifts in supply.

It is here that the “error theories” of the business cycle, or rather of the crisis, have their proper place. These theories stress the great complexity of our economic system, the lack of knowledge, the difficulties in foreseeing correctly the future demand for various products. One producer does not know what the other is doing. A given demand cannot be satisfied by producer A: producers B, C, D, etc., are accordingly called upon to satisfy it, and this creates an exaggerated impression of its volume and urgency. This leads to competitive duplication of plant and equipment, involving errors in the estimation of future wants. The circumstances conducive to bringing about such mistakes have been most fully described and analysed by Professors F. W. TAUSSIG,4 A. C. PIGOU,5 Sir WILLIAM BEVERIDGE6 and T. W. MITCHELL.7

Clearly, mistakes which lead to a misdirection of productive resources can be made at any time. But there are good reasons for the view that they are specially likely to arise during the upswing. The prosperity phase of the cycle is characterised by heavy investments for the reason that, in many lines of industry, provisions are made for satisfying future needs of the ultimate consumer as well as of producers in the intermediate stages of production. Evidently, the longer ahead demand has to be estimated the greater the risk of serious errors. If the estimate has to be made in a period of rapid changes in the economic system in general, and if new methods of production and the production of new types of goods are involved, the risk becomes still greater. Indivisibility and durability of instruments and the complicated relation between changes in the demand for finished goods and the demand for durable producers’ goods (as postulated by the acceleration principle) combine to make a smooth adjustment of cost and supply to changes in demand extremely difficult.

“Horizontal” and “vertical” maladjustments.

The border-line between horizontal and vertical maladjustments is sometimes very difficult to draw. But since the two are not mutually exclusive, since they can, and probably frequently do, coexist and reinforce one another, the fact that classification is sometimes difficult in concrete cases does not weigh too heavily in the balance.

To illustrate the close relationship between horizontal and vertical maladjustment, take again the case where a demand for a capital good (say constructional steel) drops violently as a result of a decrease or cessation of growth of demand for the product (say houses or motor-cars). It has been argued (as already stated)8 that this is in reality the consequence of a shortage of capital—in other words, of a vertical maladjustment in the structure of production—and that, if the necessary capital were formcorning, the building activity and motor-car production could continue until the replacement demand for houses and cars was such that the steel mills could use their whole capacity to satisfy it.

This may be so: but it is just as possible, and a good deal more probable, that the decrease in demand for new houses and motorcars is due to the demand situation—i.e., that the demand for houses and cars has been well satisfied for the time being relatively to other needs, and that savings are therefore invested in other directions, where no steel, or not so much steel, is needed. In this case, we have a horizontal maladjustment in the structure of production. So far as the deterioration of the steel industry and the repercussion which this might have on tributary industries and on the volume of the circulating medium are concerned, the consequences of a horizontal and a vertical maladjustment are exactly the same.

§ 4. OVER-INDEBTEDNESS

Introductory.

Professor IRVING FISHER9 thinks that there are two main causes of the recurrence of economic depressions, namely “over-indebtedness” and “deflation”. These two factors, he thinks, tend to produce and to reinforce one another. Deflation swells the burden of debts, and over-indebtedness leads to debt liquidation, which engenders a shrinkage of the money stream and a fall in prices.

Professor FISHER’S debt-deflation theory is embedded in a general view about the trade cycle which sounds prima facie somewhat strange. He likes to call “the” business cycle a myth. But a closer examination shows that he deprecates only the use of the term “cycle” in the sense of a strictly periodic and regular movement. He stresses the differences in the appearance, amplitude and length of the various “cycles”—that is, in the alternations of good and bad years—which we find in the economic history of the last hundred years. He admits and even emphasises the fact that the economic system is liable to deteriorate in a cumulative process—that there is a vicious spiral of contraction and another vicious spiral of expansion. But how far expansion or contraction goes depends (he maintains) on innumerable circumstances, which differ from case to case.

This difficulty cleared away, it is comparatively easy to determine the place of the debt-deflation theory in our system of explanations of the cycle, and to distinguish those elements which add something new from those which have been already discussed in connection with other theories.

The description of the vicious spiral downward, which comes into play after the depression has once been started, is substantially the same as we found it in the writings of the monetary and over-investment schools. A fall in demand leads to a fall in prices, to the disappearance of the profit margin, to a reduction in production, to a decrease in the velocity of money, and so to a contraction of credit, a further drop in demand, pessimism, hoarding, etc.

What, then, is the rôle of debts and over-indebtedness? They influence the course of the cycle in two respects. In the first place, the existence of large debts expressed in terms of money tends to intensify the deflation, and in the second place a state of over-indebtedness may be the cause which precipitates the crisis. Professor FISHER does not distinguish the two cases in these words, but the distinction is clearly implied by his analysis.

Debts intensify deflation.

1. The existence of large debts in terms of money is certainly a most potent factor (although not the only factor) tending to aggravate the depression. The burden of debts becomes heavier with the fall in prices; and this leads to distress selling, which depresses prices further. Thus, directly and indirectly, a liquidation of bank credits is induced, which means a shrinkage in the volume of the circulating medium and of the demand for goods in general.

It would seem that the intensifying influence of money debts on the contraction process is an important corollary of the theory of the deflation as elaborated by the writers previously reviewed. Deflation would cause depression and the process of contraction would be cumulative, even if (as it is conceivable) the upswing were financed by shares and not by bonds, and by the producers’ own capital instead of by borrowed money; but the depression would be milder if the amount of debts was smaller. (To this problem we shall return presently.)

Over-indebtedness may cause the downturn.

2. A much more precarious proposition is that which regards the state of “over-indebtedness” as the normal cause of the collapse of the boon,. What is meant by over-indebtedness? “Over indebtedness means simply that debts are out-of-line, are too big relatively to other economic factors.”10 How is over-indebtedness brought about? “It may be started by many causes, of which the most common appears to be new opportunities to invest at a big prospective profit, . . . such as through new inventions, new industries, development of new resources, opening of new lands or new markets. Easy money is the great cause of over-borrowing.”11

It seems clear that in these cases over-indebtedness is closely connected with over-investment. To say that the cause of the breakdown is over-investment is the same thing as saying that investments have been made which later turn out to be unprofitable: that is, in other words, sales proceeds do not cover cost, and one important cost item is interest on fixed and working capital. The over-investment theory tries to show why this is the necessary consequence of any inflationary boom, and how entrepreneurs are lured into too heavy investments. Professor Irving FISHER, on the other hand, stresses the fact that these over-investments have been made with borrowed money. But clearly over-investment, rather than over-indebtedness, is the primary cause of the breakdown. If the investments are excessive (in the sense that the structure of production is not in equilibrium), then these enterprises will suffer losses, whether they are financed with shares or with bonds, with borrowed capital or with the entrepreneur’s own capital. Further investment will be stopped and deflation is likely to ensue. If, on the other hand, the structure of production is in equilibrium, there is no reason why the indebtedness of the new enterprises should cause trouble. It may, however, readily be admitted that the repercussions of the breakdown of the investment boom are likely to be much more severe where the investments have been financed with borrowed money.

We may thus conclude that the “debt-factor” plays an independent rôle as intensifier of the depression, but can hardly be regarded as an independent cause of the breakdown.12

§ 5. FINANCIAL ORGANISATION AND THE SEVERITY OF THE DEPRESSION

Rigid money contracts intensify deflation.

Mr. A. LOVEDAY has called attention to certain features of our present financial organisation which tend to aggravate the consequences of a fall in the price-level. “We may not—we do not—know”, he says, “the causes of the recurrence of periods of depression; but we do know many of the factors that contribute to their severity.”13 “When prices and the national income expressed in money values diminish, the money claims represented by the contracts remain unchanged; the contractors who have received a money claim obtain a greater share of the national dividend and others obtain less. When contracts are for short periods, . . . the shift in the distribution of income may be nugatory or nil. They can be changed as rapidly or almost as rapidly as the prices of commodities move. But when they stretch over a period of years, or when rapid change is in practice difficult, they must affect the distribution of income and thus of purchasing power. . . .

“. . . The point which I desire to throw into relief is that, in a financial organisation such that claims on national income vary less readily than do prices of goods, the rigidity of those claims itself constitutes a contributory cause of further price declines. The greater the proportion of monetary fixed claims in society as a whole the greater the danger.

“In the international field, the effects of such fixed claims are still more serious, because the transfer of wealth from debtor to creditor that has to be made is not within the country. It is not the distribution of a national income that is affected directly, but its amount. A larger slice must be cut off the national income of the debtor State and handed over to the foreign creditor.”14

Bonds versus equities.

Mr. LOVEDAY then points out that for various reasons these financial rigidities have increased. “In recent years, the joint-stock system, under names varying with the law in different countries, has replaced to a constantly increasing extent the more personal enterprise. . . . Gradually with the growth of the big industrial concern, with the extension of the multiple shop . . .a greater and greater proportion of the population has been thrust out of positions of direct, independent control into the mass of wage-earning and salaried classes. Such persons can no longer invest in themselves; to the extent that they play for safety or apparent safety, and give preference to fixed-interest-bearing obligations over profit-sharing equities, they inevitably add to the rigidity of the financial system. Many forces have induced them to prefer safety to profit”15—that is, fixed-interest bonds to shares and participations.

The rising importance of the small investor as compared with the large capitalist has increased the preference for bonds, since the small capitalist has not the means of a large investor to spread his risk, and is not in a position to form a rational judgment about the chances of investments in equities. Therefore, he prefers savings deposits and fixed-interest obligations. To an increasing extent, moreover, international investments have taken the form of fixed-interest-bearing obligations in preference to shares.

There can be no doubt that these circumstances have played an important part in aggravating the depression of 1923 to 1933. These factors must therefore be incorporated in a fully elaborated theory of the business cycle: but they can find a place in any theory which recognises the deflationary nature of the depression.

 

 

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16 Compare L. Robbins, The Great Depression (1934), Chapter II.

17 See “Business Cycles” in Business Cycles and Unemployment, New York, 1923, pages 10 and 11. A similar description is to be found in other writings by Mitchell on the subject.

18 Pigou, Industrial Fluctuations, 2nd ed., London, 1929, page 228.

19 Principles of Economics, 3rd ed., 1925, Vol. 1, pages 388 et seq.

20 Industrial Fluctuations, Chapter VI (“The Structure of Modern Industry and Opportunities for Errors of Forecast”).

21 Unemployment, new ed., London, 1930.

22 “Competitive Illusion as a Cause of Business Cycles” in Quarterly Journal of Economics, Vol. 38, August 1924, pages 631 et seq.

23 By Professor Hayek.

24 Cf. his article “The Debt-deflation Theory of Great Depressions” in Econometrica, Vol. 1, No. 4, October 1933, pages 337 et seq., and his book Booms and Depressions, London, 1933.

25 Booms and Depressions, page II.

26 “The Debt-deflation Theory,” loc. cit., page 348. Italics in the original.

27 There are other factors of which Fisher seems also to think when he talks of over-indebtedness, e.g., war debts and reparation payments. It may, of course, be readily conceded that, if such political debts are excessive and if the countries concerned do not pursue an appropriate policy, the existence of such debts may lead to contraction and depression.

28 “Financial Organisation and the Price Level” in Economic Essays in Honour of Gustav Cassel, London, 1933, Page 409.

29 Op. cit., pages 410 and 411.

30 Op. cit., pages 412.

• 1The real distinction—in some cases—is between controllable and uncontrollable factors. The weather, e.g., is uncontrollable, while institutional factors are at least in theory controllable. Among factors, furthermore, which can in principle be controlled, there are those which one does not find it desirable, for one reason or another, to control or to eliminate altogether—e.g., inventions, or the liberty of the recipient of income to spend his income or to save it, or to exercise freedom of choice in regard to his consumption or occupation. Needless to say, opinion as to what it is possible and desirable to control or influence varies from time to time and from person to person.
• 2It has been attempted to give more precision to the distinction between exogenous and endogenous theories by saying that the former assume movements in the data, while the latter suppose the data to remain constant. This distinction is precise enough once the general theoretical system on which a writer builds his theory of the business cycle has been determined and accepted; but it is not possible to lay down beforehand once and for all what phenomena are to be regarded as accepted data and what are magnitudes to be explained and determined in the light of those data. What the theory of yesterday accepted as data, we try to explain to-day; and the independent variables (data) on which we build to-day may become dependent variables to-morrow. All attempts to make a definite distinction between data and results lead back to the earlier conception which regards forces or movements of a “non-economic” nature or “external” to the economic system as the “data” of economic theory. But this distinction between “economic” and “non-economic” phenomena is a purely conventional one. There is no reason why forces or movements not to be classified as economic should not become “dependent” or “explained” variables of a general—as distinct from an economic—theory.
• 3With very few exceptions, all serious explanations are neither purely exogenous nor purely endogenous. In almost all theories, both the “originating factors” and the “responses of the business system” (to use the expression of J. M. CLARK) play a rôle. On the one hand, a purely exogenous theory is impossible. Even if one assumes a weather cycle, the peculiar response of the business system, which converts harvest variations into a general alternation of prosperity and depression, has still to be explained. On the other hand, a purely endogenous theory is hardly satisfactory. It is not likely that, without outside shocks, a cyclical movement would go on for ever: and, even if it did go on, its course would certainly be profoundly influenced by outside shocks—that is, by changes in the data (however these may be defined and delimited by economically explained variables).
• 4One methodological rule of thumb may be suggested at this point, however, although it will find its full justification only later. For various reasons, it seems desirable, in the explanation of the business cycle, to attach as little importance as possible to the influence of external disturbances. In the first place, large swings in the direction of prosperity and depression as we find them in real life are difficult to explain solely by exogenous forces; and this difficulty becomes an impossibility when the alleged “disturbances” do not themselves show a wavelike movement. Even if a periodic character is assumed (e.g., in the case of crops or inventions), the hypothesis is full of difficulty. The responses of the business system seem prima facie more important in shaping the business cycle than external shocks. Secondly, historical experience seems to demonstrate that the cyclical movement has a strong tendency to persist, even where there are no outstanding extraneous influences at work which can plausibly be held responsible. This suggests that there is an inherent instability in our economic system, a tendency to move in one direction or the other. If it is possible (as we believe) to demonstrate that such a tendency exists and to indicate the conditions under which it works, it will be comparatively easy to fit all kinds of external perturbations, including all State interventions, into the scheme. Exogenous forces will then figure as the originators or disturbers of endogenous processes, with power to accelerate, retard, interrupt or reverse the endogenous movement of the economic system.
• 5One methodological rule of thumb may be suggested at this point, however, although it will find its full justification only later. For various reasons, it seems desirable, in the explanation of the business cycle, to attach as little importance as possible to the influence of external disturbances. In the first place, large swings in the direction of prosperity and depression as we find them in real life are difficult to explain solely by exogenous forces; and this difficulty becomes an impossibility when the alleged “disturbances” do not themselves show a wavelike movement. Even if a periodic character is assumed (e.g., in the case of crops or inventions), the hypothesis is full of difficulty. The responses of the business system seem prima facie more important in shaping the business cycle than external shocks. Secondly, historical experience seems to demonstrate that the cyclical movement has a strong tendency to persist, even where there are no outstanding extraneous influences at work which can plausibly be held responsible. This suggests that there is an inherent instability in our economic system, a tendency to move in one direction or the other. If it is possible (as we believe) to demonstrate that such a tendency exists and to indicate the conditions under which it works, it will be comparatively easy to fit all kinds of external perturbations, including all State interventions, into the scheme. Exogenous forces will then figure as the originators or disturbers of endogenous processes, with power to accelerate, retard, interrupt or reverse the endogenous movement of the economic system.
• 6In more recent publications, under the impression of the slump of the nineteen-thirties, Mr. HAWTREY has modified his views to some extent. He now doubts whether it can be legitimately assumed that “the expectation of falling prices is (always) the result of a preceding experience of a prolonged actual fall” and that such a condition of stagnation is not possible except in the course of a reaction from a riot of inflation.
• 7In more recent publications, under the impression of the slump of the nineteen-thirties, Mr. HAWTREY has modified his views to some extent. He now doubts whether it can be legitimately assumed that “the expectation of falling prices is (always) the result of a preceding experience of a prolonged actual fall” and that such a condition of stagnation is not possible except in the course of a reaction from a riot of inflation.
• 8The scope of the following analysis of theories has been defined in the Introduction (page I). The method followed in the exposition is thereby largely determined. No attempt has been made to present the various theories in chronological order or to picture the theoretical and sociological background of the various writers (except in so far as it may have been necessary in order to elucidate their doctrines). It has been preferred to present the theories in a systematic order, beginning (so far as possible) with the less complicated and proceeding thereafter to the more complicated. Frequently it happens that the latter cover all the factors on which the former lay stress, while drawing attention to others which the former have overlooked or treated as irrelevant or put aside by means of a convenient simplifying assumption (e.g., by a ceteris paribus clause).
• 9“If the restriction of credit did not occur, the active phase of the trade cycle could be indefinitely prolonged, at the cost, no doubt, of an indefinite rise of prices and an abandonment of the gold standard.”
• 10The process of contraction is cumulative no less than the process of expansion. “When credit has definitely turned the corner, and a contraction has succeeded to an expansion, the downward tendency of prices is sufficient to maintain the process of contraction, even though the rate of interest is no longer, according to the ordinary standards, high.”
• 11“Thus there is a principle of the instability of velocity of circulation, which is quite distinct from the principle of the instability of credit, but is very apt to aggravate its effect.”
• 12In his earlier writings Mr. HAWTREY had already mentioned the theoretical possibility of a complete credit deadlock arising. That is a situation where even exceedingly low interest rates fail to evoke a new demand for credit. In such a situation, the ordinary means of bank policy prove wholly ineffective. In his Good and Bad Trade he ascribes this phenomenon to the fact that “the rate of depreciation of prices” may be so rapid that “nothing that the bankers can do will make borrowing sufficiently attractive” to lead to a revival in the flow of money.
• 13In more recent publications, under the impression of the slump of the nineteen-thirties, Mr. HAWTREY has modified his views to some extent. He now doubts whether it can be legitimately assumed that “the expectation of falling prices is (always) the result of a preceding experience of a prolonged actual fall” and that such a condition of stagnation is not possible except in the course of a reaction from a riot of inflation.
• 14But even so, Mr. HAWTREY thinks, the recurrence of the breakdown is not inevitable. The expansion could go on indefinitely, if there were no limits to the increase in the quantity of money. The gold standard is, in the last resort, responsible for the recurrence of economic breakdowns. Under the gold standard, it is the slow response of people’s cash balances which prevents the banks from stopping expansion or contraction in time. “If an increase or decrease of credit money promptly brought with it a proportionate increase or decrease in the demand for cash, the banks would no longer either drift into a state of inflation or be led to carry the corresponding process of contraction unnecessarily far.” Given, however, this slow response of the people’s cash balances, “so long as credit is regulated with reference to reserve proportions, the trade cycle is bound to recur”.
• 15Under the automatic working of the gold standard, “the length of the cycle was determined by the rate of progress of the processes on which the cycle depended, the absorption of currency during the period of expansion and its return during the period of contraction”.
• 16Cf. J. M. Clark, Strategic Factors in Business Cycles, New York, 1935. pages 4-5 and passim.
• 17See especially Tinbergen: “Suggestions on Quantitative Business Cycle Theory” in Econometrica, Vol. Ill, No. 3, July 1935, page 241.
• 18See his book: Strategic Factors in the Business Cycle, passim.
• 19What is to be regarded as “outstanding” and “plausible” is, of course, a matter of dispute. As there is always something happening somewhere, it is always possible to find some external events which can be made the basis of a tentative explanation.
• 20For this reason, anything like perfect regularity in respect of the amplitude, length, intensity and concomitant symptoms of the cyclical movement is a priori improbable.
• 21The Lessons of Monetary Experience, page 131.
• 22Ibid., page 131, and Monetary Reconstruction, page 133.
• 23This special purpose explains the difference between the following exposition and the classification of theories and theorists given in such works as A. H. Hansen: Business Cycle Theories, Boston, 1927; W. M. Persons: “Theories of Business Fluctuations” (Quarterly Journal of Economics, Vol. 41, reprinted in Forecasting Business Cycles, New York, 1931); F. A. Hayek: Monetary Theory and the Trade Cycle, London, 1933; Macfie: Theories of the Trade Cycle, London, 1934.
• 24Trade and Credit, London, 1928, page 98.
• 25Currency and Credit, 3rd ed., London, 1928, page 153.
• 26Op. cit., page 171.
• 271913, page 186.
• 28Cf. his Trade Depression and the Way Out, 2nd ed., pages 29-31 and 133-135, Capital and Employment, pages 85-87, “A Credit Deadlock”; and his contribution to The Lessons of Monetary Experience (edited by A. D. Gayer), “The Credit Deadlock”, pages 129-145.
• 29Monetary Reconstruction, 2nd ed., London, 1926, page 135.
• 30Currency and Credit, 3rd ed., page 155.