VII
Sofar，wehavebeenprimarilyconcernedwiththewayinwhichchangesinthequantityofmoneyaffectpricesintheshortperiod。Butinthelongrunistherenotsomesimplerrelationship？
Thisisaquestionforhistoricalgeneralisationratherthanforpuretheory。Ifthereissometendencytoameasureoflong-rununiformityinthestateofliquidity-preference，theremaywellbesomesortofroughrelationshipbetweenthenationalincomeandthequantityofmoneyrequiredtosatisfyliquidity-preference，takenasameanoverperiodsofpessimismandoptimismtogether。Theremaybe，forexample，somefairlystableproportionofthenationalincomemorethanwhichpeoplewillnotreadilykeepintheshapeofidlebalancesforlongperiodstogether，providedtherateofinterestexceedsacertainpsychologicalminimum；sothatifthequantityofmoneybeyondwhatisrequiredintheactivecirculationisinexcessofthisproportionofthenationalincome，therewillbeatendencysooneror[Page307]THE
THEORYOFPRICES
laterfortherateofinteresttofalltotheneighbourhoodofthisminimum。Thefallingrateofinterestwillthen，cet。par。，increaseeffectivedemand，andtheincreasingeffectivedemandwillreachoneormoreofthesemi-criticalpointsatwhichthewage-unitwilltendtoshowadiscontinuousrise，withacorrespondingeffectonprices。Theoppositetendencieswillsetinifthequantityofsurplusmoneyisanabnormallylowproportionofthenationalincome。Thustheneteffectoffluctuationsoveraperiodoftimewillbetoestablishameanfigureinconformitywiththestableproportionbetweenthenationalincomeandthequantityofmoneytowhichthepsychologyofthepublictendssoonerorlatertorevert。
Thesetendencieswillprobablyworkwithlessfrictionintheupwardthaninthedownwarddirection。Butifthequantityofmoneyremainsverydeficientforalongtime，theescapewillbenormallyfoundinchangingthemonetarystandardorthemonetarysystemsoastoraisethequantityofmoney，ratherthaninforcingdownthewage-unitandtherebyincreasingtheburdenofdebt。Thustheverylong-runcourseofpriceshasalmostalwaysbeenupward。Forwhenmoneyisrelativelyabundant，thewage-unitrises；andwhenmoneyisrelativelyscarce，somemeansisfoundtoincreasetheeffectivequantityofmoney。
Duringthenineteenthcentury，thegrowthofpopulationandofinvention，theopening-upofnewlands，thestateofconfidenceandthefrequencyofwarovertheaverageofsayeachdecadeseemtohavebeensufficient，takeninconjunctionwiththepropensitytoconsume，toestablishascheduleofthemarginalefficiencyofcapitalwhichallowedareasonablysatisfactoryaveragelevelofemploymenttobecompatiblewitharateofinteresthighenoughtobepsychologicallyacceptabletowealth-owners。Thereisevidencethatforaperiodofalmostonehundredandfiftyyearsthelong-runtypicalrateofinterestintheleadingfinancial[Page308]THE
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centreswasabout5percent，andthegilt-edgedratebetween3and3½；percent；andthattheseratesofinterestweremodestenoughtoencouragearateofinvestmentconsistentwithanaverageofemploymentwhichwasnotintolerablylow。Sometimesthewage-unit，butmoreoftenthemonetarystandardorthemonetarysysteminparticularthroughthedevelopmentofbank-money，wouldbeadjustedsoastoensurethatthequantityofmoneyintermsofwage-unitswassufficienttosatisfynormalliquidity-preferenceatratesofinterestwhichwereseldommuchbelowthestandardratesindicatedabove。Thetendencyofthewage-unitwas，asusual，steadilyupwardsonthewhole，buttheefficiencyoflabourwasalsoincreasing。Thusthebalanceofforceswassuchastoallowafairmeasureofstabilityofprices；¾；thehighestquinquennialaverageforSauerbeck'sindexnumberbetween1820and1914
wasonly50percentabovethelowest。Thiswasnotaccidental。Itisrightlydescribedasduetoabalanceofforcesinanagewhenindividualgroupsofemployerswerestrongenoughtopreventthewage-unitfromrisingmuchfasterthantheefficiencyofproduction，andwhenmonetarysystemswereatthesametimesufficientlyfluidandsufficientlyconservativetoprovideanaveragesupplyofmoneyintermsofwage-unitswhichallowedtoprevailthelowestaveragerateofinterestreadilyacceptablebywealth-ownersundertheinfluenceoftheirliquidity-preferences。Theaveragelevelofemploymentwas，ofcourse，substantiallybelowfullemployment，butnotsointolerablybelowitastoprovokerevolutionarychanges。
To-dayandpresumablyforthefuturethescheduleofthemarginalefficiencyofcapitalis，foravarietyofreasons，muchlowerthanitwasinthenineteenthcentury。Theacutenessandthepeculiarityofourcontemporaryproblemarises，therefore，outofthepossibilitythattheaveragerateofinterestwhichwillallowareasonableaveragelevelofemploymentisone[Page309]THE
THEORYOFPRICES
sounacceptabletowealth-ownersthatitcannotbereadilyestablishedmerelybymanipulatingthequantityofmoney。Solongasatolerablelevelofemploymentcouldbeattainedontheaverageofoneortwoorthreedecadesmerelybyassuringanadequatesupplyofmoneyintermsofwage-units，eventhenineteenthcenturycouldfindaway。Ifthiswasouronlyproblemnow¾；ifasufficientdegreeofdevaluationisallweneed¾；we，to-day，wouldcertainlyfindaway。
Butthemoststable，andtheleasteasilyshifted，elementinourcontemporaryeconomyhasbeenhitherto，andmayprovetobeinfuture，theminimumrateofinterestacceptabletothegeneralityofwealth-owners。[144]Ifatolerablelevelofemploymentrequiresarateofinterestmuchbelowtheaveragerateswhichruledinthenineteenthcentury，itismostdoubtfulwhetheritcanbeachievedmerelybymanipulatingthequantityofmoney。
Fromthepercentagegain，whichthescheduleofmarginalefficiencyofcapitalallowstheborrowertoexpecttoearn，therehastobededucted1thecostofbringingborrowersandlenderstogether，2incomeandsur-taxesand3theallowancewhichthelenderrequirestocoverhisriskanduncertainty，beforewearriveatthenetyieldavailabletotemptthewealth-ownertosacrificehisliquidity。If，inconditionsoftolerableaverageemployment，thisnetyieldturnsouttobeinfinitesimal，time-honouredmethodsmayproveunavailing。
Toreturntoourimniediatesubject，thelong-runrelationshipbetweenthenationalincomeandthequantityofmoneywilldependonliquidity-preferences。
Andthelong-runstabilityorinstabilityofpriceswilldependonthestrengthoftheupwardtrendofthewage-unitor，moreprecisely，ofthecost-unitcomparedwiththerateofincreaseintheefficiencyoftheproductivesystem。
NotesontheTradeCycle[Page313]
Chapter22
NOTESONTHETRADECYCLE
Sinceweclaimtohaveshownintheprecedingchapterswhatdeterminesthevolumeofemploymentatanytime，itfollows，ifweareright，thatourtheorymustbecapableofexplainingthephenomenaofthetradecycle。
Ifweexaminethedetailsofanyactualinstanceofthetradecycle，weshallfindthatitishighlycomplexandthateveryelementinouranalysiswillberequiredforitscompleteexplanation。Inparticularweshallfindthatfluctuationsinthepropensitytoconsume，inthestateofliquidity-preference，andinthemarginalefficiencyofcapitalhaveallplayedapart。ButI
suggestthattheessentialcharacterofthetradecycleand，especially，theregularityoftime-sequenceandofdurationwhichjustifiesusincallingitacycle，ismainlyduetothewayinwhichthemarginalefficiencyofcapitalfluctuates。Thetradecycleisbestregarded，Ithink，asbeingoccasionedbyacyclicalchangeinthemarginalefficiencyofcapital，thoughcomplicatedandoftenaggravatedbyassociatedchangesintheothersignificantshort-periodvariablesoftheeconomicsystem。Todevelopthisthesiswouldoccupyabookratherthanachapter，andwouldrequireacloseexaminationoffacts。Butthefollowingshortnoteswillbesufficienttoindicatethelineofinvestigationwhichourprecedingtheorysuggests。
I
Byacyclicalmovementwemeanthatasthesystemprogressesin，e。g。theupwarddirection，theforces[Page314]THE
GENERALTHEORYOFEMPLOYMENT
propellingitupwardsatfirstgatherforceandhaveacumulativeeffectononeanotherbutgraduallylosetheirstrengthuntilatacertainpointtheytendtobereplacedbyforcesoperatingintheoppositedirection；
whichinturngatherforceforatimeandaccentuateoneanother，untiltheytoo，havingreachedtheirmaximumdevelopment，waneandgiveplacetotheiropposite。Wedonot，however，merelymeanbyacyclicalmovementthatupwardanddownwardtendencies，oncestarted，donotpersistforeverinthesamedirectionbutareultimatelyreversed。Wemeanalsothatthereissomerecognisabledegreeofregularityinthetime-sequenceanddurationoftheupwardanddownwardmovements。
Thereis，however，anothercharacteristicofwhatwecallthetradecyclewhichourexplanationmustcoverifitistobeadequate；namely，thephenomenonofthecrisis¾；thefactthatthesubstitutionofadownwardforanupwardtendencyoftentakesplacesuddenlyandviolently，whereasthereis，asarule，nosuchsharpturning-pointwhenanupwardissubstitutedforadownwardtendency。
Anyfluctuationininvestmentnotoffsetbyacorrespondingchangeinthepropensitytoconsumewill，ofcourse，resultinafluctuationinemployment。Since，therefore，thevolumeofinvestmentissubjecttohighlycomplexinfluences，itishighlyimprobablethatallfluctuationseitherininvestmentitselforinthemarginalefficiencyofcapitalwillbeofacyclicalcharacter。Onespecialcase，inparticular，namely，thatwhichisassociatedwithagriculturalfluctuations，willbeseparatelyconsideredinalatersectionofthischapter。Isuggest，however，thattherearecertaindefinitereasonswhy，inthecaseofatypicalindustrialtradecycleinthenineteenth-centuryenvironment，fluctuationsinthemarginalefficiencyofcapitalshouldhavehadcyclicalcharacteristics。Thesereasonsarebynomeansunfamiliareitherinthemselvesorasexplanationsofthetrade[Page315]NOTES
ONTHETRADECYCLE
cycle。Myonlypurposehereistolinkthemupwiththeprecedingtheory。
II
IcanbestintroducewhatIhavetosaybybeginningwiththelaterstagesoftheboomandtheonsetofthe'crisis'。
Wehaveseenabovethatthemarginalefficiencyofcapital[145]depends，notonlyontheexistingabundanceorscarcityofcapital-goodsandthecurrentcostofproductionofcapital-goods，butalsooncurrentexpectationsastothefutureyieldofcapital-goods。Inthecaseofdurableassetsitis，therefore，naturalandreasonablethatexpectationsofthefutureshouldplayadominantpartindeterminingthescaleonwhichnewinvestmentisdeemedadvisable。But，aswehaveseen，thebasisforsuchexpectationsisveryprecarious。Beingbasedonshiftingandunreliableevidence，theyaresubjecttosuddenandviolentchanges。
Now，wehavebeenaccustomedinexplainingthe'crisis'tolaystressontherisingtendencyoftherateofinterestundertheinfluenceoftheincreaseddemandformoneybothfortradeandspeculativepurposes。Attimesthisfactormaycertainlyplayanaggravatingand，occasionallyperhaps，aninitiatingpart。ButIsuggestthatamoretypical，andoftenthepredominant，explanationofthecrisisis，notprimarilyariseintherateofinterest，butasuddencollapseinthemarginalefficiencyofcapital。
Thelaterstagesoftheboomarecharacterisedbyoptimisticexpectationsastothefutureyieldofcapital-goodssufficientlystrongtooffsettheirgrowingabundanceandtheirrisingcostsofproductionand，probably，ariseintherateofinterestalso。Itisofthenatureof[Page316]THE
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organisedinvestmentmarkets，undertheinfluenceofpurchaserslargelyignorantofwhattheyarebuyingandofspeculatorswhoaremoreconcernedwithforecastingthenextshiftofmarketsentimentthanwithareasonableestimateofthefutureyieldofcapital-assets，that，whendisillusionfallsuponanover-optimisticandover-boughtmarket，itshouldfallwithsuddenandevencatastrophicforce。[146]Nloreover，thedismayanduncertaintyastothefuturewhichaccompaniesacollapseinthemarginalefficiencyofcapitalnaturallyprecipitatesasharpincreaseinliquidity-preference¾；andhenceariseintherateofinterest。Thusthefactthatacollapseinthemarginalefficiencyofcapitaltendstobeassociatedwithariseintherateofinterestmayseriouslyaggravatethedeclineininvestment。
Buttheessenceofthesituationistobefound，nevertheless，inthecollapseinthemarginalefficiencyofcapital，particularlyinthecaseofthosetypesofcapitalwhichhavebeencontributingmosttothepreviousphaseofheavynewinvestment。Liquidity-preference，exceptthosemanifestationsofitwhichareassociatedwithincreasingtradeandspeculation，doesnotincreaseuntilafterthecollapseinthemarginalefficiencyofcapital。
Itisthis，indeed，whichrenderstheslumpsointractable。Lateron，adeclineintherateofinterestwillbeagreataidtorecoveryand，probably，anecessaryconditionofit。But，forthemoment，thecollapseinthemarginalefficiencyofcapitalmaybesocompletethatnopracticablereductionintherateofinterestwillbeenough。Ifareductionintherateofinterestwascapableofprovinganeffectiveremedybyitself；
itmightbepossibletoachievearecoverywithouttheelapseofanyconsiderableintervaloftimeandbymeansmoreorlessdirectlyunderthecontrolofthemonetary[Page317]NOTES
ONTHETRADECYCLE
authority。But，infact，thisisnotusuallythecase；anditisnotsoeasytorevivethemarginalefficiencyofcapital，determined，asitis，bytheuncontrollableanddisobedientpsychologyofthebusinessworld。
Itisthereturnofconfidence，tospeakinordinarylanguage，whichissoinsusceptibletocontrolinaneconomyofindividualisticcapitalism。
Thisistheaspectoftheslumpwhichbankersandbusinessmenhavebeenrightinemphasising，andwhichtheeconomistswhohaveputtheirfaithina'purelymonetary'remedyhaveunderestimated。
Thisbringsmetomypoint。Theexplanationofthetime-elementinthetradecycle，ofthefactthatanintervaloftimeofaparticularorderofmagnitudemustusuallyelapsebeforerecoverybegins，istobesoughtintheinfluenceswhichgoverntherecoveryofthemarginalefficiencyofcapital。Therearereasons，givenfirstlybythelengthoflifeofdurableassetsinrelationtothenormalrateofgrowthinagivenepoch，andsecondlybythecarrying-costsofsurplusstocks，whythedurationofthedownwardmovementshouldhaveanorderofmagnitudewhichisnotfortuitous，whichdoesnotfluctuatebetween，say，oneyearthistimeandtenyearsnexttime，butwhichshowssomeregularityofhabitbetween，letussay，threeandfiveyears。
Letusrecurtowhathappensatthecrisis。Solongastheboomwascontinuing，muchofthenewinvestmentshowedanotunsatisfactorycurrentyield。Thedisillusioncomesbecausedoubtssuddenlyariseconcerningthereliabilityoftheprospectiveyield，perhapsbecausethecurrentyieldshowssignsoffallingoff，asthestockofnewlyproduceddurablegoodssteadilyincreases。Ifcurrentcostsofproductionarethoughttobehigherthantheywillbelateron，thatwillbeafurtherreasonforafallinthemarginalefficiencyofcapital。Oncedoubtbeginsitspreadsrapidly。
Thusattheoutsetoftheslumpthereisprobablymuchcapitalofwhichthemarginalefficiencyhasbecomenegligibleoreven[Page318]THE
GENERALTHEORYOFEMPLOYMENT
negative。Buttheintervaloftime，whichwillhavetoelapsebeforetheshortageofcapitalthroughuse，decayandobsolescencecausesasufficientlyobviousscarcitytoincreasethemarginalefficiency，maybeasomewhatstablefunctionoftheaveragedurabilityofcapitalinagivenepoch。
Ifthecharacteristicsoftheepochshift，thestandardtime-intervalwillchange。If，forexample，wepassfromaperiodofincreasingpopulationintooneofdecliningpopulation，thecharacteristicphaseofthecyclewillbelengthened。Butwehaveintheaboveasubstantialreasonwhythedurationoftheslumpshouldhaveadefiniterelationshiptothelengthoflifeofdurableassetsandtothenormalrateofgrowthinagivenepoch。
Thesecondstabletime-factorisduetothecarrying-costsofsurplusstockswhichforcetheirabsorptionwithinacertainperiod，neitherveryshortnorverylong。Thesuddencessationofnewinvestmentafterthecrisiswillprobablyleadtoanaccumulationofsurplusstocksofunfinishedgoods。
Thecarrying-costsofthesestockswillseldombelessthan10percent。
perannum。Thusthefallintheirpriceneedstobesufficienttobringaboutarestrictionwhichprovidesfortheirabsorptionwithinaperiodof；say，threetofiveyearsattheoutside。Nowtheprocessofabsorbingthestocksrepresentsnegativeinvestment，whichisafurtherdeterrenttoemployment；and，whenitisover，amanifestreliefwillbeexperienced。
Moreover，thereductioninworkingcapital，whichisnecessarilyattendantonthedeclineinoutputonthedownwardphase，representsafurtherelementofdisinvestment，whichmaybelarge；and，oncetherecessionhasbegun，thisexertsastrongcumulativeinfluenceinthedownwarddirection。Intheearliestphaseofatypicalslumptherewillprobablybeaninvestmentinincreasingstockswhichhelpstooffsetdisinvestmentinworking-capital；
inthenextphasetheremaybeashortperiodofdisinvestmentbothinstocksandinworking-
[Page319]NOTES
ONTHETRADECYCLE
capital；afterthelowestpointhasbeenpassedthereislikelytobeafurtherdisinvestmentinstockswhichpartiallyoffsetsreinvestmentinworking-capital；and，finally，aftertherecoveryiswellonitsway，bothfactorswillbesimultaneouslyfavourabletoinvestment。Itisagainstthisbackgroundthattheadditionalandsuperimposedeffectsoffluctuationsofinvestmentindurablegoodsmustbeexamined。Whenadeclineinthistypeofinvestmenthassetacyclicalfluctuationinmotiontherewillbelittleencouragementtoarecoveryinsuchinvestmentuntilthecyclehaspartlyrunitscourse。[147]
Unfortunatelyaseriousfallinthemarginalefficiencyofcapitalalsotendstoaffectadverselythepropensitytoconsume。Foritinvolvesaseveredeclineinthemarketvalueofstockexchangeequities。Now，ontheclasswhotakeanactiveinterestintheirstockexchangeinvestments，especiallyiftheyareemployingborrowedfunds，thisnaturallyexertsaverydepressinginfluence。Thesepeopleare，perhaps，evenmoreinfluencedintheirreadinesstospendbyrisesandfallsinthevalueoftheirinvestmentsthanbythestateoftheirincomes。Witha'stock-minded'publicasintheUnitedStatesto-day，arisingstock-marketmaybeanalmostessentialconditionofasatisfactorypropensitytoconsume；andthiscircumstance，generallyoverlookeduntillately，obviouslyservestoaggravatestillfurtherthedepressingeffectofadeclineinthemarginalefficiencyofcapital。
Whenoncetherecoveryhasbeenstarted，themannerinwhichitfeedsonitselfandcumulatesisobvious。Butduringthedownwardphase，whenbothfixedcapitalandstocksofmaterialsareforthetimebeingredundantandworking-capitalisbeingreduced，thescheduleofthemarginalefficiencyofcapitalmayfallsolowthatitcanscarcelybecorrected，soasto[Page320]THE
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secureasatisfactoryrateofnewinvestment，byanypracticablereductionintherateofinterest。Thuswithmarketsorganisedandinfluencedastheyareatpresent，themarketestimationofthemarginalefficiencyofcapitalmaysuffersuchenormouslywidefluctuationsthatitcannotbesufficientlyoffsetbycorrespondingfluctuationsintherateofinterest。
Moreover，thecorrespondingmovementsinthestock-marketmay，aswehaveseenabove，depressthepropensitytoconsumejustwlaenitismostneeded。
Inconditionsoflaissez-fairetheavoidanceofwidefluctuationsinemploymentmay，therefore，proveimpossiblewithoutafar-reachingchangeinthepsychologyofinvestmentmarketssuchasthereisnoreasontoexpect。
Iconcludethatthedutyoforderingthecurrentvolumeofinvestmentcannotsafelybeleftinprivatehands。
III
Theprecedinganalysismayappeartobeinconformitywiththeviewofthosewhoholdthatover-investmentisthecharacteristicoftheboom，thattheavoidanceofthisover-investmentistheonlypossibleremedyfortheensuingslump，andthat，whilstforthereasonsgivenabovetheslumpcannotbepreventedbyalowrateofinterest，neverthelesstheboomcanbeavoidedbyahighrateofinterest。Thereis，indeed，forceintheargumentthatahighrateofinterestismuchmoreeffectiveagainstaboomthanalowrateofinterestagainstaslump。
Toinfertheseconclusionsfromtheabovewould，however，misinterpretmyanalysis；andwould，accordingtomywayofthinking，involveseriouserror。Forthetermover-investmentisambiguous。Itmayrefertoinvestmentswhicharedestinedtodisappointtheexpectationswhichpromptedthemorforwhichthereisnouseinconditionsofsevereunemployment，oritmayindicateastateofaffairswhereeverykindofcapital-
[Page321]NOTES
ONTHETRADECYCLE
goodsissoabundantthatthereisnonewinvestmentwhichisexpected，eveninconditionsoffullemployment，toearninthecourseofitslifemorethanitsreplacementcost。Itisonlythelatterstateofaffairswhichisoneofover-investment，strictlyspeaking，inthesensethatanyfurtherinvestmentwouldbeasheerwasteofresources。[148]Moreover，evenifover-investmentinthissensewasanormalcharacteristicoftheboom，theremedywouldnotlieinclappingonahighrateofinterestwhichwouldprobablydetersomeusefulinvestmentsandmightfurtherdiminishthepropensitytoconsume，butintakingdrasticsteps，byredistributingincomesorotherwise，tostimulatethepropensitytoconsume。
Accordingtomyanalysis，however，itisonlyintheformersensethattheboomcanbesaidtobecharacterisedbyover-investment。Thesituation，whichIamindicatingastypical，isnotoneinwhichcapitalissoabundantthatthecommunityasawholehasnoreasonableuseforanymore，butwhereinvestmentisbeingmadeinconditionswhichareunstableandcannotendure，becauseitispromptedbyexpectationswhicharedestinedtodisappointment。
Itmay，ofcourse，bethecase¾；indeeditislikelytobe¾；thattheillusionsoftheboomcauseparticulartypesofcapital-assetstobeproducedinsuchexcessiveabundancethatsomepartoftheoutputis，onanycriterion，awasteofresources；¾；whichsometimeshappens，wemayadd，evenwhenthereisnoboom。Itleads，thatistosay，tomisdirectedinvestment。Butoverandabovethisitisanessentialcharacteristicoftheboomthatinvestmentswhichwillinfactyield，say，2percentinconditionsoffullemploymentaremadeintheexpectationofayieldof；say，6percent，andarevaluedaccordingly。Whenthedisillusioncomes，thisexpectationis[Page322]THE
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replacedbyacontrary'errorofpessimism'，withtheresultthattheinvestments，whichwouldinfactyield2percentinconditionsoffullemployment，areexpectedtoyieldlessthannothing；andtheresultingcollapseofnewinvestmentthenleadstoastateofunemploymentinwhichtheinvestments，whichwouldhaveyielded2percentinconditionsoffullemployment，infactyieldlessthannothing。Wereachaconditionwherethereisashortageofhouses，butwhereneverthelessnoonecanaffordtoliveinthehousesthatthereare。
Thustheremedyfortheboomisnotahigherrateofinterestbutalowerrateofinterest！[149]Forthatmayenabletheso-calledboomtolast。Therightremedyforthetradecycleisnottobefoundinabolishingboomsandthuskeepinguspermanentlyinasemi-slump；butinabolishingslumpsandthuskeepinguspermanentlyinaquasi-boom。
Theboomwhichisdestinedtoendinaslumpiscaused，therefore，bythecombinationofarateofinterest，whichinacorrectstateofexpectationwouldbetoohighforfullemployment，withamisguidedstateofexpectationwhich，solongasitlasts，preventsthisrateofinterestfrombeinginfactdeterrent。Aboomisasituationinwhichover-optimismtriumphsoverarateofinterestwhich，inacoolerlight，wouldbeseentobeexcessive。
Exceptduringthewar，Idoubtifwehaveanyrecentexperienceofaboomsostrongthatitledtofullemployment。IntheUnitedStatesemploymentwasverysatisfactoryin1928-29onnormalstandards；
butIhaveseennoevidenceofashortageoflabour，except，perhaps，inthecaseofafewgroupsofhighlyspecialisedworkers。Some'bottle-necks'
werereached，butoutputasawholewasstillcapableoffurtherexpansion。
Norwasthereover-investmentinthesensethatthe[Page323]NOTES
ONTHETRADECYCLE
standardandequipmentofhousingwassohighthateveryone，assumingfullemployment，hadallhewantedataratewhichwouldnomorethancoverthereplacementcost，withoutanyallowanceforinterest，overthelifeofthehouse；andthattransport，publicservicesandagriculturalimprovementhadbeencarriedtoapointwherefurtheradditionscouldnotreasonablybeexpectedtoyieldeventheirreplacementcost。Quitethecontrary。ItwouldbeabsurdtoassertoftheUnitedStatesin1929theexistenceofover-investmentinthestrictsense。Thetruestateofaffairswasofadifferentcharacter。Newinvestmentduringthepreviousfiveyearshadbeen，indeed，onsoenormousascaleintheaggregatethattheprospectiveyieldoffurtheradditionswas，coollyconsidered，fallingrapidly。Correctforesightwouldhavebroughtdownthemarginalefficiencyofcapitaltoanunprecedentedlylowfigure；sothatthe'boom'couldnothavecontinuedonasoundbasisexceptwithaverylowlong-termrateofinterest，andanavoidanceofmisdirectedinvestmentintheparticulardirectionswhichwereindangerofbeingover-exploited。Infact，therateofinterestwashighenoughtodeternewinvestmentexceptinthoseparticulardirectionswhichwereundertheinfluenceofspeculativeexcitementand，therefore，inspecialdangerofbeingover-exploited；andarateofinterest，highenoughtoovercomethespeculativeexcitement，wouldhavechecked，atthesametime，everykindofreasonablenewinvestment。Thusanincreaseintherateofinterest，asaremedyforthestateofaffairsarisingoutofaprolongedperiodofabnormallyheavynewinvestment，belongstothespeciesofremedywhichcuresthediseasebykillingthepatient。
Itis，indeed，verypossiblethattheprolongationofapproximatelyfullemploymentoveraperiodofyearswouldbeassociatedincountriessowealthyasGreatBritainortheUnitedStateswithavolumeofnewinvestment，assumingtheexistingpropensitytocon-
[Page324]THE
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sume，sogreatthatitwouldeventuallyleadtoastateoffullinvestmentinthesensethatanaggregategrossyieldinexcessofreplacementcostcouldnolongerbeexpectedonareasonablecalculationfromafurtherincrementofdurablegoodsofanytypewhatever。Moreover，thissituationmightbereachedcomparativelysoon¾；saywithintwenty-fiveyearsorless。Imustnotbetakentodenythis，becauseIassertthatastateoffullinvestmentinthestrictsensehasneveryetoccurred，notevenmomentarily。
Furthermore，evenifweweretosupposethatcontemporaryboomsareapttobeassociatedwithamomentaryconditionoffullinvestmentorover-investmentinthestrictsense，itwouldstillbeabsurdtoregardahigherrateofinterestastheappropriateremedy。Forinthiseventthecaseofthosewhoattributethediseasetounder-consumptionwouldbewhollyestablished。
Theremedywouldlieinvariousmeasuresdesignedtoincreasethepropensitytoconsumebytheredistributionofincomesorotherwise；sothatagivenlevelofemploymentwouldrequireasmallervolumeofcurrentinvestmenttosupportit。
IV
Itmaybeconvenientatthispointtosayawordabouttheimportantschoolsofthoughtwhichmaintain，fromvariouspointsofview，thatthechronictendencyofcontemporarysocietiestounder-employmentistobetracedtounder-consumption；¾；thatistosay，tosocialpracticesandtoadistributionofwealthwhichresultinapropensitytoconsumewhichisundulylow。
Inexistingconditions¾；or，atleast，intheconditionwhichexisteduntillately¾；wherethevolumeofinvestmentisunplannedanduncontrolled，subjecttothevagariesofthemarginalefficiencyofcapitalasdeterminedbytheprivatejudgmentofindividualsignorant[Page325]NOTES
ONTHETRADECYCLE
orspeculative，andtoalong-termrateofinterestwhichseldomorneverfallsbelowaconventionallevel，theseschoolsofthoughtare，asguidestopracticalpolicy，undoubtedlyintheright。Forinsuchconditionsthereisnoothermeansofraisingtheaveragelevelofemploymenttoamoresatisfactorylevel。Ifitisimpracticablemateriallytoincreaseinvestment，obviouslythereisnomeansofsecuringahigherlevelofemploymentexceptbyincreasingconsumption。
PracticallyIonlydifferfromtheseschoolsofthoughtinthinkingthattheymaylayalittletoomuchemphasisonincreasedconsumptionatatimewhenthereisstillmuchsocialadvantagetobeobtainedfromincreasedinvestment。Theoretically，however，theyareopentothecriticismofneglectingthefactthattherearetwowaystoexpandoutput。Evenifweweretodecidethatitwouldbebettertoincreasecapitalmoreslowlyandtoconcentrateeffortonincreasingconsumption，wemustdecidethiswithopeneyesafterwellconsideringthealternative。Iammyselfimpressedbythegreatsocialadvantagesofincreasingthestockofcapitaluntilitceasestobescarce。
Butthisisapracticaljudgment，notatheoreticalimperative。
Moreover，Ishouldreadilyconcedethatthewisestcourseistoadvanceonbothfrontsatonce。Whilstaimingatasociallycontrolledrateofinvestmentwithaviewtoaprogressivedeclineinthemarginalefficiencyofcapital，Ishouldsupportatthesametimeallsortsofpoliciesforincreasingthepropensitytoconsume。Foritisunlikelythatfullemploymentcanbemaintained，whateverwemaydoaboutinvestment，withtheexistingpropensitytoconsume。Thereisroom，therefore，forbothpoliciestooperatetogether；¾；topromoteinvestmentand，atthesametime，topromoteconsumption，notmerelytothelevelwhichwiththeexistingpropensitytoconsumewouldcorrespondtotheincreasedinvestment，buttoahigherlevelstill。If¾；totakeroundfiguresforthepurposeofillus-
[Page326]THE
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tration¾；theaveragelevelofoutputofto-dayis15percentbelowwhatitwouldbewithcontinuousfullemployment，andif10percentofthisoutputrepresentsnetinvestmentand90percentofitconsumption¾；if，furthermore，netinvestmentwouldhavetorise50percentinordertosecurefullemploymentwiththeexistingpropensitytoconsume，sothatwithfullemploymentoutputwouldrisefrom100to115，consumptionfrom90to100andnetinvestmentfrom10to15:¾；thenwemightaim，perhaps，atsomodifyingthepropensitytoconsumethatwithfullemploymentconsumptionwouldrisefrom90to103andnetinvestmentfrom10to12。
V
Anotherschoolofthoughtfindsthesolutionofthetradecycle，notinincreasingeitherconsumptionorinvestment，butindiminishingthesupplyoflabourseekingemployment；i。e。byredistributingtheexistingvolumeofemploymentwithoutincreasingemploymentoroutput。
Thisseemstometobeaprematurepolicy¾；muchmoreclearlysothantheplanofincreasingconsumption。Apointcomeswhereeveryindividualweighstheadvantagesofincreasedleisureagainstincreasedincome。Butatpresenttheevidenceis，Ithink，strongthatthegreatmajorityofindividualswouldpreferincreasedincometoincreasedleisure；andIseenosufficientreasonforcompellingthosewhowouldprefermoreincometoenjoymoreleisure。
VI
Itmayappearextraordinarythataschoolofthoughtshouldexistwhichfindsthesolutionforthetradecycleincheckingtheboominitsearlystagesbyahigherrateofinterest。Theonlylineofargument，alongwhichanyjustificationforthispolicycanbe[Page327]NOTES
ONTHETRADECYCLE
discovered，isthatputforwardbyMrD。H。Robertson，whoassumes，ineffect，thatfullemploymentisanimpracticableidealandthatthebestthatwecanhopeforisalevelofemploymentmuchmorestablethanatpresentandaveraging，perhaps，alittlehigher。
Ifweruleoutmajorchangesofpolicyaffectingeitherthecontrolofinvestmentorthepropensitytoconsume，andassume，broadlyspeaking，acontinuanceoftheexistingstateofaffairs，itis，Ithink，arguablethatamoreadvantageousaveragestateofexpectationmightresultfromabankingpolicywhichalwaysnippedinthebudanincipientboombyarateofinteresthighenoughtodetereventhemostmisguidedoptimists。
Thedisappointmentofexpectation，characteristicoftheslump，mayleadtosomuchlossandwastethattheaveragelevelofusefulinvestmentmightbehigherifadeterrentisapplied。Itisdifficulttobesurewhetherornotthisiscorrectonitsownassumptions；itisamatterforpracticaljudgmentwheredetailedevidenceiswanting。Itmaybethatitoverlooksthesocialadvantagewhichaccruesfromtheincreasedconsumptionwhichattendsevenoninvestmentwhichprovestohavebeentotallymisdirected，sothatevensuchinvestmentmaybemorebeneficialthannoinvestmentatall。Nevertheless，themostenlightenedmonetarycontrolmightfinditselfindifficulties，facedwithaboomofthe1929typeinAmerica，andarmedwithnootherweaponsthanthosepossessedatthattimebytheFederalReserveSystem；andnoneofthealternativeswithinitspowermightmakemuchdifferencetotheresult。Howeverthismaybe，suchanoutlookseemstometobedangerouslyandunnecessarilydefeatist。Itrecommends，oratleastassumes，forpermanentacceptancetoomuchthatisdefectiveinourexistingeconomicscheme。
Theaustereview，whichwouldemployahighrateofinteresttocheckatonceanytendencyinthelevelofemploymenttoriseappreciablyabovetheaverage[Page328]THE
GENERALTHEORYOFEMPLOYMENT
of；say，thepreviousdecade，is，however，moreusuallysupportedbyargumentswhichhavenofoundationatallapartfromconfusionofmind。
Itflows，insomecases，fromthebeliefthatinaboominvestmenttendstooutrunsaving，andthatahigherrateofinterestwillrestoreequilibriumbycheckinginvestmentontheonehandandstimulatingsavingsontheother。
Thisimpliesthatsavingandinvestmentcanbeunequal，andhas，therefore，nomeaninguntilthesetermshavebeendefinedinsomespecialsense。Oritissometimessuggestedthattheincreasedsavingwhichaccompaniesincreasedinvestmentisundesirableandunjustbecauseitis，asarule，alsoassociatedwithrisingprices。Butifthiswereso，anyupwardchangeintheexistinglevelofoutputandemploymentistobedeprecated。Fortheriseinpricesisnotessentiallyduetotheincreaseininvestment；¾；itisduetothefactthatintheshortperiodsupplypriceusuallyincreaseswithincreasingoutput，onaccounteitherofthephysicalfactofdiminishingreturnorofthetendencyofthecost-unittoriseintermsofmoneywhenoutputincreases。Iftheconditionswerethoseofconstantsupply-price，therewould，ofcourse，benoriseofprices；yet，allthesame，increasedsavingwouldaccompanyincreasedinvestment。Itistheincreasedoutputwhichproducestheincreasedsaving；andtheriseofpricesismerelyaby-productoftheincreasedoutput，whichwilloccurequallyifthereisnoincreasedsavingbut，instead，anincreasedpropensitytoconsume。Noonehasalegitimatevestedinterestinbeingabletobuyatpriceswhichareonlylowbecauseoutputislow。
Or，again，theevilissupposedtocreepiniftheincreasedinvestmenthasbeenpromotedbyafallintherateofinterestengineeredbyanincreaseinthequantityofmoney。Yetthereisnospecialvirtueinthepre-existingrateofinterest，andthenewmoneyisnot'forced'onanyone；¾；itiscreatedinordertosatisfytheincreasedliquidity-preferencewhichcorre-
[Page329]NOTES
ONTHETRADECYCLE
spondstothelowerrateofinterestortheincreasedvolumeoftransactions，anditisheldbythoseindividualswhoprefertoholdmoneyratherthantolenditatthelowerrateofinterest。Or，oncemore，itissuggestedthataboomischaracterisedby'capitalconsumption'，whichpresumablymeansnegativenetinvestment，i。e。byanexcessivepropensitytoconsume。
Unlessthephenomenaofthetradecyclehavebeenconfusedwiththoseofaflightfromthecurrencysuchasoccurredduringthepost-warEuropeancurrencycollapses，theevidenceiswhollytothecontrary。Moreover，evenifitwereso，areductionintherateofinterestwouldbeamoreplausibleremedythanariseintherateofinterestforconditionsofunder-investment。
Icanmakenosenseatalloftheseschoolsofthought；except，perhaps，bysupplyingatacitassumptionthataggregateoutputisincapableofchange。
Butatheorywhichassumesconstantoutputisobviouslynotveryserviceableforexplainingthetradecycle。
VII
Intheearlierstudiesofthetradecycle，notablybyJevons，anexplanationwasfoundinagriculturalfluctuationsduetotheseasons，ratherthaninthephenomenaofindustry。Inthelightoftheabovetheorythisappearsasanextremelyplausibleapproachtotheproblem。Forevento-dayfluctuationinthestocksofagriculturalproductsasbetweenoneyearandanotherisoneofthelargestindividualitemsamongstthecausesofchangesintherateofcurrentinvestment；whilstatthetimewhenJevonswrote¾；andmoreparticularlyovertheperiodtowhichmostofhisstatisticsapplied¾；thisfactormusthavefaroutweighedallothers。Jevons'stheory，thatthetradecyclewasprimarilyduetothefluctuationsinthebountyoftheharvest，canbere-statedasfollows。Whenanexceptionallylargeharvestisgatheredin，animportantadditionisusually[Page330]THE
GENERALTHEORYOFEMPLOYMENT
madetothequantitycarriedoverintolateryears。Theproceedsofthisadditionareaddedtothecurrentincomesofthefarmersandaretreatedbythemasincome；whereastheincreasedcarry-overinvolvesnodrainontheincome-expenditureofothersectionsofthecommunitybutisfinancedoutofsavings。Thatistosay，theadditiontothecarry-overisanadditiontocurrentinvestment。Thisconclusionisnotinvalidatedevenifpricesfallsharply。Similarlywhenthereisapoorharvest，thecarry-overisdrawnuponforcurrentconsumption，sothatacorrespondingpartoftheincome-expenditureoftheconsumerscreatesnocurrentincomeforthefarmers。
Thatistosay，whatistakenfromthecarry-overinvolvesacorrespondingreductionincurrentinvestment。Thus，ifinvestmentinotherdirectionsistakentobeconstant，thedifferenceinaggregateinvestmentbetweenayearinwhichthereisasubstantialadditiontothecarry-overandayearinwhichthereisasubstantialsubtractionfromitmaybelarge；
andinacommunitywhereagricultureisthepredominantindustryitwillbeoverwhelminglylargecomparedwithanyotherusualcauseofinvestmentfluctuations。Thusitisnaturalthatweshouldfindtheupwardturning-pointtobemarkedbybountifulharvestsandthedownwardturning-pointbydeficientharvests。Thefurthertheory，thattherearephysicalcausesforaregularcycleofgoodandbadharvests，is，ofcourse，adifferentmatterwithwhichwearenotconcernedhere。
Morerecently，thetheoryhasbeenadvancedthatitisbadharvests，notgoodharvests，whicharegoodfortrade，eitherbecausebadharvestsmakethepopulationreadytoworkforasmallerrealrewardorbecausetheresultingredistributionofpurchasing-powerisheldtobefavourabletoconsumption。Needlesstosay，itisnotthesetheorieswhichIhaveinmindintheabovedescriptionofharvestphenomenaasanexplanationofthetradecycle。
[Page331]NOTES
ONTHETRADECYCLE
Theagriculturalcausesoffluctuationare，however，muchlessimportantinthemodernworldfortworeasons。Inthefirstplaceagriculturaloutputisamuchsmallerproportionoftotaloutput。Andinthesecondplacethedevelopmentofaworldmarketformostagriculturalproducts，drawinguponbothhemispheres，leadstoanaveragingoutoftheeffectsofgoodandbadseasons，thepercentagefluctuationintheamountoftheworldharvestbeingfarlessthanthepercentagefluctuationsintheharvestsofindividualcountries。Butinolddays，whenacountrywasmainlydependentonitsownharvest，itisdifficulttoseeanypossiblecauseoffluctuationsininvestment，exceptwar，whichwasinanywaycomparableinmagnitudewithchangesinthecarry-overofagriculturalproducts。
Evento-dayitisimportanttopaycloseattentiontothepartplayedbychangesinthestocksofrawmaterials，bothagriculturalandmineral，inthedeterminationoftherateofcurrentinvestment。Ishouldattributetheslowrateofrecoveryfromaslump，aftertheturning-pointhasbeenreached，mainlytothedeflationaryeffectofthereductionofredundantstockstoanormallevel。Atfirsttheaccumulationofstocks，whichoccursaftertheboomhasbroken，moderatestherateofthecollapse；butwehavetopayforthisrelieflateroninthedamping-downofthesubsequentrateofrecovery。Sometimes，indeed，thereductionofstocksmayhavetobevirtuallycompletedbeforeanymeasurabledegreeofrecoverycanbedetected。
Forarateofinvestmentinotherdirections，whichissufficienttoproduceanupwardmovementwhenthereisnocurrentdisinvestmentinstockstosetoffagainstit，maybequiteinadequatesolongassuchdisinvestmentisstillproceeding。
Wehaveseen，Ithink，asignalexampleofthisintheearlierphasesofAmerica's'NewDeal'。WhenPresidentRoosevelt'ssubstantialloanexpenditurebegan，stocksofallkinds¾；andparticularlyofagri-
[Page332]THE
GENERALTHEORYOFEMPLOYMENT
culturalproducts¾；stillstoodataveryhighlevel。The'NewDeal'partlyconsistedinastrenuousattempttoreducethesestocks¾；bycurtailmentofcurrentoutputandinallsortsofways。Thereductionofstockstoanormallevelwasanecessaryprocess¾；aphasewhichhadtobeendured。Butsolongasitlasted，namely，abouttwoyears，itconstitutedasubstantialoffsettotheloanexpenditurewhichwasbeingincurredinotherdirections。Onlywhenithadbeencompletedwasthewaypreparedforsubstantialrecovery。
RecentAmericanexperiencehasalsoaffordedgoodexamplesofthepartplayedbyfluctuationsinthestocksoffinishedandunfinishedgoods¾；'inventories'
asitisbecomingusualtocallthem¾；incausingtheminoroscillationswithinthemainmovementofthetradecycle。
Manufacturers，settingindustryinmotiontoprovideforascaleofconsumptionwhichisexpectedtoprevailsomemonthslater，areapttomakeminormiscalculations，generallyinthedirectionofrunningalittleaheadofthefacts。Whentheydiscovertheirmistaketheyhavetocontractforashorttimetoalevelbelowthatofcurrentconsumptionsoastoallowfortheabsorptionoftheexcessinventories；andthedifferenceofpacebetweenrunningalittleaheadanddroppingbackagainhasprovedsufficientinitseffectonthecurrentrateofinvestmenttodisplayitselfquiteclearlyagainstthebackgroundoftheexcellentlycompletestatisticsnowavailableintheUnitedStates。
NotesonMercantilism，etc。[Page333]
Chapter23
NOTESONMERCANTILISM，THE
USURYLAWS，STAMPEDMONEY
ANDTHEORIESOF
UNDER-CONSUMPTION
I
Forsometwohundredyearsbotheconomictheoristsandpracticalmendidnotdoubtthatthereisapeculiaradvantagetoacountryinafavourablebalanceoftrade，andgravedangerinanunfavourablebalance，particularlyifitresultsinaneffiuxofthepreciousmetals。Butforthepastonehundredyearstherehasbeenaremarkabledivergenceofopinion。Themajorityofstatesmenandpracticalmeninmostcountries，andnearlyhalfofthemeveninGreatBritain，thehomeoftheoppositeview，haveremainedfaithfultotheancientdoctrine；whereasalmostalleconomictheoristshaveheldthatanxietyconcerningsuchmattersisabsolutelygroundlessexceptonaveryshortview，sincethemechanismofforeigntradeisself-adjustingandattemptstointerferewithitarenotonlyfutile，butgreatlyimpoverishthosewhopractisethembecausetheyforfeittheadvantagesoftheinternationaldivisionoflabour。Itwillbeconvenient，inaccordancewithtradition，todesignatetheolderopinionasmercantilismandthenewerasfreetrade，thoughtheseterms，sinceeachofthemhasbothabroaderandanarrowersignification，mustbeinterpretedwithreferencetothecontext。
Generallyspeaking，moderneconomistshavemaintainednotmerelythatthereis，asarule，abalanceof[Page334]THE
GENERALTHEORYOFEMPLOYMENT
gainfromtheinternationaldivisionoflaboursufficienttooutweighsuchadvantagesasmercantilistpracticecanfairlyclaim，butthatthemercantilistargumentisbased，fromstarttofinish，onanintellectualconfusion。
Marshall，[150]forexample，althoughhisreferencestomercantilismarenotaltogetherunsympathetic，hadnoregardfortheircentraltheoryassuchanddoesnotevenmentionthoseelementsoftruthintheircontentionswhichIshallexaminebelow。[151]Inthesameway，thetheoreticalconcessionswhichfree-tradeeconomistshavebeenreadytomakeincontemporarycontroversies，relating，forexample，totheencouragementofinfantindustriesortotheimprovementofthetermsoftrade，arenotconcernedwiththerealsubstanceofthemercantilistcase。DuringthefiscalcontroversyofthefirstquarterofthepresentcenturyIdonotrememberthatanyconcessionwaseverallowedbyeconomiststotheclaimthatprotectionmightincreasedomesticemployment。Itwillbefairest，perhaps，toquote，asanexample，whatIwrotemyself。Solatelyas1923，asafaithfulpupiloftheclassicalschoolwhodidnotatthattimedoubtwhathehadbeentaughtandentertainedonthismatternoreservesatall，Iwrote:'IfthereisonethingthatProtectioncannotdo，itistocureUnemployment……TherearesomeargumentsforProtection，baseduponitssecuringpossiblebutimprobableadvantages，towhichthereisnosimpleanswer。ButtheclaimtocureUnemploymentinvolvestheProtectionistfallacyinitsgrossestandcrudestform。'[
152]Asforearliermercantilisttheory，no[Page335]NOTES
ONMERCANTILISM，ETC。
intelligibleaccountwasavailable；andwewerebroughtuptobelievethatitwaslittlebetterthannonsense。Soabsolutelyoverwhelmingandcompletehasbeenthedominationoftheclassicalschool。
II
Letmefirststateinmyowntermswhatnowseemstometobetheelementofscientifictruthinmercantilistdoctrine。Wewillthencomparethiswiththeactualargumentsofthemercantilists。Itshouldbeunderstoodthattheadvantagesclaimedareavowedlynationaladvantagesandareunlikelytobenefittheworldasawhole。
Whenacountryisgrowinginwealthsomewhatrapidly，thefurtherprogressofthishappystateofaffairsisliabletobeinterrupted，inconditionsoflaissez-faire，bytheinsufficiencyoftheinducementstonewinvestment。Giventhesocialandpoliticalenvironmentandthenationalcharacteristicswhichdeterminethepropensitytoconsume，thewell-beingofaprogressivestateessentiallydepends，forthereasonswehavealreadyexplained，onthesufficiencyofsuchinducements。Theymaybefoundeitherinhomeinvestmentorinforeigninvestmentincludinginthelattertheaccumulationofthepreciousmetals，which，betweenthem，makeupaggregateinvestment。Inconditionsinwhichthequantityofaggregateinvestmentisdeterminedbytheprofitmotivealone，theopportunitiesforhomeinvestmentwillbegoverned，inthelongrun，bythedomesticrateofinterest；whilstthevolumeofforeigninvestmentisnecessarilydeterminedbythesizeofthefavourablebalanceoftrade。Thus，inasocietywherethereisnoquestionofdirectinvestmentundertheaegisofpublicauthority，theeconomicobjects，withwhichitisreasonableforthegovernmenttobepreoccupied，arethedomesticrateofinterestandthebalanceofforeigntrade。
[Page336]THE
GENERALTHEORYOFEMPLOYMENT
Now，ifthewage-unitissomewhatstableandnotliabletospontaneouschangesofsignificantmagnitudeaconditionwhichisalmostalwayssatisfied，ifthestateofliquidity-preferenceissomewhatstable，takenasanaverageofitsshort-periodfluctuations，andifbankingconventionsarealsostable，therateofinterestwilltendtobegovernedbythequantityofthepreciousmetals，measuredintermsofthewage-unit，availabletosatisfythecommunity'sdesireforliquidity。Atthesametime，inanageinwhichsubstantialforeignloansandtheoutrightownershipofwealthlocatedabroadarescarcelypracticable，increasesanddecreasesinthequantityofthepreciousmetalswilllargelydependonwhetherthebalanceoftradeisfavourableorunfavourable。
Thus，asithappens，apreoccupationonthepartoftheauthoritieswithafavourablebalanceoftradeservedbothpurposes；andwas，furthermore，theonlyavailablemeansofpromotingthem。Atatimewhentheauthoritieshadnodirectcontroloverthedomesticrateofinterestortheotherinducementstohomeinvestment，measurestoincreasethefavourablebalanceoftradeweretheonlydirectmeansattheirdisposalforincreasingforeigninvestment；and，atthesametime，theeffectofafavourablebalanceoftradeontheinfluxofthepreciousmetalswastheironlyindirectmeansofreducingthedomesticrateofinterestandsoincreasingtheinducementtohomeinvestment。
Thereare，however，twolimitationsonthesuccessofthispolicywhichmustnotbeoverlooked。Ifthedomesticrateofinterestfallssolowthatthevolumeofinvestmentissufficientlystimulatedtoraiseemploymenttoalevelwhichbreaksthroughsomeofthecriticalpointsatwhichthewage-unitrises，theincreaseinthedomesticlevelofcostswillbegintoreactunfavourablyonthebalanceofforeigntrade，sothattheefforttoincreasethelatterwillhaveoverreachedanddefeateditself。Again，ifthedomesticrateofinterest[Page337]NOTES
ONMERCANTILISM，ETC。
fallssolowrelativelytoratesofinterestelsewhereastostimulateavolumeofforeignlendingwhichisdisproportionatetothefavourablebalance，theremayensueaneffiuxofthepreciousmetalssufficienttoreversetheadvantagespreviouslyobtained。Theriskofoneorotheroftheselimitationsbecomingoperativeisincreasedinthecaseofacountrywhichislargeandinternationallyimportantbythefactthat，inconditionswherethecurrentoutputofthepreciousmetalsfromtheminesisonarelativelysmallscale，aninfluxofmoneyintoonecountrymeansaneffiuxfromanother；sothattheadverseeffectsofrisingcostsandfallingratesofinterestathomemaybeaccentuatedifthemercantilistpolicyispushedtoofarbyfallingcostsandrisingratesofinterestabroad。
TheeconomichistoryofSpaininthelatterpartofthefifteenthandinthesixteenthcenturiesprovidesanexampleofacountrywhoseforeigntradewasdestroyedbytheeffectonthewage-unitofanexcessiveabundanceofthepreciousmetals。GreatBritaininthepre-waryearsofthetwentiethcenturyprovidesanexampleofacountryinwhichtheexcessivefacilitiesforforeignlendingandthepurchaseofpropertiesabroadfrequentlystoodinthewayofthedeclineinthedomesticrateofinterestwhichwasrequiredtoensurefullemploymentathome。ThehistoryofIndiaatalltimeshasprovidedanexampleofacountryimpoverishedbyapreferenceforliquidityamountingtosostrongapassionthatevenanenormousandchronicinfluxofthepreciousmetalshasbeeninsufficienttobringdowntherateofinteresttoalevelwhichwascompatiblewiththegrowthofrealwealth。
Nevertheless，ifwecontemplateasocietywithasomewhatstablewage-unit，withnationalcharacteristicswhichdeterminethepropensitytoconsumeandthepreferenceforliquidity，andwithamonetarysystemwhichrigidlylinksthequantityofmoneytothestockofthepreciousmetals，itwillbeessentialforthemain-
[Page338]THE
GENERALTHEORYOFEMPLOYMENT
tenanceofprosperitythattheauthoritiesshouldpaycloseattentiontothestateofthebalanceoftrade。Forafavourablebalance，provideditisnottoolarge，willproveextremelystimulating；whilstanunfavourablebalancemaysoonproduceastateofpersistentdepression。
Itdoesnotfollowfromthisthatthemaximumdegreeofrestrictionofimportswillpromotethemaximumfavourablebalanceoftrade。Theearliermercantilistslaidgreatemphasisonthisandwereoftentobefoundopposingtraderestrictionsbecauseonalongviewtheywereliabletooperateadverselytoafavourablebalance。Itis，indeed，arguablethatinthespecialcircumstancesofmid-nineteenth-centuryGreatBritainanalmostcompletefreedomoftradewasthepolicymostconducivetothedevelopmentofafavourablebalance。
Contemporaryexperienceoftraderestrictionsinpost-warEuropeoffersmanifoldexamplesofill-conceivedimpedimentsonfreedomwhich，designedtoimprovethefavourablebalance，hadinfactacontrarytendency。
Forthisandotherreasonsthereadermustnotreachaprematureconclusionastothepracticalpolicytowhichourargumentleadsup。Therearestrongpresumptionsofageneralcharacteragainsttraderestrictionsunlesstheycanbejustifiedonspecialgrounds。Theadvantagesoftheinternationaldivisionoflabourarerealandsubstantial，eventhoughtheclassicalschoolgreatlyoverstressedthem。Thefactthattheadvantagewhichourowncountrygainsfromafavourablebalanceisliabletoinvolveanequaldisadvantagetosomeothercountryapointtowhichthemercantilistswerefullyalivemeansnotonlythatgreatmoderationisnecessary，sothatacountrysecuresforitselfnolargerashareofthestockofthepreciousmetalsthanisfairandreasonable，butalsothatanimmoderatepolicymayleadtoasenselessinternationalcompetitionforafavourablebalancewhichinjuresall[Page339]NOTES
ONMERCANTILISM，ETC。
alike。[153]Andfinally，apolicyoftraderestrictionsisatreacherousinstrumentevenfortheattainmentofitsostensibleobject，sinceprivateinterest，administrativeincompetenceandtheintrinsicdifficultyofthetaskmaydivertitintoproducingresultsdirectlyoppositetothoseintended。
Thus，theweightofmycriticismisdirectedagainsttheinadequacyofthetheoreticalfoundationsofthelaissez-fairedoctrineuponwhichIwasbroughtupandwhichformanyyearsItaught；¾；againstthenotionthattherateofinterestandthevolumeofinvestmentareself-adjustingattheoptimumlevel，sothatpreoccupationwiththebalanceoftradeisawasteoftime。Forwe，thefacultyofeconomists，provetohavebeenguiltyofpresumptuouserrorintreatingasapuerileobsessionwhatforcenturieshasbeenaprimeobjectofpracticalstatecraft。
UndertheinfluenceofthisfaultytheorytheCityofLondongraduallydevisedthemostdangeroustechniqueforthemaintenanceofequilibriumwhichcanpossiblybeimagined，namely，thetechniqueofbankratecoupledwitharigidparityoftheforeignexchanges。Forthismeantthattheobjectiveofmaintainingadomesticrateofinterestconsistentwithfullemploymentwaswhollyruledout。Since，inpractice，itisimpossibletoneglectthebalanceofpayments，ameansofcontrollingitwasevolvedwhich，insteadofprotectingthedomesticrateofinterest，sacrificedittotheoperationofblindforces。Recently，practicalbankersinLondonhavelearntmuch，andonecanalmosthopethatinGreatBritainthetechniqueofbankratewillneverbeusedagaintoprotecttheforeignbalanceinconditionsinwhichitislikelytocauseunemploymentathome。
Regardedasthetheoryoftheindividualfirmand[Page340]THE
GENERALTHEORYOFEMPLOYMENT
ofthedistributionoftheproductresultingfromtheemploymentofagivenquantityofresources，theclassicaltheoryhasmadeacontributiontoeconomicthinkingwhichcannotbeimpugned。Itisimpossibletothinkclearlyonthesubjectwithoutthistheoryasapartofone'sapparatusofthought。Imustnotbesupposedtoquestionthisincallingattentiontotheirneglectofwhatwasvaluableintheirpredecessors。Nevertheless，asacontributiontostatecraft，whichisconcernedwiththeeconomicsystemasawholeandwithsecuringtheoptimumemploymentofthesystem'sentireresources，themethodsoftheearlypioneersofeconomicthinkinginthesixteenthandseventeenthcenturiesmayhaveattainedtofragmentsofpracticalwisdomwhichtheunrealisticabstractionsofRicardofirstforgotandthenobliterated。Therewaswisdomintheirintensepreoccupationwithkeepingdowntherateofinterestbymeansofusurylawstowhichwewillreturnlaterinthischapter，bymaintainingthedomesticstockofmoneyandbydiscouragingrisesinthewage-unit；andintheirreadinessinthelastresorttorestorethestockofmoneybydevaluation，ifithadbecomeplainlydeficientthroughanunavoidableforeigndrain，ariseinthewage-unit，[154]oranyothercause。
III
Theearlypioneersofeconomicthinkingmayhavehitupontheirmaximsofpracticalwisdomwithouthavinghadmuchcognisanceoftheunderlyingtheoreticalgrounds。Letus，therefore，examinebrieflythereasonstheygaveaswellaswhattheyrecommended。Thisis[Page341]NOTES
ONMERCANTILISM，ETC。
madeeasybyreferencetoProfessorHeckscher'sgreatworkonMercantilism，inwhichtheessentialcharacteristicsofeconomicthoughtoveraperiodoftwocenturiesaremadeavailableforthefirsttimetothegeneraleconomicreader。Thequotationswhichfollowaremainlytakenfromhispages。[
155]
1Mercantilists'thoughtneversupposedthattherewasaself-adjustingtendencybywhichtherateofinterestwouldbeestablishedattheappropriatelevel。Onthecontrarytheywereemphaticthatanundulyhighrateofinterestwasthemainobstacletothegrowthofwealth；andtheywereevenawarethattherateofinterestdependedonliquidity-preferenceandthequantityofmoney。Theywereconcernedbothwithdiminishingliquidity-preferenceandwithincreasingthequantityofmoney，andseveralofthemmadeitclearthattheirpreoccupationwithincreasingthequantityofmoneywasduetotheirdesiretodiminishtherateofinterest。ProfessorHeckschersumsupthisaspectoftheirtheoryasfollows:Thepositionofthemoreperspicaciousmercantilistswasinthisrespect，asinmanyothers，perfectlyclearwithincertainlimits。
Forthem，moneywas¾；tousetheterminologyofto-day¾；afactorofproduction，onthesamefootingasland，sometimesregardedas'artificial'wealthasdistinctfromthe'natural'wealth；interestoncapitalwasthepaymentfortherentingofmoneysimilartorentforland。Insofarasmercantilistssoughttodiscoverobjectivereasonsfortheheightoftherateofinterest¾；andtheydidsomoreandmoreduringthisperiod¾；theyfoundsuchreasonsinthetotalquantityofmoney。Fromtheabundantmaterialavailable，onlythemosttypicalexampleswillbeselected，soastodemonstratefirstandforemosthowlastingthisnotionwas，howdeep-rootedandindependentofpracticalconsiderations。
Bothoftheprotagonistsinthestruggleovermonetary[Page342]THE
GENERALTHEORYOFEMPLOYMENTpolicyandtheEastIndiatradeintheearly1620'sinEnglandwereinentireagreementonthispoint。GerardMalynesstated，givingdetailedreasonforhisassertion，that'Plentyofmoneydecreasethusuryinpriceorrate'LexMercatoriaandMaintenanceofFreeTrade，1622。
Histruculentandratherunscrupulousadversary，EdwardMisselden，repliedthat'TheremedyforUsurymaybeplentyofmoney'FreeTradeortheMeanestomakeTradeFlorish，sameyear。Oftheleadingwritersofhalfacenturylater，Child，theomnipotentleaderoftheEastIndiaCompanyanditsmostskilfuladvocate，discussed1668thequestionofhowfarthelegalmaximumrateofinterest，whichheemphaticallydemanded，wouldresultindrawing'themoney'oftheDutchawayfromEngland。Hefoundaremedyforthisdreadeddisadvantageintheeasiertransferenceofbillsofdebt，ifthesewereusedascurrency，forthis，hesaid，'willcertainlysupplythedefectofatleastone-halfofallthereadymoneywehaveinuseinthenation'。Petty，theotherwriter，whowasentirelyunaffectedbytheclashofinterests，wasinagreementwiththerestwhenheexplainedthe'natural'fallintherateofinterestfrom10percentto6percentbytheincreaseintheamountofmoneyPoliticalArithmetick，1676，andadvisedlendingatinterestasanappropriateremedyforacountrywithtoomuch'Coin'QuantulumcunqueconcerningMoney，1682。
Thisreasoning，naturallyenough，wasbynomeansconfinedtoEngland。
Severalyearslater1701and1706，forexample，Frenchmerchantsandstatesmencomplainedoftheprevailingscarcityofcoindisettedesespè；cesasthecauseofthehighinterestrates，andtheywereanxioustolowertherateofusurybyincreasingthecirculationofmoney。
[156]ThegreatLockewas，perhaps，thefirsttoexpressinabstracttermstherelationshipbetweentherateofinterestandthequantityofmoneyinhiscontroversywithPetty。[157]HewasopposingPetty'sproposalofamaximumrateofinterestonthegroundthatitwasasimpracticableastofixamaximumrentforland，since'thenaturalValueofMoney，asitisapttoyieldsuch[Page343]NOTES
ONMERCANTILISM，ETC。
anyearlyIncomebyInterest，dependsonthewholequantityofthethenpassingMoneyoftheKingdom，inproportiontothewholeTradeoftheKingdomi。e。thegeneralVentofallthecommodities'。[158]Lockeexplainsthatmoneyhastwovalues:iitsvalueinusewhichisgivenbytherateofinterestandinthisithastheNatureofLand，theIncomeofonebeingcalledRent，oftheother，Use[159]'，and2itsvalueinexchange'andinthisithastheNatureofaCommodity'，itsvalueinexchange'dependingonlyonthePlentyorScarcityofMoneyinproportiontothePlentyorScarcityofthosethingsandnotonwhatInterestshallbe'。ThusLockewastheparentoftwinquantitytheories。Inthefirstplaceheheldthattherateofinterestdependedontheproportionofthequantityofmoneyallowingforthevelocityofcirculationtothetotalvalueoftrade。
Inthesecondplaceheheldthatthevalueofmoneyinexchangedependedontheproportionofthequantityofmoneytothetotalvolumeofgoodsinthemarket。But¾；standingwithonefootinthemercantilistworldandwithonefootintheclassicalworld[160]¾；hewasconfusedconcerningtherelationbetweenthesetwoproportions，andheoverlookedaltogetherthepossibilityoffluctuationsinliquidity-preference。Hewas，however，eagertoexplainthata[Page344]THE
GENERALTHEORYOFEMPLOYMENT
reductionintherateofinteresthasnodirecteffectontheprice-levelandaffectsprices'onlyastheChangeofInterestinTradeconducestothebringinginorcarryingoutMoneyorCommodity，andsointimevaryingtheirProportionhereinEnglandfromwhatitwasbefore'，i。e。ifthereductionintherateofinterestleadstotheexportofcashoranincreaseinoutput。Buthenever，Ithink，proceedstoagenuinesynthesis。[161]
Howeasilythemercantilistminddistinguishedbetweentherateofinterestandthemarginalefficiencyofcapitalisillustratedbyapassageprintedin1621whichLockequotesfromALettertoafriendconcerningUsury:
'HighInterestdecaysTrade。TheadvantagefromInterestisgreaterthantheProfitfromTrade，whichmakestherichMerchantsgiveover，andputouttheirStocktoInterest，andthelesserMerchantsBreak。'FortreyEngland'sInterestandImprovement，1663affordsanotherexampleofthestresslaidonalowrateofinterestasameansofincreasingwealth。
Themercantilistsdidnotoverlookthepointthat，ifanexcessiveliquidity-preferenceweretowithdrawtheinfluxofpreciousmetalsintohoards，theadvantagetotherateofinterestwouldbelost。Insomecasese。g。MuntheobjectofenhancingthepoweroftheStateledthem，nevertheless，toadvocatetheaccumulationofstatetreasure。Butothersfranklyopposedthispolicy:Schrö；tter，forinstance，employedtheusualmercantilistargumentsindrawingaluridpictureofhowthecirculationinthecountrywouldberobbedofallitsmoneythroughagreatlyincreasingstatetreasury……he，too，drewaperfectlylogicalparallelbetweentheaccumulationoftreasurebythe[Page345]NOTES
ONMERCANTILISM，ETC。monasteriesandtheexportsurplusofpreciousmetals，which，tohim，wasindeedtheworstpossiblethingwhichhecouldthinkof。DavenantexplainedtheextremepovertyofmanyEasternnations¾；whowerebelievedtohavemoregoldandsilverthananyothercountriesintheworld¾；bythefactthattreasure'issufferedtostagnateinthePrinces'Coffers'……Ifhoardingbythestatewasconsidered，atbest，adoubtfulboon，andoftenagreatdanger，itgoeswithoutsayingthatprivatehoardingwastobeshunnedlikethepest。