[Article] British Treasury Responses to

the Keynesian Revolution, 1925-19391

G.C. Peden

sury officials of the 1920s regarded the sys- I Introduction tem of public finance that had been estab- When J.M. Keynes tried to convince lished in Britain before 1914 as ideal. First, policy-makers that his ideas offered practical the gold standard gave an independent cen- solutions to economic problems, the Treasury tral bank, the Bank of England, a target for was the department that he most needed to the value of sterling that was free from convince. In Britain the Treasury is more political influence. Second, free trade ensured than a ministry of finance. Like finance that there was no political bargaining with ministers in other countries, the minister in agriculture or industry for tariffs. Third, the charge of the Treasury, the Chancellor of the principle that the Chancellor should balance Exchequer, is responsible for legislation his budget each year (except in wartime) relating to the financial system, for taxation ensured that any political advantage to be and public debts, and for accounting for gained from increasing public expenditure government expenditure. However, in addi- had to be balanced against the political dis- tion, the Treasury's prior approval is nor- advantage of increasing taxation. The link mally required for any expenditure by central between public expenditure and taxation also government, or subsidies to local government created the expectation that the Treasury or public utilities. The Keynesian revolution would control public expenditure to ensure in public policy required the support of the that taxpayers' money was not spent waste- Treasury. fully. Public works, such as harbours or tele- The senior Treasury officials who phone systems could be financed by borrow- advised the Chancellor were not economists. ing, provided they would produce a money They were administrators who were con- return that would cover both interest on, and cerned that Keynes's ideas would make repayment of, the debt. The whole system Britain's system of public finance more sub- was designed to protect politicians from the ject to party-political influence. The debate temptation to use economic policy or loan- between Keynes and the Treasury was thus financed public expenditure for party politi- not simply a debate about economic theory. It cal advantage (Peden 2002). was also, and often more so, a debate about In contrast, Keynes's ideas implied a public finance, and the danger that a more good deal of political discretion. He advocat- active role for the state in managing the ed the management of sterling to stabilise economy might be used by political parties to domestic prices rather than the exchange win votes or to reward interest groups. Trea- rate, and in 1925 he opposed the return to the

-31- 経 済 学 史 学 会 年報 第44号(2003年11月) gold standard at the pre-1914 parity of $4.86. of the exchange rate (a position that he had Although he had been an outspoken supporter held since publishing his Tract on Monetary of free trade in 1923, he advocated a revenue Reform in 1923). Section 6 explains why the tariff in 1931 to help to balance the budget, Treasury preferred to rely on monetary policy and in 1933 he supported protection as a rather than budget deficits to revive private means of achieving independence in national investment in the 1930s. Section 7 shows that economic policy. From 1924 he supported Ralph Hawtrey, the Treasury's in-house econ- schemes for expenditure on public works to omist, did not regard Keynes's General Theory be accelerated in times of high unemploy- as being of practical importance for eco- ment. Unlike the Treasury, he thought that nomic and financial policy. However, Keynes such expenditure need not be limited to pub- was nonetheless able to influence Treasury lic works that produced a money return. thinking. In section 8 I argue that the Trea- Most famously, in The General Theory of sury accepted the need for macroeconomic Employment, Interest and Money (1936) he management of the economy as a result of argued that even the building of pyramids the need to finance pre-war rearmament by could increase economic welfare by increas- borrowing. Treasury officials still believed ing effective demand (Keynes vol. 7, p. 220). that practical difficulties limited the extent This was not a doctrine that Treasury offi- to which public works could be varied from cials trained in the principles of pre-1914 year to year, and they still saw monetary public finance could readily accept. policy as the principal means of managing the My paper is organized in several sec- economy. Moreover, it was not until the sum- tions. In the second section I look briefly at mer of 1939 that the Treasury accepted the return to the gold standard and the diffi- Keynes's argument that government expendi- culty of making British exports competitive ture could increase national income, and at the pre-war exchange rate of $4.86. In thereby the savings necessary to finance section 3 I review the intellectual sources for government expenditure, without inflation - the Treasury view of 1929 that government and then only in the context of direct state expenditure would tend to crowd out private controls over private and local authority investment. Section 4 notes how the Treasury investment. Section 9 looks at the Treasury's avoided theoretical debate with Keynes on greater willingness to adopt Keynes's ideas this issue in 1930, and instead emphasised the during the war and in post-war planning for practical problems of implementing a public employment policy and monetary policy. works programme. Section 5 deals briefly However, even then officials were concerned with the end of free trade and the suspension to preserve the principle that, while budgets of the gold standard, changes that were need not balance every year, they should forced on the Treasury by the pressure of balance over a longer period. The conclusion events rather than by Keynes's persuasion. notes that this concern with sound finance is However, by 1931 Treasury officials still central to fiscal policy. accepted the need to reverse the fall in world II The Return to the Gold Standard prices since 1929. They also agreed with Keynes that the stability of the domestic The decision in 1925 to return to the gold economy was more important than stability standard at the pre-war parity was taken

-32- G. C. Peden British Treasury Responses to... (Series : Economic Thought and Policy in the Interwar Period) with professional economic advice. Keynes's III Public Works and the Treasury View' Cambridge colleague, Professor A. C. Pigou, of 1929 was a member of the Chamberlain-Bradbury Committee that recommended an immediate In 1928 Keynes supported proposals by return. Keynes, as an expert witness before the Liberal leader, David Lloyd George, for the committee, had warned that the policy unemployment to be halved by public expend- would require drastic credit restriction to iture on roads, harbours, housing, electricity prevent a loss of gold, and would increase supply, telephones and land drainage - to British export prices. The committee, how- be financed by borrowing. Having consulted ever, believed that his alternative of a his officials, Churchill rejected the proposals managed currency with a floating exchange in his budget speech on 15 April 1929. The rate was not practical. The Treasury's con- orthodox Treasury view, as Churchill called troller of finance, Sir Otto Niemeyer, advised it, was that government borrowing in the the Chancellor, Winston Churchill, that a money market tended to crowd out private fixed exchange rate was necessary to main- enterprise, and that public works financed by tain London's position in international borrowing would create no permanent addi- finance. Other leading currencies were on tional employment. The onus was therefore gold or were about to return to gold, and on government to show that its loan- international traders would prefer to use expenditure would have more beneficial these currencies rather than sterling if the results than if the money had been left avail- value of the latter fluctuated (Moggridge able for private industry (Peden 1996, 69-70). 1972, 264-65). Treasury officials mistakenly The Treasury view is usually seen as a assumed that wages would continue to be logical implication of classical economics flexible downwards, as they had been in the (Corry 1958). However, not all economists post-war recession. Frederick Leith-Ross, the whom Keynes called classical' provided sup- deputy controller of finance, was surprised to port for the Treasury view. John Stuart Mill, be told in 1928 by Hawtrey that Keynes was for example, wrote in his Principles of Politi- correct to claim that wages had not fallen cal Economy that in a wealthy country, like significantly since 1925, although wholesale Britain, capital accumulation would rapidly and retail prices had. Leith-Ross then admit- replace funds borrowed by the government. ted that the Chamberlain-Bradbury Commit- Indeed, Mill believed that probably the only tee had seriously underestimated the diffi effects of government borrowing would be culty of bringing wages into line with prices.2 that less capital would be exported and less From that date he and other officials looked would be wasted in speculation (Mill 1848, to improvements in industrial organisation to book IV, chapter 5). Peter Clarke has shown reduce costs, and thereby to make British how officials referred to an article published goods internationally competitive. The Trea- by Hawtrey in Economica in 1925 when draft- sury was thus looking for microeconomic ing the statement of the Treasury view for solutions to what Keynes saw as a macro- Churchill - Hawtrey himself being on leave economic problem. teaching economics at Harvard (Clarke 1988, 63). However, Treasury officials had opposed proposals by Lloyd George for loan-

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financed public works to reduce unemploy- Insofar as the Treasury view was based on ment in 1921 (Peden 1993), and one has to go Cunningham's work, it was a statement about back further than 1925 to trace the intellec- the need to achieve a balance between invest- tual sources of the Treasury view. ment in fixed capital and the production of In his exposition of the Treasury view in marketable goods. his budget speech in 1929 Churchill cited Hawtrey had asserted in his first book, William Cunningham's The Growth of Eng- Good and Bad Trade (1913), that borrowing lish Industry and Commerce in Modern for public works would withdraw from the Times (1903), a work that would have been investment market savings that would other- known to officials who had studied political wise be applied, sooner or later, by private economy for the Civil Service examination. enterprise to the creation of fixed capital or Cunningham was a member of the Economics invested abroad (Hawtrey 1913, 260-61). Syndicate at Cambridge, but he preferred a Hawtrey assumed, as the Treasury still did in historical approach to economic subjects, 1929, that overseas investment stimulated and had opposed Alfred Marshall's efforts demand for British exports - an assump- to promote the study of economic analysis tion that Keynes no longer shared by the late of along the lines of the latter's Principles 1920s. However, even in 1913 Hawtrey's ver- of Economics (Nishizawa 2002, 22-29). sion of the Treasury view did not commend Cunningham's version of crowding out itself to Pigou (whom Keynes called as a related to private investment, and drew upon classical' economist). Pigou described the analysis of James Wilson, the founder of Hawtrey's crowding out hypothesis as a fal- the Economist. Wilson, in his Capital, Cur- lacy that he believed that he had dealt with in rency and Banking (1847), attributed the his own Wealth and Welfare, published in depression of 1847 to over-investment in rail- 1912 (Pigou 1913 ; Pigou 1912, 476-86). ways. He argued that a railway under con- The sources of the Treasury view were struction diverted capital from other thus Cunningham (and through him Wilson) branches of industry, but produced no goods and Hawtrey, not Mill or Pigou. While the that could be exported, whereas the employ- Treasury view was compatible with the ideas ment created increased imports and turned of Adam Smith or Say's law, one should not the foreign exchanges against sterling. As identify the Treasury view too closely with Cunningham noted, the Bank of England then some of the people whom Keynes called clas- had to raise bank rate to prevent an outflow sical economists. Cunningham would not of gold (Cunningham 1917, 826-28). Bank have regarded himself as an economist, clas- rate was the rate at which banks could dis- sical or otherwise, in the sense that Marshall count British government bonds or approved was. Keynes did not regard Hawtrey as a bills of exchange, and thus determined the classical economist (Keynes vol. 14, 202 n). level of interest rates generally. If either the Yet Hawtrey told Keynes in 1937 that ; I government or private industry invested in have adhered to my fundamental ideas since fixed capital to an extent that put pressure 1913'-that is when he had published Good on the exchange rate, bank rate would have and Bad Trade (Deutscher 1990, 55). to be raised. Private investment would there- Hawtrey's argument in his Economica by be discouraged and employment reduced. article in 1925 started with the condition that

-34- G. C. Peden British Treasury Responses to... (Series : Economic Thought and Policy in the Interwar Period) government borrowing was to be from the of 1894-95 (Hawtrey 1925). In 1929 bank rate genuine savings' of the non-bank public, and stood at 6 % per cent before the New York not from the banks or from people who had stock market crash in October. After the borrowed from banks. Within that constraint, crash the Bank of England reduced bank rate government could attract idle balances held in stages, in step with New York, to 3 per by the non-bank public by selling bonds, but cent by May 1930, and the Treasury had normally expenditure from this borrowed hopes that cheap credit would encourage money would be at the expense of future private enterprise (Howson 1975, 68). So expenditure by the private sector. Hawtrey long as such hopes persisted, and insofar as believed that the public, as a whole, would the Treasury was influenced by Hawtrey's always keep an unspent margin of its income article, there was no reason why officials in the form of cash balances. Therefore an should approve an expansion of public works increase in the investing public's holdings of to create employment. government bonds must, on his initial condi- IV The Ref ormulation of the Treasury tion relating to genuine savings, normally View, 1930 lead to an equal reduction in private capital issues. He thought that the proportion of the After the general election of 1929 Labour public's income that would be kept as cash took office as a minority government, depen- balances would vary according to changes in dent on Liberal support. The Labour party the velocity of circulation of money. How- had committed itself to doing something ever, it was only when business confidence about unemployment and the Labour Chan- was exceptionally low that the sale of gov- cellor of the Exchequer, Philip Snowden, was ernment bonds could increase the velocity of prepared to borrow for road building, despite circulation by attracting idle balances. Treasury advice that it should be paid for out Hawtrey then argued that matters would of revenue. Keynes was a member of both the be different if the government borrowed from Macmillan Committee on Finance and Indus- the banks, or from people who financed pur- try, which was appointed in November 1929 chases of government bonds by borrowing to inquire into how the banking system from banks. Then government borrowing affected the economy, and the Economic would create the bank credits that would Advisory Council, which was established in enable the non-bank public to maintain their January 1930 to advise the government on all cash balances and to invest in more secu- aspects of economic policy. Treasury offi- rities. In these circumstances, loan-financed cials thus had to respond to Keynes in a very public works would create additional employ- different political context from when they ment. However, assuming a normal degree of had drafted the Treasury view for Churchill. enterprise on the part of business, he conclud- Moreover, by June 1929 Hawtrey had ed that the creation of extra bank credit returned from Harvard, and he could be alone would be equally effective in giving consulted at first hand rather than by reading employment. In Hawtrey's view, public his article in Economica. Hawtrey produced a works would be necessary only when business memorandum on Lloyd George's plan that did not respond to a reduction in bank rate to was less hostile than earlier Treasury criti- 2 per cent, as had happened in the depression cisms had been. Hawtrey shared Keynes's

-35- 経 済 学史 学会 年 報 第44号(2003年11月) conviction that falling prices led to restric- a wide range of books on economics, from tion of production, and that there could be no basic textbooks to current controversies. He general reduction of wages. Like Keynes, does not seem to have been impressed by Hawtrey was an advocate of reducing un- economists' ability to provide solutions to employment by increasing the value of money Britain's economic difficulties. He was to output. He accepted that borrowing for the comment in 1932: Liberal plan for public works could reduce overseas investment and increase internal It seems useless to endeavour to follow capital outlay, if a high enough rate of inter- professional economic teaching, for there is est were offered. However, he regarded the no criterion for determining the proper Liberal plan as nothing more than a very economists to follow, and whoever one elaborate and roundabout alternative to rais- chooses, one is apt to find oneself led into ing loans abroad for the strengthening of our actions which are either repugnant to com- gold reserves.' The prospect of a loss of gold mon sense or incapable of practical was the only obstacle to curing unemploy- achievement (Howson 1975, 91). ment by an expansion of credit that would benefit the private sector. Moreover, an elab- In the absence of contemporary econo- orate programme of public works, once start- mists' support for the Treasury view of 1929, ed, would involve the Treasury in heavy Treasury officials fell back on what they commitments, that could not be easily or quick- understood best : public finance. Hopkins said ly cut back even if they were greater than he did not believe that public works were of what was required to cure unemployment.3 no use for reducing unemployment, and he Hawtrey thus did not provide much support agreed with Keynes that nearly all his (Hop- for the Treasury view as stated by Churchill kins's) evidence amounted to saying that it in 1929, but he retained his faith in the effects was difficult to find new good public works of credit expansion on the private sector, and to invest in. By good, Hopkins meant public he shared his colleagues' concerns about elab- works that would produce a money return to orate schemes of public expenditure. pay interest on money borrowed for the pur- The Treasury's evidence to the Macmil- pose, and repay the loan, or which could be lan Committee was given by Sir Richard justified economically. He argued that the Hopkins, who had taken over from Niemeyer Liberal plan for accelerated public works as controller of finance in 1927. Hopkins was would lead to wasteful expenditure. Local also controller for supply services ; that is he authorities, the Post Office, or semi-public was responsible for the control of government bodies like the Central Electricity Board expenditure, and thus for ensuring that public would be unable to carry out the programme money was not spent wastefully. Hopkins in the time allotted without creating bottle- avoided debating economic theory with necks, excessive profits, and protests from Keynes in the committee, and instead focused private interests (for example, from people on the practical problems of implementing a adversely affected by new roads). Moreover, public works programme. Hopkins had stud- unemployed workers often lived far from ied classics and history at Cambridge, but where the new roads were required. Given after his appointment to the Treasury he read these problems, it seemed to him to be really

-36- G.C. Peden British Treasury Responses to... (Series : Economic Thought and Policy in the Interwar Period) beside the point' to argue in theoretical terms continuing lack of confidence in sterling (as Keynes did) how much of the money forced this National Government to suspend could be obtained by diverting investment the gold standard on 21 September 1931. from abroad, or from savings, or from in- Free trade did not long survive the change creased prosperity. Hopkins feared that a of government. A Conservative Chancellor, large scheme of public works that seemed to Neville Chamberlain, who had a long- be extravagant might lead investors to take standing commitment to protection, replaced their capital abroad (Keynes vol. 20,166-79) . Snowden in November. Thereafter Treasury Roger Middleton has argued that contempo- officials had to draft arguments in favour of rary financial markets' perceptions of public tariffs, in accordance with the views of their finance, and the balance of payments implica- new political master, and protection soon tions of a major public works programme, replaced revenue as the principal objective of both give substance to the Treasury view tariffs. The Conservatives' wish to protect (Middleton 1985, 149-65). agriculture and industry from foreign compe- tition, rather than Keynes's economic theory, V The End of the Gold Standard dictated the change (Peden 2000, 240-43; and Free Trade 260-64). As the depression deepened in 1931, By 1931 Treasury officials accepted that Keynes accepted the argument that a policy the gold standard was having a destabilising of loan-financed public works was liable to effect on the world economy. A reduction in reduce business confidence because business- American overseas investment since 1928, men would draw a false analogy between the together with a drain of gold to France (the national finances and an individual's finances franc was undervalued) forced other coun- (Keynes vol. 9, 232 ; 234-35). In March he tries to deflate in order to preserve the gold advised the Prime Minister, Ramsay Mac- parities of their currencies. Export markets Donald, that the budget must be balanced, if contracted, and unemployment rose. Falling a financial crisis were to be averted. Keynes prices increased the burden of debts proposed a revenue tariff, which he believed (Hawtrey 1931), Frederick Phillips, the could be removed once world prices, which under-secretary responsible for finance, had been falling for two years, had recovered under Hopkins, advocated de facto stabilisa- to their 1929 level. Treasury officials, how- tion of sterling at a reduced parity with gold, ever, advised the Chancellor, Snowden, a while retaining the right to let sterling float convinced free trader, that once a tariff had to a lower parity, depending on what been imposed it could not easily be removed, happened to gold prices. He thereby hoped to as vested interests in its retention would encourage a rise in prices back to their 1929 develop. The Treasury's preferred means of level, while also hoping that money wages balancing the budget would have been to curb would remain stable, as they had done the growth of expenditure on unemployment through the depression. Hawtrey advised that relief. In the event, the Labour government sterling should be pegged at $3.40, but this split when it could not agree to cut unemploy- figure was not agreed on until after Keynes ment benefits. It was succeeded by a coalition had also provided arguments in favour of it. drawn from all three political parties, but On this occasion, Treasury officials were

-37- 経 済 学 史 学会 年 報 第44号(2003年11月) glad to seek his advice (Howson 1975, 83-86; published a series of four articles, entitled 173-79). Moreover, from 1932 to 1939 the The means to prosperity,' in The Times in stability of the domestic economy was given March 1933. He argued that the only way to priority over stability of the exchange rate balance the budget was to increase national (Howson 1980). Bank rate was reduced to 2 income, which was much the same thing as per cent, compared with the 6 per cent to increasing employment. Using what he regar- which it had been raised in 1931 to defend the ded as a low multiplier of 1.5, he calculated gold standard. the benefits of public works to the Chancel- lor's budget. He also applied the multiplier VI Public Works in the 1930s argument to tax cuts, since the increased The Treasury hoped that cheap money' spending power of the taxpayer would have (low interest rates) would aid recovery from the same favourable repercussions as public the slump (Howson 1975, 83-89 ; 94-95; works. He suggested that the orthodox prac- 173-79). However, unemployment was slow tice of repaying the national debt through an to fall, and in March 1933 Keynes renewed his annual sinking fund should be suspended. He campaign for loan-financed public works as also suggested borrowing to cover the cost of the means to recovery. A World Economic roads and part of the cost of unemployment Conference was due to be held in London in benefit (Keynes vol. 9, 335-66). Treasury offi- June to try to agree on international co- cials' objections to public works still centred operation to deal with the depression. Both on the difficulty of accelerating them and on Keynes and Treasury officials agreed on the the implications of domestic expansion for desirability of international action to raise the balance of payments. Moreover, Keynes prices, although the Treasury was sceptical failed to convert them to his theory about about the chances of success, especially given expenditure and savings. Keynes believed France's attachment to the gold standard. that expenditure financed by borrowing Keynes and Hubert Henderson, an economist would create the savings required to finance who was joint secretary of the Economic the public works. Phillips commented : It is Advisory Council, produced a plan for the no good saying that the works will produce Bank for International Settlements to issue the savings for investment, for ex hypothesis notes which would be the equivalent of gold, the borrowing precedes the works.' 4) In the thereby enabling governments of debtor coun- General Theory Keynes claimed that an tries to carry out expansionary policies. The increase in investment would bring about an Treasury gave the Keynes-Henderson plan exactly equal increase in savings, savings and serious consideration, and it was dropped investment being brought into equilibrium by only because of the opposition expected from a change in the level of national income. other delegations at the conference (Howson However, in 1937 he conceded, in response to and Winch 1977, 114-21). Where Keynes and criticism by his Cambridge colleague, Dennis the Treasury differed was over the desirabil- Robertson, that the banking system would ity of domestic action to supplement the have to expand credit to bridge the time lag Treasury's policy of cheap money. between investment and the subsequent flow Keynes used the concept of the multiplier of funds available for investment (Trevithick for the first time in public debate when he 1994). But, as Hawtrey had pointed out in

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1925 and 1929, the creation of credit alone, ent tendency for the yield of capital to fall, without the complications of public works, that is to say for the more profitable openings would normally be sufficient to stimulate for investment to be successively filled, leav- private enterprise. Treasury officials regard- ing only those that offered a lower and lower ed the suspension of the sinking fund and yield. Hawtrey believed that technological borrowing for roads and unemployment bene- progress would continue to provide new open- fits as the equivalent of unbalancing the ings for investment. Consequently he thought budget, which was politically dangerous. that Keynes assumed too easily that un- Once borrowing for current expenditure was employment could not be solved by monetary accepted as the way to prosperity, they means.5 Insofar as Treasury officials were claimed, it would be impossible for the Chan- influenced by Hawtrey's criticism of the cellor to control public expenditure. More- General Theory, they would not have been over, they pointed out that budget deficits led to believe that Keynes's theory was of had not brought rapid recovery to other coun- immediate significance to the work of the tries, notably the United States. Cheap money Treasury. might be a slow policy, but it avoided politi- On other hand, Hawtrey was not the only cal complications. In the event, the size of the economist with direct access to Treasury sinking fund was reduced, but the appearance officials. Leith-Ross (from 1932) and Phillips of balanced budgets was maintained (Midd- (from 1935) attended meetings of the Eco- leton 1982). nomic Advisory Council's Committee on Eco- nomic Information, the membership of which VII Keynes, Hawtrey and included Keynes, and (from 1936) Robertson. Economic Advice Phillips has been credited, along with his Keynes was principally concerned in the immediate superior, Hopkins, with being General Theory to persuade his fellow econo- prepared to rethink the theoretical bases of mists to re-examine the assumptions on economic policy, under Keynes's influence which their theories were based (Keynes vol. (Howson and Winch 1977, 108-09). Phillips 7, xxi). He spent a good deal of time corre- had studied mathematics and natural sci- sponding with Hawtrey while completing the ences at Cambridge, but he was familiar with book. Nevertheless, he was to be disap- Keynes's Treatise on Money shortly after it pointed by the commentary that Hawtrey was published in 1930. He did not, however, wrote for internal Treasury use. Hawtrey's regard himself as an economist and down to main purpose was to show whether the Gen- 1939 he seems to have used Hawtrey both to eral Theory had any bearing on practical help him understand theory and to act as a measures of economic and financial policy. counter-balance to Keynes's advice. Keynes felt that the paper left out about VIII Rearmament and Management of three-quarters of what he himself attached the Economy importance to in his book, and was of value only as an indication of how Hawtrey saw the By 1937 the British economy had been differences between their theories. (Keynes recovering from the slump for five years. vol. 14, 14-18). Hawtrey did not share Unemployment had halved between 1932 and Keynes's assumption that there was a persist- 1937, from 22.1 per cent to 10,8 per cent of the

-39- 経 済学 史 学 会 年 報 第44号(2003年11月) insured labour force - to use the contempo- important work arising from the whole rary statistics - or from 17.0 per cent to 8.5 range of ideas connected with control of per cent of the total labour force. It was capital expenditure and investment, and with known that the government would have to the diversion of savings into particular chan- rely increasingly on borrowing to finance nels'.6) An Interdepartmental Committee on rearmament. In January 1937 Keynes took Public Capital Expenditure, chaired by Phil- the view that it was more important to avoid lips, reported in August 1937 that it might be a descent into another slump than to stimu- possible to vary public capital expenditure by late. .. a still greater activity than we have.' up to 50 million between a year of maxi- He advocated planning to ensure as much mum reduction and a year of maximum stability of aggregate investment as we can acceleration, with the transition between manage,' which would mean holding back these stages being at least a year. This figure public works for a time when they would be was well below Lloyd George's proposal in needed to maintain demand. On the other 1929 to increase public capital expenditure by hand, he warned against raising interest 250 million over two years. As usual, the rates, for then it would be difficult to lower Treasury emphasised the practical diffi- them to correct a downturn in the economy. culties of implementing counter-cyclical pub- A low enough long-term rate of interest lic works. The report also pointed out that a cannot be achieved if we allow it to be slump towards the completion of the rearma- believed that better terms will be obtained ment programme would occur at a time when from time to time by those who keep their the national debt would have greatly in- resources liquid. The long-term rate of inter- creased, and might seem excessive to the est must be kept continuously as near as public. Any public works programme that possible to what we believe to be the long- forced the government to borrow more might term optimum.' Instead, he advised the gov- give rise to serious fears as to the state of the ernment to pay for most of rearmament out national finances. Such fears would make it of taxation, withholding tax relief until there difficult for the Treasury and the Bank of were signs of recession (Keynes vol. 21, 384-95). England to bring about that lowering of the In February 1937 the Committee on Eco- rate of interest which must always remain nomic Information endorsed Keynes's belief the principal weapon in the hands of the that at the current stage of the trade cycle an authorities during times of trade depression.' 7) attempt to increase investment outside Hawtrey disagreed with Keynes on the designated areas of high unemployment need to avoid higher interest rates. While he would raise profits rather than employment. believed that low interest rates need not rise Accordingly, it recommended that public for the moment, he wrote : A rise in bank investment in roads, housing and telephones rate can be adjusted to circumstances and so should be postponed, except in these areas of regulated that it moderates the growth of high unemployment, and held in reserve for activity to any desired extent.' 8) Phillips when aggregate investment fell (Howson and wanted to keep bank rate low until prices had Winch 1977, 343-53). By March 1937 Phillips recovered to their 1929 level, and also expected that the Treasury's home finance because low interest rates kept down the cost division would in future have additional and of borrowing for rearmament. However, he

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was prepared to raise interest rates when If there were no reflationary finance, the necessary to prevent a boom getting out of government works would tend merely to hand. Moreover, the Treasury continued its replace private works without much effect long-standing policy of funding the national on employment. But this is the famous or debt, despite Keynes's criticism, based on his infamous Treasury view,' still a most bit- concept of liquidity preference, that this pol- ter subject of controversy.' icy tended to raise the long-term rate of interest (Howson 1975, 128-31). In the event, Reflation through rearmament was the a renewed slump in 1938 removed the pres- product of political necessity rather than a sure for a rise in bank rate. departure from the Treasury view. The shift Treasury officials agreed with Keynes in by the Treasury from Hawtrey's monetary 1937 that rearmament should be paid for as theory to Keynes's monetary theory did not much as possible by taxation. However, the occur until the summer of 1939, The Bank of slump in 1938 changed matters. Although England recommended in April 1939 that the rearmament was associated with a growing maximum rates of interest for medium and balance of payments problem, Hopkins and long-term government bonds should be fixed Phillips advised the Chancellor to make only at the outbreak of war and held constant for token increases in his budget in April 1939, to all subsequent issues. A Treasury Committee help maintain confidence in sterling. They on the Control of Savings and Investment recommended that the government should was set up on 30 June, with Phillips as chair- pay for rearmament mainly by borrowing. man. There were two economists on the The Treasury was waiting for rearmament committee : Henry Clay, from the Bank of expenditure to bring the economy to full England, previously professor of economics employment. At full employment, the yield of at the University of Manchester, and Robert- taxation would be significantly increased, son, professor of economics at LSE since and a higher level of savings would make it 1938. Robertson explained to Phillips how, in easier for the government to borrow from the certain circumstances, Keynes's idea that non-bank public. To that extent, the Trea- government expenditure would increase sury now agreed with Keynes. However, national income, and thereby create the sav- Phillips advised Hopkins that once prices ings necessary to finance government continued to rise without employment expenditure without inflation, could be made increasing, the government and the Bank of to work. He classified the measures for re- England must use the usual controls,' includ- pressing inflation as : (1) direct government ing higher interest rates as well as heavier control of investment by local authorities and taxation and higher tariffs. Phillips agreed public utilities ; (2) rationing of building with Hawtrey that there was no basis for materials ; (3) control of new issues on the Keynes's belief that interest rates could be stock market and requests to clearing banks held down in a boom.9 Phillips also agreed not to lend for purposes not approved by the with Hawtrey that the stimulus to economic government ; (4) compulsory borrowing of recovery came not from the government's companies' undistributed profits ; and (5) expenditure, but from the extent to which its hardening of interest rates.' Robertson said borrowing led to an expansion of credit : that he still felt surprise at the warmth with

-41- 経 済 学 史 学 会 年 報 第44号(2003年11月) which (5) was rejected by some (including and munitions workers that they would not Keynes) but he was not committed to higher face mass unemployment after the war. Econ- interest rates on principle, if they could be omists in the Economic Section of the Offices avoided." On 20 July the Committee on Eco- of the War Cabinet argued that Keynes's nomic Information, with Phillips present with economic theory showed that it was possible Keynes and Robertson, recommended con- for the government to maintain full employ- trols on investment, to reserve capacity for ment, notwithstanding Treasury officials' defence production and exports. The Com- reservations. With the publication of the 1944 mittee rejected the classical' remedy for white paper, Employment Policy, the govern- inflation of high interest rates, on the grounds ment accepted as one of their primary respon- that they would not be very effective where sibilities the maintenance of a high and stable firms normally financed investment out of level of employment after the war. The white undistributed profits and depreciation funds, paper attempted to reconcile deep differences and would increase the cost of government between the Keynesian economists of the borrowing. The Treasury Committee report- Economic Section, who supported deficit ed along the same lines on 11 August (How- finance as a means of maintaining aggregate son 1993, 27-29). The Treasury Committee's demand, and Treasury officials, who wished report represented an acceptance of Keynes's to preserve budget discipline. The outcome liquidity preference theory, recommending was that the white paper employed a the issue of short and medium-term securities Keynesian analysis of macroeconomic aimed at different holders of savings. How- demand being the sum of private consump- ever, it did so in circumstances in which there tion, private investment, government expend- would be government controls over private iture and the foreign balance. Public invest- investment. ment would be planned to offset fluctuations in private investment. As a second line of IX Changes in the Second World War defence, private consumption would be On Keynes's advice, the 1941 budget maintained, perhaps through variations in introduced macroeconomic management social insurance contributions or rates of based on a national income accounting ana- taxation. It made clear, however, that there lytical framework. However, the context was were practical limits to variations in public the control of inflation and Treasury officials investment and that, while the Chancellor's continued to be sceptical about proposals for budget for central government expenditure reducing unemployment by raising aggregate need not balance every year, it should balance demand. Nevertheless, from 1942 there were over a longer period (Peden 1988, 40-49). political pressures that they could not ignore. Keynes discussed monetary policy with A report by Sir William Beveridge in that Treasury and Inland Revenue officials when year proposed an ambitious scheme of social Hopkins set up a committee in February 1945' insurance that would only be actuarially to enquire into the national debt. The minutes sound if unemployment were lower after the of the committee show that wartime experi- war than it had been in the inter-war period. ence of offering a range of bonds that all- The government could not ignore the politi- owed the public to be as liquid as it wished cal need to reassure millions of servicemen predisposed officials to accept Keynes's ideas

-42- G.C. Peden British Treasury Responses to... (Series : Economic Thought and Policy in the Interwar Period) based on liquidity preference. The National Insofar at the Treasury view of 1929 drew Debt Enquiry's first report, drafted by Hop- upon theory, the relevant authorities were kins, quoted the General Theory, but bal- Cunningham and Hawtrey rather than Mill or anced Keynes's theory with statements of the later economists whom Keynes described as conditions within which it might be expected classical.' to work. These were the continuation of G.C. Peden : University of Stirling, Scotland, UK direct controls over capital issues on the stock exchange ; government allocation of Notes goods, such as steel, needed for investment 1) This article is based on research funded by the British Academy for an edition of Trea- during the reconstruction period ; and perma- sury documents to be published in the British nent control over external capital move- Academy's Records of Social and Economic ments. Hopkins also repeated a warning, History series. An earlier version was originally made in the white paper on employ- presented at a workshop at Sano Shoin, ment policy, that theory could be applied with Hitotsubashi University, Tokyo, in Decem- confidence to practical policy only as experi- ber 2002. 2) Note by F. W. Leith-Ross, 9 August 1928, ence accumulated (Howson 1993, 47-52; Treasury papers, series 172, file 2095 (here- Peden 2000, 356-57). The report provided the after T 172/2095), the National Archives of basis for monetary policy during the period the United Kingdom : Public Record Office of the Labour government in 1945-51, while (hereafter TNA : PRO). direct controls on investment were still effec- 3) R.G. Hawtrey, The Liberal unemployment tive. Thereafter variations in interest rates plan; 13 June 1929, T 175/26, TNA : PRO. 4) Questions for Keynes; 20 March 1933, T 175/ were once more used to influence demand. 17, TNA : PRO. X Conclusions 5) Hawtrey, Mr Keynes's General theory of employment, interest and money; 14 March In the light of experience, it is not clear 1936, T 208/195, TNA : PRO. that all of the Treasury's criticisms of 6) Minutes of Treasury Organisation Commit- Keynes were wrong. Keynes clearly had the tee, 9 March 1937, T 199/50 c, TNA : PRO. 7) Inter-Departmental Committee on Public better of the argument over the gold stan- Capital Expenditure : Report, 13 August dard, as the Treasury would have acknowled- 1937, Cabinet Office papers, series 24, volume ged by 1932. On the other hand, Treasury 640, TNA : PRO. scepticism about the political effects of more 8) Hawtrey, '"How to avoid a slump" : Mr flexible rules of public finance with regard to Keynes's articles in The Times (12th to 14th January, 1937); 13 February 1937, T 208/196, public works and fiscal policy had some justi- TNA : PRO. fication. There are echoes of their concerns 9) Sir Frederick Phillips, Keynes on borrow- in Gordon Brown's golden rule,' introduced ing; 24 April 1939, T 177/47, TNA : PRO. For in 1998, whereby over the economic cycle discussion of this first attempt to use fiscal government is to borrow only to invest and policy to manage macroeconomic demand, not to fund current expenditure (HM Trea- see Middleton (1985),118-21,181. 10) Note by Phillips, 29 April 1939, T 208/201, sury 2002, 135-40; 159-73). Treasury offi- TNA : PRO. cials in the inter-war period drew upon practi- 11) Dennis Robertson, The problem of "pre-war" cal experience of carrying out public works finance; 7 July 1939, T 160/1289/F.19426/1, programmes as well as economic theory. TNA : PRO.

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