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　　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

　　GENERALTHEORYOFEMPLOYMENT

　　centreswasabout5percent，andthegilt-edgedratebetween3and3&frac12；percent；andthattheseratesofinterestweremodestenoughtoencouragearateofinvestmentconsistentwithanaverageofemploymentwhichwasnotintolerablylow。Sometimesthewage-unit，butmoreoftenthemonetarystandardorthemonetarysysteminparticularthroughthedevelopmentofbank-money，wouldbeadjustedsoastoensurethatthequantityofmoneyintermsofwage-unitswassufficienttosatisfynormalliquidity-preferenceatratesofinterestwhichwereseldommuchbelowthestandardratesindicatedabove。Thetendencyofthewage-unitwas，asusual，steadilyupwardsonthewhole，buttheefficiencyoflabourwasalsoincreasing。Thusthebalanceofforceswassuchastoallowafairmeasureofstabilityofprices；&frac34；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。Ifthiswasouronlyproblemnow&frac34；ifasufficientdegreeofdevaluationisallweneed&frac34；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，thephenomenonofthecrisis&frac34；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

　　GENERALTHEORYOFEMPLOYMENT

　　organisedinvestmentmarkets，undertheinfluenceofpurchaserslargelyignorantofwhattheyarebuyingandofspeculatorswhoaremoreconcernedwithforecastingthenextshiftofmarketsentimentthanwithareasonableestimateofthefutureyieldofcapital-assets，that，whendisillusionfallsuponanover-optimisticandover-boughtmarket，itshouldfallwithsuddenandevencatastrophicforce。[146]Nloreover，thedismayanduncertaintyastothefuturewhichaccompaniesacollapseinthemarginalefficiencyofcapitalnaturallyprecipitatesasharpincreaseinliquidity-preference&frac34；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，bethecase&frac34；indeeditislikelytobe&frac34；thattheillusionsoftheboomcauseparticulartypesofcapital-assetstobeproducedinsuchexcessiveabundancethatsomepartoftheoutputis，onanycriterion，awasteofresources；&frac34；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-

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　　sume，sogreatthatitwouldeventuallyleadtoastateoffullinvestmentinthesensethatanaggregategrossyieldinexcessofreplacementcostcouldnolongerbeexpectedonareasonablecalculationfromafurtherincrementofdurablegoodsofanytypewhatever。Moreover，thissituationmightbereachedcomparativelysoon&frac34；saywithintwenty-fiveyearsorless。Imustnotbetakentodenythis，becauseIassertthatastateoffullinvestmentinthestrictsensehasneveryetoccurred，notevenmomentarily。

　　Furthermore，evenifweweretosupposethatcontemporaryboomsareapttobeassociatedwithamomentaryconditionoffullinvestmentorover-investmentinthestrictsense，itwouldstillbeabsurdtoregardahigherrateofinterestastheappropriateremedy。Forinthiseventthecaseofthosewhoattributethediseasetounder-consumptionwouldbewhollyestablished。

　　Theremedywouldlieinvariousmeasuresdesignedtoincreasethepropensitytoconsumebytheredistributionofincomesorotherwise；sothatagivenlevelofemploymentwouldrequireasmallervolumeofcurrentinvestmenttosupportit。

　　IV

　　Itmaybeconvenientatthispointtosayawordabouttheimportantschoolsofthoughtwhichmaintain，fromvariouspointsofview，thatthechronictendencyofcontemporarysocietiestounder-employmentistobetracedtounder-consumption；&frac34；thatistosay，tosocialpracticesandtoadistributionofwealthwhichresultinapropensitytoconsumewhichisundulylow。

　　Inexistingconditions&frac34；or，atleast，intheconditionwhichexisteduntillately&frac34；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；&frac34；topromoteinvestmentand，atthesametime，topromoteconsumption，notmerelytothelevelwhichwiththeexistingpropensitytoconsumewouldcorrespondtotheincreasedinvestment，buttoahigherlevelstill。If&frac34；totakeroundfiguresforthepurposeofillus-

　　[Page326]THE

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　　tration&frac34；theaveragelevelofoutputofto-dayis15percentbelowwhatitwouldbewithcontinuousfullemployment，andif10percentofthisoutputrepresentsnetinvestmentand90percentofitconsumption&frac34；if，furthermore，netinvestmentwouldhavetorise50percentinordertosecurefullemploymentwiththeexistingpropensitytoconsume，sothatwithfullemploymentoutputwouldrisefrom100to115，consumptionfrom90to100andnetinvestmentfrom10to15:&frac34；thenwemightaim，perhaps，atsomodifyingthepropensitytoconsumethatwithfullemploymentconsumptionwouldrisefrom90to103andnetinvestmentfrom10to12。

　　V

　　Anotherschoolofthoughtfindsthesolutionofthetradecycle，notinincreasingeitherconsumptionorinvestment，butindiminishingthesupplyoflabourseekingemployment；i。e。byredistributingtheexistingvolumeofemploymentwithoutincreasingemploymentoroutput。

　　Thisseemstometobeaprematurepolicy&frac34；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；&frac34；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；&frac34；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；whilstatthetimewhenJevonswrote&frac34；andmoreparticularlyovertheperiodtowhichmostofhisstatisticsapplied&frac34；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，stocksofallkinds&frac34；andparticularlyofagri-

　　[Page332]THE

　　GENERALTHEORYOFEMPLOYMENT

　　culturalproducts&frac34；stillstoodataveryhighlevel。The\'NewDeal\'partlyconsistedinastrenuousattempttoreducethesestocks&frac34；bycurtailmentofcurrentoutputandinallsortsofways。Thereductionofstockstoanormallevelwasanecessaryprocess&frac34；aphasewhichhadtobeendured。Butsolongasitlasted，namely，abouttwoyears，itconstitutedasubstantialoffsettotheloanexpenditurewhichwasbeingincurredinotherdirections。Onlywhenithadbeencompletedwasthewaypreparedforsubstantialrecovery。

　　RecentAmericanexperiencehasalsoaffordedgoodexamplesofthepartplayedbyfluctuationsinthestocksoffinishedandunfinishedgoods&frac34；\'inventories\'

　　asitisbecomingusualtocallthem&frac34；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

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　　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；&frac34；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，moneywas&frac34；tousetheterminologyofto-day&frac34；afactorofproduction，onthesamefootingasland，sometimesregardedas\'artificial\'wealthasdistinctfromthe\'natural\'wealth；interestoncapitalwasthepaymentfortherentingofmoneysimilartorentforland。Insofarasmercantilistssoughttodiscoverobjectivereasonsfortheheightoftherateofinterest&frac34；andtheydidsomoreandmoreduringthisperiod&frac34；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，Frenchmerchantsandstatesmencomplainedoftheprevailingscarcityofcoindisettedesesp&egrave；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。But&frac34；standingwithonefootinthemercantilistworldandwithonefootintheclassicalworld[160]&frac34；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:Schr&ouml；tter，forinstance，employedtheusualmercantilistargumentsindrawingaluridpictureofhowthecirculationinthecountrywouldberobbedofallitsmoneythroughagreatlyincreasingstatetreasury……he，too，drewaperfectlylogicalparallelbetweentheaccumulationoftreasurebythe[Page345]NOTES

　　ONMERCANTILISM，ETC。monasteriesandtheexportsurplusofpreciousmetals，which，tohim，wasindeedtheworstpossiblethingwhichhecouldthinkof。DavenantexplainedtheextremepovertyofmanyEasternnations&frac34；whowerebelievedtohavemoregoldandsilverthananyothercountriesintheworld&frac34；bythefactthattreasure\'issufferedtostagnateinthePrinces\'Coffers\'……Ifhoardingbythestatewasconsidered，atbest，adoubtfulboon，andoftenagreatdanger，itgoeswithoutsayingthatprivatehoardingwastobeshunnedlikethepest。