Prosperity and Depression

CHAPTER 7 HARVEST THEORIES.
AGRICULTURE AND THE BUSINESS CYCLE

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§ 1. INTRODUCTION

Theories of periodic harvest variation.

The relation between changes in the agricultural situation and industrial fluctuations is much more complicated than many people think. There exist a good many theories on the subject, which are not easy to reconcile though all are either based on, or backed by, statistical research. One group of theories, which includes the writings of W. S. JEVONS,1 H. S. JEVONS,2 and H. L. MOORE,3 seeks to account for the periodicity of business cycles by establishing the existence of a similar periodicity in agricultural output. The chain of causation runs from cosmic influences to weather conditions, from weather conditions to harvests, and from harvests to general business.

The authors of these theories are generally willing to admit that the effects of weather-induced harvest variations may be partially or totally offset by the effects of other causes, whether causes outside the economic system (wars, revolutions, inventions, currency depreciations and so forth) or causes inherent in the economic system. On the other hand, these factors may also operate to reinforce the harvest variations. W. S. JEVONS suggested on one occasion4 that “if, then, the English money market is naturally fitted to swing or roll in periods of ten or eleven years, comparatively slight variations in the goodness of harvest repeated at like intervals would suffice to produce those alternations of depression, activity, excitement, and collapse which undoubtedly occur in marked succession”.

Professor H. S. JEVONS believes that the industrial system and the emotional outlook of the business community take longer to revolve than the period of a complete harvest cycle, and that the impulses liberated in two or more harvest cycles accumulate accordingly until a major business cycle is generated.

One consideration which tells against those theories is the absence of agreement as to the exact period of crop variations. W. S. JEVONS based his argument on a crop-cycle of ten and a-half years, Professor H. S. JEVONS on a period of three and a-half years, and Professor H. L. MOORE on an eight-year period. It is, however, conceivable that the same agricultural series may contain fluctuations, or tendencies to fluctuate at intervals of different lengths (i.e., shorter cycles superimposed on longer ones) as also, for that matter, that general business should exhibit a similar tendency. Moreover, different branches of agricultural output show fluctuations of different periods. The crop-fluctuations which had the greatest effect on general business in the eighteenth and early nineteenth centuries may not be same as those which have had the greatest effect in succeeding epochs. The attempt to find an explanation of the changing periods of business cycles on lines consistent with their agricultural origin is not therefore hopeless.

Other views as to the relation between agriculture and business.

It is not necessary, in order to establish a causal connection between agricultural output and the business cycle, to assume a cyclical movement in agricultural output itself. Fluctuations in cropyield or in the output of live-stock and animal products may be regarded as analogous to inventions, wars, earthquakes, etc., which appear at irregular intervals, and set in motion cumulative processes of expansion or contraction in the industrial system, or alternatively reinforce or retard a concurrent expansion or contraction. Harvest fluctuations which do not happen to coincide with a turning-point in the business cycle will tend rather to disturb the periodicity of the cycle than to determine it.

The above may be presumed to be the view taken by Professor PIGOU5 and Professor ROBERTSON,6 since, though they treat harvest variations as important potential causes operating to precipitate cumulative upward and downward movements, they attribute to these cumulative processes a life of their own with periods determined—in part—by psychological and other factors and in any case with no relation to the periods of crop-fluctuations. Professor SPIETHOFF,7 for his part, speaks of good harvests and innovations as two amongst many possible initiating factors of industrial expansion; But none of these writers can be represented as putting forward an “agricultural theory” of the trade-cycle. They do not ignore the agricultural factors; but they combine them with other factors in integrated but flexible schemes, in which allowance is made for various processes of response—monetary, psychological and technical.

There is a third view, held mainly by American economists such as Professors A. HANSEN 8 and J. M. CLARK,9 which denies that fluctuations in agricultural output are among the causes of the cyclical fluctuation of business. Agriculture, these writers say, is not an active but a passive element. The very inelasticity of agricultural supply exposes the farming community to considerable instability of income as a result of changes in demand arising out of trade fluctuations brought about by internal forces of the business economy. In the words of Professor HANSEN, agriculture is the “football of business”.

Compatibility of different theories.

These three points of view are not necessarily mutually exclusive. It is possible to reconcile a general lack of response on the part of agricultural output to changes in demand with occasional or periodic spontaneous variations which may have an effect on business. The writers of the second and third groups referred to are probably not so much at odds on the theory as on the statistical question whether the influence of agricultural fluctuations can in fact be traced in business indices.

It is a more serious shortcoming of these “agricultural” theories that they are not agreed on the important point as to whether plentiful harvests are correlated with prosperity and poor harvests with depression, or the other way round; and their divergence in this respect is symptomatic of a fundamental disagreement as to the channels by which the influence of agricultural fluctuations is brought to bear on other departments of economic life.

We have therefore, if we are to investigate the problem systematically, to consider the various possible ways in which (1) agricultural fluctuations can influence general business and (2) industrial fluctuations can influence agriculture.

§ 2.    HOW AGRICULTURAL FLUCTUATIONS INFLUENCE INDUSTRY AND TRADE

Assumption of a closed economy.

Here, as in so many departments of economic theory, it is necessary to begin with the consideration of a closed economic system. The world economy as a whole has to be brought under review before it is possible to discuss the relationship of parts of the whole (e.g., single countries) with the rest of the world. The following enumeration of the repercussions (through all the different channels) of fluctuations in agricultural output relates, therefore, in the first instance (sections A to H) to a self-sufficient economic system. In section I, the position is considered from the standpoint of the external trade relations of an individual country.

A. “Real” elasticity theories.

Professors PIGOU and ROBERTSON link up harvest variations and industrial fluctuations by arguments appropriate to an economic system without a common medium of exchange (i.e., a barter economy), and then proceed to take account of the modifications introduced into the relationship by the fact that economic incentives present themselves in a money form.

The successive steps of the argument, as culled from various chapters of Professor PIGOU’S Industrial Fluctuations and his Theory of Unemployment, seem to be as follows.

An exceptionally good harvest leads to a larger demand on the part of agriculturists in terms of agricultural produce for the products of industry.10

In so far as this raises the real income of the community, it will lead to an increase in the supply of new capital from savings, a downward tendency in interest rates and an increase in the demand for labour in terms of wage-goods.11

In so far as it involves an increase in the employers’ expectations of the yield of labour in terms of goods in general, the rise in the agricultural demand for industrial products will increase the employers’ demand for capital and pro tanto—whether the demand is satisfied out of stocks or savings—the demand for labour in terms of wage-goods.12 Whether the big harvest will in fact increase the employers’ expectations of the “real” yield of labour depends, according to Professor PIGOU, on the “elasticity of the general demand for agricultural produce”. He writes: “If the general demand for agricultural produce is highly inelastic—i.e., has an elasticity less than unity—the enlarged amount of agricultural produce obtainable” for a unit of industrial output represents, “not an enlarged, but a diminished amount of things in general”. In this case there will not be any increased willingness to save nor yet any increased expectation of yield to induce employers to borrow more for the purpose of increasing their real demand for labour.13

Supposing, however, that the general demand for agricultural products is elastic, the increase in the demand for labour in terms of wage-goods will lead to more employment for the reason that the supply-schedule of labour, thanks to the rigidity of wage rates, is highly elastic.14

So far, the analysis proceeds on the assumption of a purely barter economy. The following is Professor PIGOU’S adaptation of the argument to a money economy.

The additional borrowing requirements of the employers, induced by their improved expectations of yield, are satisfied partly by the banks. The result is a monetary expansion of a cumulative nature which, in a variety of ways, enhances the demand for labour in terms of wage-goods and thus increases industrial output.15

Since workers under the influence of the “money illusion” are willing to accept lower real wages if they appear in the shape of rising prices, the rise in prices which results from monetary expansion has the effect of increasing the supply of labour available at a given real wage. Hence, industrial activity responds more sharply to an increase in the real demand of the agriculturists.16

Elasticity of demand in terms of money and of “effort”.

This argument is obscured by the ambiguity of the phrase “elasticity of the general demand for agricultural produce”. Normally, we think of an elasticity of demand in terms of money; but it might be translated into “real” terms as relating to the quantity of industrial produce, the use or consumption of which the industrial population as a whole is willing to forgo in exchange for varying quantities of agricultural produce, the total production of industrial produce remaining unchanged.

This would seem the most natural interpretation of the phrase. But an examination of the footnote on page 42, and of the whole discussion in Chapter V, of PIGOU’S Industrial Fluctuations shows that PIGOU supposes any increase or diminution in the amount of industrial goods offered for agricultural produce to represent an equivalent increase or diminution in the production of industrial goods. In this case, “elasticity of demand for agricultural produce” seems to relate to the total amount of effort or activity industrialists will undertake to produce goods for their own consumption and for exchange against varying quantities of agricultural produce. Thus, by assuming the elasticity of the industrialists for agricultural products in terms of effort as given, Professor PIGOU assumes a knowledge of how total industrial output changes in response to changes in the harvest. But it is this magnitude which the theory is concerned to discover. It is the unknown quantity. It must not be assumed in advance.

It is only when interpreted in the first sense mentioned above—viz., in terms of money (or its complement in real terms)—that the phrase “elasticity of demand” can play a useful role in the explanation of the repercussions on industry of agricultural fluctuations. But, a soon as “elasticity of demand” is thus interpreted, we are confronted with the difficulty that movements in the money demand for industrial labour vary in the contrary direction to the “real” demand in the sense in which the term “real” is employed by Professor PIGOU. He says that the increased supply of agricultural produce represents an increased “real” demand for industrial produce (and gives rise to an increased “real” demand for labour) only if the demand for agricultural produce is elastic. But these are the very circumstances in which the money demand for industrial output will diminish, since a greater proportion of expenditure goes in such case to agricultural produce: and, since wage-earners respond primarily to the money demand for labour, an elastic demand for agricultural produce in terms of money and of goods already produced means an inelastic demand in terms of effort and employment.

Similar difficulties and ambiguities are encountered in connection with Professor ROBERTSON’S treatment of the problem in his Banking Policy and the Price Level. He enquires by what process, and with what price accompaniments, a given response in industrial output (represented by iron) to enhanced agricultural output (represented by wheat), such as would take place in barter conditions, will be reached under the operation of this or that policy on the part of the monetary authority. He realises, and expressly states, that “iron-makers” react more readily to increased money receipts than to falling prices in the objects of expenditure: but, for him, the money demand for iron depends only on the effort-elasticity of the demand for wheat and the general price-level as determined by monetary policy. He appears to overlook the fact that the buyer’s elasticity of demand for wheat in terms of iron—in the absence of any change in the total money demand—influences the money demand for, and supply of, iron and pro tanto the effort-elasticity of the iron-makers’ demand for wheat.

In a monetary economy, it is never possible to take the effort-elasticity of the demand for a particular commodity—or, generally, of the demand of industry as a whole for agricultural produce—as a psychological datum, as it is convenient to do in the case of the elasticities of buyers’ demand for a single good. Producers are stimulated almost entirely by monetary incentives, so that a long process of analysis by progressive stages, coupled with assumptions as to the operation of the monetary factors throughout, is required if it is desired to arrive at conclusions as to the actual effort-elasticity of demand in any given case. It is not therefore permissible, in order to indicate the probable consequences on industry of agricultural fluctuations, to assume a particular effort-elasticity from the start; for this is equivalent to assuming the solution of the problem. Nor is it permissible to estimate the effort-elasticity of demand from actual experience of how industrial production has responded to agricultural fluctuations, and to proceed to treat the estimate as a relatively stable psychological function, independent of monetary conditions.

B. Influence on industries using agricultural raw materials.

Changes in agricultural output of all sorts exercise a dominating influence over those industries which utilise agricultural raw material, such as the food and textile industries, as also the industries engaged in the handling and transportation of the crop or animal produce.

The nexus between an industry and its source of raw materials is necessarily very close. In the absence of surplus stocks which can be drawn on, a short crop will restrict the activity of the industry which it serves. A bumper crop will lower the price of the raw material in relation to that of the finished product, till either the manufacturers decide to absorb it all by increased output or the holders decide to keep the surplus in store. In any case, the activity of the later stages will be increased, because the holding of stocks never completely offsets harvest fluctuations.

Transport concerns which are accustomed to handle agricultural produce are in much the same position vis-à-vis crop fluctuations as are the industries utilising the produce as raw material.

C. Influence on real wages.

In dealing with the “effort-elasticity” theories, it was pointed out that the supply of labour varied rather with the money demand for labour than with the demand in terms of goods and services. But the “real” equivalent of the money wage is not something quite irrelevant to the incentive to work or to accept employment. If, for example, food prices fall, it may be easier to reduce money wages or to prevent them from rising, and vice versa if food prices go up. This is particularly likely to be the case where wage-scales are based on cost-of-living indices. On the whole, however, this factor is probably of little practical importance in the short run.

D. Migration of labour between town and countryside.

There is another channel by which the industrial labour supply may conceivably be influenced by good and bad crops. Most crops taken individually, and certainly agricultural production as a whole, have to face an inelastic demand (in terms of money) on the part of consumers who have the choice between agricultural and non-agricultural commodities. Therefore, good crops mean low farm incomes. It is conceivable that a fall in agricultural incomes may give rise to an exodus of labour from agriculture to industry. The process is known to work in the opposite direction in many countries, where the agricultural labour supply varies with industrial prosperity. The converse movement, though rarer, is not unknown.

E. Effects on non-agricultural consumer’s goods industries.

The more contentious questions arise when we come to deal with the effects of crop fluctuations on industries not utilising agricultural raw materials. These may be divided for convenience into consumers’ goods industries and producers’ goods industries, or again into industries serving the agricultural population and industries serving the nonagricultural population. It may fairly be assumed that, except in advanced phases of expansion, the elasticity of supply of goods in face of an increase in the money demand is considerable.

The effect of a big harvest on non-agricultural consumers’ goods industries will depend on whether the money demand for consumers’ goods of agricultural origin is elastic or not. The less elastic it is the more probable it is that the big harvest and the consequent fall in the price of food will result in a diversion of demand from food to non-agricultural goods, inducing a rise in the supply of the latter, the extent of which depends on supply conditions. The same is true, mutatis mutandis, of poor harvests.

F. Farmers’ purchasing power.

While there may be a general tendency for crop changes to affect non-agricultural consumers’ goods industries as a whole in a given direction, a distinction must be made between those which supply the agricultural population and those which supply the non-agricultural population. It is often asserted that changes in agricultural output affect general business by changing the purchasing power of the agriculturist. Good harvests either increase or dminish the farmer’s income, according as the elasticity of demand is greater or less than unity, and so affect the prosperity of the branches of industry which serve his needs. It is clear, however, that this argument in itself proves nothing. For what the farmer loses in purchasing power other people are bound to gain, and vice versa. Business flags in the case of the industries supplying the farmer, but is brisk in the case of the industries supplying other people. The net result of this redistribution of purchasing power will depend on the concrete situation, the phase of the trade cycle, the credit situation in the various countries and localities affected by the redistribution, and so on.

G. Effects on investment.

It is important to consider the effect of crop fluctuations on investment both because of the initial effect on the activity of investment-goods industries and because of the indirect effect on monetary expansion or contraction in subsequent periods. Roughly speaking, the following may be expected to be the effects of a good harvest, for which the demand in money terms is inelastic:

 

(a)   A fall in investment by agricultural producers;

(b)   A rise in investment by industries transporting and utilising the crop;

(c)   A rise in investment by consumers’ goods industries not utilising agricultural materials, particularly those not serving the agricultural population;

(d)   A change in the amount of investment in holding stocks of agricultural produce. This aspect has recently been stressed by Mr. KEYNES.17 A distinction must be made between the initial effect occurring immediately after the harvest (which will probably be a fall in the value, as distinct from the physical quantity, of stocks held as compared with a normal year) and the subsequent effect (which may be an increase in the value of the carry-over).

Strictly speaking, these movements refer less to investments than to the “tendency to invest”, or the demand for investment funds. To what extent this demand will be satisfied, and the tendency to invest take the shape of actual investment, depends on the elasticity of the supply of investible funds in the various countries concerned. It is not impossible, for example, that a violent redistribution of incomes between agriculturists and others, accompanied by a flow of money from agricultural to non-agricultural countries, or vice versa, might ultimately result in a deflationary shock to the credit system, which would tend to neutralise any increased demand for investible funds that might be simultaneously engendered.

H. Effects on saving.

Before any conclusions can be drawn as to the further consequences of crop fluctuations on the industrial economy by way of cumulative monetary expansion or contraction, the effects on investment must be compared with the effects on saving. An excess of investment over saving would generate an expansion, while an excess of saving over investment would cause a contraction. Mr. J. H. KIRK18 bases his conclusions as to the deflationary effects of big harvests on the tendency of consumers to save a part of the extra purchasing power accruing to them through the fall in agricultural prices. Obviously, no conclusion as to the net effect can be drawn a priori: but, in any concrete case, the attempt must be made to strike a balance between all the tendencies towards changes in investment and all the tendencies towards changes in saving. As was pointed out, tendencies towards increased investment, in conjunction with an elastic credit-supply, engender monetary expansion, while tendencies towards increased saving, if unaccompanied by increased investment, engender monetary contraction.

I. International aspects.

We may now pass from the analysis of the effects of fluctuations in the total crop of a self-sufficing economy on the industrial activity of that economy as a whole to an examination of the effects of fluctuations in the crop of a geographical subdivision of the total economy (a district or country) on the industrial activity of that subdivision.

The elasticity of demand for the crops of a single country (in terms of international money) is of course much greater than that for the crops of the world as a whole: and the smaller the country, and the more perfect the world market for the crops, the greater the elasticity of the demand. It is greater, for example, in the case of New Zealand than in the case of the United States of America, and greater in the case of wheat than in the case of most animal products. Thus, in many or most cases, an increase in the crop of one country, unaccompanied by any change in the crops of other countries, will result in an increase in the money receipts of the agriculturists in the country concerned. (If the elasticity of demand is less than unity, agriculturists elsewhere will lose to a more than equivalent extent.) Furthermore, a given increase in the money receipts of the agriculturists will mean an even greater increase in the money receipts of the country as a whole, since the home population will be spending less than before on farm products and (probably) more than before on home industrial products, so that both the agriculturists and industrialists will rejoice in increased receipts—and that increase can only come from outside.

This initial increase in the receipts and incomes of the country which has been blessed by a good crop will provide an inflationary stimulus to the industry of that country (though we must take account of the continual “leakage” of purchasing power abroad). It will be gathered from the new considerations thus introduced in the argument that conclusions as to the general effect on world industry of a net world crop variation cannot be drawn from a comparison between the agricultural fluctuations of any given country and the industrial activity of that country. In the case of countries like Australia, New Zealand, Roumania, Argentine, Canada, etc., this is obvious; but it is often lost sight of, particularly in the case of the United States.

Summary.

It will be apparent that the channels through which fluctuations in agricultural output (good and bad harvests) exercise their effect upon the economic system in general and industrial activity in particular are no other than those with which we have become familiar in the perusal of the various theories discussed in the earlier sections of this work. The several processes of monetary expansion and contraction originating in the varying demand for capital, of over-saving resulting from plenty, and of the dependence of investment on consumers’ demand—to each of which a varying degree of importance is attached by the different schools of thought—are all relevant to the problem. There can be no “agriculture theory” of the cycle in the sense of an alternative to, say, the monetary theory or the over-investment theory any more than there can be an “invention theory” or an “earthquake theory”. All that can be attempted in this direction is to bring out the importance of agricultural fluctuations as one amongst other potential stimuli in the economic system. What has been said of agriculture and the trade cycle might be said with scarcely any modification of inventions and the trade cycle, or even of earthquakes or wars and the trade cycle.

It will be observed that no attempt has been made to strike a balance between the arguments for and against the proposition that good harvests are good for trade and bad harvests bad. On the whole, the arguments in favour of the proposition that good harvests have a stimulating effect dominate the literature on the subject, though the opposite view is not without support. There is of course very little doubt that a good harvest in a particular country tends to stimulate the business life of that country. The problem only becomes obscure when a completely closed economy is the object of study.

A priori, analysis cannot settle the question, because forces are released which pull in opposite directions; and only estimates of the quantitative importance of the different factors—effect on investment, effect on saving, effect on the credit structure, etc.—can supply a basis for judgment as to which tendency will prevail. Much probably depends on the phase of the business cycle in which the disturbance occurs. It is conceivable that a good harvest may exercise now a stimulating and now a depressing influence according to the phase of the cycle and the portions of the earth’s surface and the world’s population affected. Nor must it be too readily assumed that a good wheat crop and a good cotton crop have the same kind of effect. After it has been decided in all the different possible cases whether the influence of crop-fluctuations on general business is positive or negative and whether that influence is important enough to outweigh other influences operating simultaneously, it will still remain to consider to what degree crop fluctuations are cyclical and, if they are cyclical, to what degree they are spontaneous and independent of the general business cycle.

§    3. INFLUENCE OF THE BUSINESS CYCLE ON AGRICULTURE

Inelasticity of farm output.

As each part of the economic system is to some degree sensitive to developments in all other parts, industrial fluctuations are bound to exercise a certain influence on agriculture. This influence operates through the demand for, and price of, agricultural produce on the incomes of the agricultural classes. If there was a fairly immediate and substantial reaction on the part of agricultural output to the movements in monetary demand, there would be no reason why the trade cycle should be regarded as a primarily industrial phenomenon. In fact, however, agricultural output is, on the whole, so unresponsive to money incentives that the trade cycle is often regarded as confined (so far as production is concerned) to industry, and in particular to that branch of industry which is not supplied with its raw materials by agriculture—namely, the production of durable and investment goods. It is not, however, altogether impossible that industrial fluctuations may influence agricultural output in the long run, though only after a period so long that the words “response” or “elasticity of supply” cease to have much meaning. The “responses” in such case will have the same effect as spontaneous variations in output. On the other hand, industrial fluctuations will affect both the demand for agricultural products and—to a lesser degree—their cost of production.

Effect on demand.

Many writers, including L. H. BEAN,19 J. M. CLARK,20 A. Hansen21 and J. H. KIRK,22 recognise the important influence exercised on agricultural incomes by fluctuations in industrial activity accompanied by similar fluctuations in money demand in general. There is a relationship of reciprocal causation (as will be shown in Part II of this work) between increasing supplies of effective money and increasing industrial activity; and the same holds true of the downswing. In view of the importance to consumers of products manufactured with agricultural raw materials, it is not surprising that part of the general rise and fall in money demand should be passed on to agriculture. But the process is tempered by two factors:

 

(1) The demand for consumers’ goods as a whole is more stable than the demand for all goods;

(2) The demand for consumers’ goods of agricultural origin is more stable than that for consumers’ goods as a whole.

On the other hand, the inelasticity in the supply of agricultural output tends to make the fluctuations in demand greater, at least in the first instance, than they might otherwise be.

The close correlation between agricultural prices and industrial activity, due to the causal connection between industrial activity and the demand for agricultural produce, may be taken by the unwary as a proof that low agricultural prices and incomes, due presumably to agricultural over-production, are responsible for low industrial activity.

Effect on costs.

The cost items of agriculture are largely of agricultural origin; and to some extent they will vary with the demand for agricultural produce—the variation being only another aspect of the inelasticity of the supply.

To some extent, however, industry competes with agriculture for factors of production; and this competition may be so strong as to force a reduction of agricultural output when demand is high, and vice versa.

(1)   With respect to the supply of implements and the investment funds for buying them, it seems probable that the farmers’ increased desire to acquire instruments in good times will outweigh the competitive demand of industry for both of these things. The farmer can finance increased purchase in part from his own increased earnings.

(2)   On the other hand, there is an important tendency in many countries for labour to be drained off from agriculture to industry during boom periods and to flow back during slumps.23

Concluding remarks.

The above review of the possible interactions of agriculture and industry on one another cannot be said to yield a clear picture. Industrial crises may arise for monetary or other causes, and then work out their effects on agricultural incomes and—to a lesser extent, and by obscure channels—on agricultural output.

Spontaneous agricultural fluctuations may have a positive or a negative effect on the general business cycle and on monetary demand and may react back on agriculture through this channel. Lastly, variations, however caused, in the demand for and cost of agricultural produce may, after a time, give rise to variations in agricultural output which will act on industry like spontaneous disturbances, and set up a vicious circle of expansion or contraction.

 

 

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24 The Solar Period and the Price of Corn, 1875; The Periodicity of Commercial Crises and its Physical Explanation, 1878; and Commercial Crises and Sun-spots, 1879—all reprinted in Investigations in Currency and Finance, 2nd edition, London, 1909.

25 The Causes of Unemployment, The Sun’s Heat and Trade Activity, London, 1910; and “Trade Fluctuations and Solar Activity “in Contemporary Review, August 1909.

26 Economic Cycles: their Law and Cause, New York, 1914, and Generating Economic Cycles, New York, 1923.

27 In a paper read to the British Association in 1875 on “The Solar Period and the Price of Corn” (in Investigations in Currency and Finance, page 185).

28 Industrial Fluctuations.

29 A Study of Industrial Fluctuation and Banking Policy and the Price Level.

30 Article “Krisen” in “Handwörterbuch der Staatswissenschaften.”

31 “The Business Cycle in its Relation to Agriculture” in Journal of Farm Economics, 1932.

32 Strategic Factors in the Business Cycle.

33 Industrial Fluctuations, 2nd ed., Chapter IV, page 41.

34 Ibid., Chapter III, page 20.

35 Ibid., Chapters III and XI.

36 Industrial Fluctuations, 2nd ed., page 41.

37 Ibid., Chapter II, page 20, and Chapter XX.

38 Ibid., Chapter III, page 33, Chapters XVI and XVII, etc.

39 Theory of Unemployment, Part IV and Part V, Chapter IX.

40 The General Theory of Employment, Interest and Money, pages 329 et seq.

41 Agriculture and the Trade Cycle, London, 1933.

42 E.g., “Post-War Interrelations between Agriculture and Business in the United States,” U.S. Department of Agriculture, Bureau of Agricultural Economics l.9.Ec.752.Pa.

43 Strategic Factors in the Business Cycle.

44 “The Business Cycle in its Relation to Agriculture” in Journal of Farm Economics, 14: 59-68, 1932.

45 Agriculture and the Trade Cycle, Part I.

46 See, especially, Gustav Cassel: The Theory of Social Economy, Vol. II, Book IV, Chapter XV, § 65.

• 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.
• 2With 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).
• 3In 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.
• 4It 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.
• 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.
• 6One 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.
• 7A feature of particular interest in Mr. HAWTREY’S monetary theory of the business cycle is the demonstration and analysis of the cumulative nature of the process of expansion and contraction. In this respect, there is, as we shall see, much agreement between theorists of different schools of thought. Mr. HAWTREY’S propositions on this point, largely taken over from MARSHALL and the Cambridge tradition, have found a place in the theory of a great number of writers.
• 8In 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.
• 9He still believes that “a failure of cheap money to stimulate revival” is “a rare occurrence” but he admits that “since 1930, it has come to plague the world and has confronted us with problems which have threatened the fabric of civilisation with destruction”.
• 10This 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.
• 11Op. cit., page 171.
• 12Ibid., page 58.
• 13Trade and Credit, London, 1928, page 98.
• 14Cf. 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.
• 15Mr. Durbin argued that if the rate of increase of production is constant (say 10% per year) an increasing amount of money can be put into circulation without raising prices, because the absolute increase in output per unit of time increases (the 10% is reckoned from an are ever-increasing total). Evidently, different quantitative assumptions can be made, and it is impossible to say which one corresponds best to reality. For further comments on the failure of the writers of the present school to make their assumptions quantitatively precise, see the following paragraph.
• 16“Monetary Expansion and the Structure of Production” in Social Research, Vol. I, New York, November 1934, pages 434 et seq. Similar objections had been raised by Piero Sraffa, Economic Journal, March 1932.
• 17Currency and Credit, 3rd ed., London, 1928, page 153.
• 181913, page 186.
• 19Monetary Reconstruction, 2nd ed., London, 1926, page 135.
• 20Currency and Credit, 3rd ed., page 155.
• 21See Les Crises industrielles en Angleterre, Paris, 1913 (translated from the Russian). For further references, see A. H. Hansen, Business Cycle Theory, 1927, Ch. IV.
• 22Cf., e.g., the highly interesting analysis of the cyclical movement on the basis of the Cassel-Spiethoff theory by Professor Georg Halm in his article “Das Zinsproblem am Geld- und Kapitalmarkt” in Jahrbücher für Nationalökonomie und Statistik, Vol. 125, 1926, pages 1-34 and 97-121.
• 23See his paper “Money and Index-Numbers” in Journal of the Royal Statistical Society, 1930, reprinted in The Art of Central Banking, pages 303-332.
• 24Cf. J. M. Clark, Strategic Factors in Business Cycles, New York, 1935. pages 4-5 and passim.
• 25See his book: Strategic Factors in the Business Cycle, passim.
• 26The Lessons of Monetary Experience, page 131.
• 27See especially Tinbergen: “Suggestions on Quantitative Business Cycle Theory” in Econometrica, Vol. Ill, No. 3, July 1935, page 241.
• 28What 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.
• 29For this reason, anything like perfect regularity in respect of the amplitude, length, intensity and concomitant symptoms of the cyclical movement is a priori improbable.
• 30No attempt has been made to establish priorities or to trace the various lines of thought to their historical origins.
• 31Ibid., page 131, and Monetary Reconstruction, page 133.
• 32Capital and Employment, page 86.
• 33The 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).
• 34“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.”
• 35In his Prices and Production, Professor HAYEK argues that, even where the extension of the structure of production which entrepreneurs were induced to undertake by the artificial cheapening of credit is completed, the old arrangement tends to be restored later on for the reason that consumers will “attempt to expand consumption to the usual proportion” and “the money stream will be re-distributed between consumptive and productive uses” in the same, or nearly the same, proportion as it was distributed before such proportion was artificially distorted from the normal by the injection of money.
• 36“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.”
• 37In 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.
• 38Against this objection, the following argument has been advanced. It is true, in an economy where the output, owing to improvements in the methods of production, grows at a constant rate, that a steady expansion in terms of money may be made: that is to say, per unit of time a constant amount of new money may be put into circulation. But even if this is just enough to keep the price level of finished goods constant, prices of factors of production will rise continuously. Hence, successive additions to the money stock will only be able to buy successively diminishing amounts of the factors of production. But, to render the completion of the newly initiated processes of production possible, the entrepreneurs in the upper stages must be enabled to absorb factors of production àt a constant rate; and, as the prices of factors of production rise, a credit expansion at an increasing rate will be necessary to enable them to do so. The conclusion is that a relative inflation, such as can be made within the limits of a constant price level, is not sufficient to allow of the completion of the new roundabout methods of production which have been initiated under the stimulus of the expansion. Either the rate of expansion of credit will be sufficiently increased and prices will be driven up and the inevitable breakdown will be postponed, or the boom will collapse at once owing to an insufficiency in the capital supply.
• 39But, as Professor NEISSER has shown, there is no reason to expect this return to the old arrangement, if the new roundabout methods of production have been brought to completion. When they are completed, the flow of consumers’ goods which was temporarily reduced will rise again, and will even reach a higher level than that from which the expansion started, so that consumers can safely expand their consumption. Forced saving will cease to be necessary when the new processes of production are completed. When they are completed, all that is required to maintain them is that the entrepreneurs—not the consumers—should refrain from “disinvestments”, that is, from consuming capital or from spending amortisation quotas on consumption. There is no reason why the old proportion between money spent for consumers’ and for producers’ goods should be restored. It is not true that the whole of newly injected money becomes income either at once or after a while. Part of it must be retained by the entrepreneurs in order to pay for intermediate goods (in contradistinction to payments for the original factors of production). In other words, only a part of the new money becomes income. Another part remains permanently in the business sphere. It is only if entrepreneurs “dissave”—i.e., if they eat up their capital and refrain from investing that part of their gross receipts which is not net income (working capital and amortisation quotas)—that the pre-inflation arrangement is restored.
• 40The 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.”
• 41In 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.
• 42But 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”.
• 43Under 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”.
• 44The most prominent writers in this group are Professors A. SPIETHOFF and G. CASSEL. In the writings of these two authors (of SPIETHOFF especially), we find the culmination of a very important line of thought which can be traced back to MARX. Spiethoff’s immediate forerunner was the well-known Russian author TUGAN-BARANOWSKI. Both SPIETHOFF and CASSEL have had a great influence on business cycle theory, particularly in Germany, but also in the Scandinavian and Anglo-Saxon countries. WICKSELL himself adopted SPIETHOFF’S explanation of the cycle.
• 45The most prominent writers in this group are Professors A. SPIETHOFF and G. CASSEL. In the writings of these two authors (of SPIETHOFF especially), we find the culmination of a very important line of thought which can be traced back to MARX. Spiethoff’s immediate forerunner was the well-known Russian author TUGAN-BARANOWSKI. Both SPIETHOFF and CASSEL have had a great influence on business cycle theory, particularly in Germany, but also in the Scandinavian and Anglo-Saxon countries. WICKSELL himself adopted SPIETHOFF’S explanation of the cycle.
• 46To complete the picture of Mr. HAWTREY’S theory, a word must be said as to the policy banks should pursue in order to eliminate the credit cycle, and with it the trade cycle. The banks, and especially the leaders of the banking system, the central banks, should not watch the reserve proportions so much as the flow of purchasing power. The demand for goods, the flow of money, is the important thing—not the outstanding aggregate of money units. The aim of banking policy should be to keep the consumer’s outlay constant, including (as has been pointed out) outlay for new investment. But account should be taken of changes in the factors of production—not merely the growth of population, but also the growth of capital—and allowance ought to be made for the proportion of skilled labour of varying grades and for the appropriate amount of economic rent. In other words, the aim should be to stabilise, not the price level of commodities, but the price level of the factors of production.