I extract the following from an excellent post on the EconLib blog. on Alfred Marshall's view on Depression as expressed in a book he published in 1879. Later, he felt it was too brief & lacking in rigour & sought to have existing copies recalled & destroyed.
Excerpted from Alfred and Mary Paley Marshall,
The Economics of Industry, 1879, Book 3 c.1, s.4, italics added.
After every crisis, in every period of commercial depression, it is said that supply is in excess of demand…And it is thought that this state of things is one of general over-production.
Should the Government impose output quotas on enterprises or buy up commodities & destroy them? No. Ordinary people needed to be able to buy more nice things.
We shall however find that it really is nothing but a state of commercial disorganization; and that the remedy for it is a revival of confidence.
There is a coordination or concurrency problem. If everybody starts investing & hiring more workers the outcome will be good. But who will kickstart this process? The first mover might go bankrupt.
…For when confidence has been shaken by failures, capital cannot be got to start new companies or extend old ones. …Other trades, finding a poor market for their goods, produce less; they earn less, and therefore they buy less; the diminution of the demand for their wares makes them demand less of other trades. Thus commercial disorganization spreads, the disorganization of one trade throws others out of gear, and they react on it and increase its disorganization.
This sounds quite Keynesian!
The chief cause of the evil is a want of confidence.
Keynes would speak of 'animal spirits'.
The greater part of it could be removed almost in an instant if confidence could return, touch all industries with her magic wand, and make them continue their production and their demand for the wares of others….Confidence by growing would cause itself to grow ….
There is of course no formal agreement between the different trades to begin again to work full times and so make a market for each other’s wares. But the revival of industry comes about through the gradual and often simultaneous growth of confidence among many various trades; it begins as soon as traders think that prices will not continue to fall: and with a revival of industry prices rise.
Schumpeter might say that new technology creates new products. True, their price will decline as economies of scope & scale kick in but lots of people want to be the first person in their social service to get the cool new gadget.
I suppose the automobile was a big game-changer. It is estimated that London had 300,000 horses in the late nineteenth century. There are only 200 now. That's why the streets aren't caked with dung.
I extract the following from the Social Democracy blog.The UK “Royal Commission on the Value of Gold and Silver” was instituted in 1887 after a report on the “depression of trade.”
Was it caused by deflation- i.e. increased purchasing power of money? Was the solution to go off gold & introduce 'bi-metalism' (which Marshall endorsed in his last book)? More radically, why not have a pure fiat currency? After the Great War, many countries had no choice but to embrace this option.
The commission was to investigate the question of changes in the value of gold and silver and the effects on trade and production.Alfred Marshall was called to give evidence and this exchange with Henry Chaplin is interesting:“[Henry Chaplin, MP:] Do you share the general opinion that during the last few years we have been passing through a period of severe depression? …[Marshall]: Yes, of severe depression of profits.[Henry Chaplin, MP:. And that has been during a period of abnormally low prices? …[Marshall]: A severe depression of profits and of prices.
real wages had risen but many more people were having to apply for assistance under the Poor Law. Since there was a stigma attached to this, many people were living miserable lives. Marxist & other Socialist ideologies were gaining ground in the 1880s.
I have read nearly all the evidence that was given before the Depression of Trade and Industry Commission, and I really could not see that there was any very serious attempt to prove anything else than a depression of prices, a depression of interest, and a depression of profits; there is that undoubtedly. I cannot see any reason for believing that there is any considerable depression in any other respect.” (Court 1965: 20).
But the 'poor rate' was going up. The rate-payer wasn't happy. Moreover, high rates means lower property prices, ceteris paribus. There is less incentive for building & construction.
So according to Marshall there was a “severe depression of profits.”With price deflation, there was a squeeze on profits, as deflated prices meant lower profits in nominal terms and perhaps even in real terms when wages did not fall enough as well.
'downward stickiness of wages'!
Labour apparently often had rising real wages in this period, as wages did not fall as rapidly as prices. When business tried to cut wages, that provoked labour disputes (Livingston 1986: 34).
Indeed. This was the period of 'New Unionism' affecting less skilled & women (e.g. the Byrant & May match girls). Unlike the 'Labour Aristocracy' which was happy enough with the two main parties, the New Unions could sponsor a Labour party similar to the Social Democrats in Germany. Bismarck was happy to do a deal with them though they were more Marxist and radical in their thinking than the British working class.
Marshall felt that the standard economic model places too much emphasis on the profit motive. He distinguished between the "Honest" Entrepreneur and the 'cheating merchant'. The "bold and virtuous entrepreneur" often acted in the best interest of the community.
In the "ordinary business of life," business confidence is often rooted in the character of industrial leaders (the "gentlemen" of industry) who have a sense of social responsibility, rather than just cold, calculating self-interest.
Marshall later focused more heavily on the idea that "the most valuable of all capital is that invested in human beings'. The UK had been a little tardy in adopting free universal education. Germany was pulling ahead in some technological fields.
Keynes, in his beautifully written biographical essay on Marshall explains why his mentor turned from Mathematics or the lure of Missionary work to Economics. He quotes Marshall at length-
'About the year 1867 (while mainly occupied with teaching Mathematics at Cambridge), Mansel's Bamptont Lectures came into my hands and caused me to think that man's own possibilities were the most important subject for his study.
No doubt, Darwin's theory had an important effect. Why wait for 'natural selection'? Man could improve his own species-life.
So I gave myself for a time to the study of Metaphysics; but soon passed to what seemed to be the more progressive study of Psychology. Its fascinating inquiries into the possibilities of the higher and more rapid development of human faculties brought me into touch with the question: how far do the conditions of life of the British (and other) working classes generally suffice for fullness of life ?
Previously, the concern was that if conditions of life for workers were too horrible, it would be difficult for them to remain Christian. Vice would triumph amongst the Mill workers even as Wealth piled up in Mayfair
Older and wiser men told me that the resources of production do not suffice for affording to the great body of the people the leisure and the opportunity for study; and they told me that I needed to studv Political Economy. I followed their advice, and regarded myself as a wanderer in the land of dry facts; looking forward to a speedy return to the luxuriance of pure thought. But the more I studied economic science, the smaller appeared the knowledge which I had of it, in proportion to the knowledge that I needed; and now, at the end of nearly half a century of almost exclusive study of it, I am conscious of more ignorance of it than I was at the beginning of the study."
Sadly, mathematical economists discarded any such humility.
In 1868, when he was still in his metaphysical stage, a desire to read Kant in the original led him to Germany. "
Mill had attacked the contemporary attempt to found Christian dogmatics on Kantian metaphysics with his essay ' An Examination of Sir William Hamilton's Philosophy (1865)'
Kant my guide," he once said, " the only man I ever worshipped: but I could not get further: beyond seemed misty, and social problems came imperceptibly to the front. Are the opportunities of real life to be confined to a few ? " He lived at Dresden with a German Professor who had previously coached Henry Sidgwick. Hegel's Philosophy of History greatly influenced him. He also came in contact with the work of the German economists, particularly Roscher.
a founder of the Historical school of Political Economy.
Keynes seeks to explain why good economists are rare-
the master-economist must possess a rare combination of gifts.
Why not just find one principle or methodology & see if it fits a wide variety of cases? I suppose what Keynes means by 'master-economist' is a person who best captures or most improves the Weltanschauung of his age.
He must reach a high standard in several different directions and must combine talents not often found together. He must be mathematician, historian, statesman, philosopher- in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought.
Samuelson would have disagreed. For his Economics is ergodic and of restricted scope- it only deals with what is scarce. There is hysteresis in history and metaphysics in philosophy. But neither are needful if your task is how to minimize the use of scarce resources and maximise the 'surplus' which accrues to society. Here Utility is merely the other side of the coin of productivity. What is useful enables you to do more with less.
He must study the present in the light of the past for the purposes of the future.
Marshall's world was rescued from deflation by new, high-tech, industries. Sadly, this also made war much more lethal.
No part of man's nature or his institutions must lie entirely outside his regard. He must be purposefil and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician. Much, but not all, of this ideal many-sidedness Marshall possessed. But chiefly his mixed training and divided nature furnished him with the most essential and fundamental of the economist's necessary gifts- he was conspicuously historian and mathematician, a dealer in the particular and the general, the temporal and the eternal, at the same time.
The problem was 'Knightian Uncertainty'- we don't all possible future states of the world or how probable they are. This militates for something like 'regret minimization' rather than utility maximisation.
Keynes plays up the importance of the four months Marshall spent in the US in 1875. I think he believed that America would soon start to experience diminishing returns in agriculture- which was what Keynes said in 'Economic consequences of the peace'. I suppose 'increasing returns' (or 'non-convexity') is difficult to express mathematically.
Marshall himself gave this account of his intellectual development between 1867 & 1875
"While still giving private lessons in mathematics, he translated as many as possible of Ricardo's reasonings into mathematics; and he endeavoured to make them more general.
So 'diminishing returns' got baked into his thinking.
Meanwhile he was attracted towards the new views of economics taken by Roscher and other German economists; and by Marx, Lassalle and other Socialists. But it seemed to him that the analytical methods of the historical economists were not always sufficiently thorough to justify their confidence that the causes which they assigned to economic events were the true causes. He thought indeed that the interpretation of the economic past was almost as difficult as the prediction of the future. The Socialists also seemed to him to underrate the difficulty of their problems, and to be too quick to assume that the abolition of private property would purge away the faults and deficiencies of human nature. . . . He set himself to get into closer contact with practical business and with the life of the working classes. On the one side he aimed at learning the broad features of the technique of every chief industry; and on the other he sought the society of trade unionists, co-operators and other working-class leaders. Seeing, however, that direct studies of life and work would not yield much fruit for many years, he decided to fill the interval by writing a separate monograph or special treatise on Foreign Trade; for the chief facts relating to it can be obtained from printed documents. He proposed that this should be the first of a group of monographs on special economic problems; and he hoped ultimately to compress these monographs into a general treatise of a similar scope to Mill's. After writing that larger treatise, but not before, he thought he might be ready to write a short popular treatise. He has never changed his opinion that this is the best order of work; but his plans were overruled, and almost inverted, by the force of circumstances. He did indeed write the first draft of a monograph on Foreign Trade; and in 1875 he visited the chief seats of industry in America with the purpose of studying the problem of Protection in a new country. But this work was suspended by his marriage; and while engaged, in conjunction with his wife, in writing a short account of the Economics of Industry, forcibly simplified for working-class readers, he contracted an illness so serious that for some time he appeared unlikely to be able to do any more hard work. A little later he thought his strength might hold out for recasting his diagrammatic illustrations of economic problems. Though urged by the late Professor Walras about 1873 to publish these, he had declined to do so; because he feared that if separated from all concrete study of actual conditions, they might seem to claim a more direct bearing on real problems than they in fact had.
Marshall's scrupulousness meant Jevons got priority. However, credit for the first diagrammatic representation of consumer & producer surplus goes to a French engineer, Jules Dupuit, published his seminal paper, "De la mesure de l'utilité des travaux publics" (On the Measurement of the Utility of Public Works) in 1844. I suppose he is the true father of welfare economics.
Keynes believed that Marshall had a fully worked out theory of money and had anticipated the finding of Irving Fischer & others.
Since Money was from the early seventies onwards one of his favourite topics for lectures, his main ideas became known to pupils in a general way,' with the result that there grew up at Cambridge an oral tradition, first from Marshall's own lectures and since his retirement from those of Professor Pigou, different from, and (I think it may be claimed) superior to, anything that could be found in printed books until recently.
Why did Marshall not simply endorse fiat money with monetary policy focused on price stability? Perhaps it was the fear of inflation engendered by irresponsible politicians. If you can print money why not engage in wars of 'national glory'?
It may be convenient at this point to attempt a brief summary of Marshall's main contributions to Monetary Theory. Marshall printed nothing whatever on the subject of Money previously to the Bimetallic controversy, and even then he waited a considerable time before he intervened. His first serious contribution to the subject was contained in his answers to a questionnaire printed by the Royal Commission on the Depression of Trade and Industry in 1886. This was followed by his article on " Remedies for Fluctuations of General Prices " in the Contemporary Review for March 1887; and a little later by his voluminous evidence before the Gold and Silver Commission in 1887 and 1888. In 1899 came his evidence before the Indian Currency Committee. But his theories were not expounded in a systematic form until the appearance of Money Credit and Commerce in 1923. By this date nearly all his main ideas had found expression in the works of others. He had passed his eightieth year; his strength was no longer equal to much more than piecing together earlier fragments; and its jejune treatment, carefully avoiding difficulties and complications, yields the mere shadow of what he had had it in him to bring forth twenty or (better) thirty years earlier.
Alternatively, he didn't really have a theory. Perhaps, he believed deflation was good for the working class as well as for the 'widows & orphans' who lived on fixed incomes. The problem was unemployment. Maybe, he thought this would encourage emigration to the Settler Colonies which, in turn, would rebound to the advantage of the home islands.
Keynes's account of Marshall's theory of money (given in 1924) is interesting because it contrasts to much that was revolutionary in his own General Theory.
He always taught that the value of money is a function of its supply on the one hand,
this elides the question of what is money & to what extent it is the same thing as 'credit'. Depending on what people Expect, somethings are money and others aren't. If you think the world is going to hell, you may bury gold and silver and use something whose value is not expected to rise. This is Gresham's law- 'Bad money drives out good'
and the demand for it, on the other, as measured by " the average stock of command over commodities which each person cares to keep in a ready form."
This is Keynes's 'Transactions' demand. But, it fluctuates. In boom times bills of exchange may be very liquid. Also, technological advances reduce 'transaction' demand. We now have much less cash in our wallet than we did thirty years ago.
He went on to explain how each individual decides how much to keep in a ready form as the result of a balance of advantage between this and alternative forms of wealth. " The exchange value of the whole amount of coin in the Kingdom," he wrote in the manuscript of1871 mentioned above, "is just equal to that of the whole amount of the commodities over which the members of the community have decided to keep a command in this ready form.
But this changes if Credit is easily available because the economy is booming.
Thus with a silver currency if we know the number of ounces of silver in circulation
if the value of silver is rising, more may be hoarded- i.e. be pulled out of circulation.
we can determine what the value of one ounce of silver will be in terms of other commodities by dividing the value of above given amount of commodities
we have no way of knowing what the amount might be.
by the number of ounces.
This may be the case if ex post equals ex ante and there are no endogenous shocks or non-convexities etc. But, otherwise, this is a fairy tale.
Suppose that on the average each individual in a community chose to keep command over commodities in a ready form to the extent of one-tenth of his year's income.
Ex ante, he may wish to do so. Ex post he discovers it is impossible because prices unexpectedly rose or Credit conditions changed. The other point is poorer people may have no choice but to hold all income in coinage. Keynes would emphasize the different 'marginal propensities' of different classes of people. You could increase the money supply but if that money gets hoarded by the rich and never reaches the pockets of the poor, you would have a 'liquidity trap'. Keynes introduces 'Speculative Demand' to overcome this problem but emphasizes that you have to boost aggregate demand to get out of a slump;
The money, supposed in this case exclusively silver, in the Kingdom will be equal in value to one-tenth of the annual income of the kingdom. Let their habits alter, eachperson being willing, for the sake of gain- in other ways, to be to a greater extent without the power of having each want satisfied as soon as it arises. Let on the average each person choose to keep command over commodities in a ready form only to the extent of a twentieth part of his income.
The velocity of circulation falls. Cateris paribus prices & economic activity fall.
So much silver as before not being wanted at the old value, it will fall in value.
Not if prices crash because of the lack of aggregate demand.
It would accordingly be more used in manufactures,
not if manufacturers can't sell their wares to a more frugal populace.
while its production from the mines would be checked. ..."
Not necessarily. People may sell stocks and shares & buy precious metal.
He points out that the great advantage of this method of approach is that it avoids the awkward conception of " rapidity of circulation (though he is able to show the exact logical relation between the two conceptions):
It was necessary. MV=PT.
" When, however, we try to establish a connection between ' the rapidity of circulation ' and the value of money, it introduces grave complications. Mr. Mill is aware of the evil (Political Economy, Book III. chap. viii. ? 3, latter part), but he has not pointed the remedy."
There was no remedy. If Business Confidence collapses. People tighten their belts & invest in bullion. The velocity of circulation falls. Prices fall. Economic activity falls even though there is no change in the money supply.
2 Marshall also expounded long ago the way in which distrust of a currency raises prices by diminishing the willingness of the public to hold stocks of it-
if you distrust the currency but are obliged to accept it because it is legal tender, you try to spend it as soon as possible. Velocity of circulation goes up. This may raise prices or output or both.
a phenomenon to which recent events have now called everyone's attention; and he was aware that the fluctuation in the price level, which is an accompaniment of the trade cycle, corresponds to a fluctuation in the volume of " ready command " which the public desire to hold.
In countries with hyperinflation, everybody rushes to pay off their mortgages and to buy land & other imperishable commodities.
(2) The distinction between the "real" rate of interest and the "money" rate of interest, and the relevance of this to the credit cycle, when the value of money is fluctuating. The first clear exposition of this is, I think, that given in the Principles (1890), Book VI. chap. vi. (concluding note).
Sadly, we don't know the real rate even after the fact because there is no perfect measure of inflation. As Milton Friedman would later explain there is a 'signal extraction problem'. Keynes himself would speak of 'money illusion'. Savers may be fooled by high nominal but negative real interest rates.
(3) The causal train by which, in modern credit systems, an additional supply of money influences prices, and the part played by the rate of discount. The locus classicus for an account of this, and the only detailed account for many years to whichstudents could be referred, is Marshall's Evidence before the Gold and Silver Commission, 1887 (particularly the earlier part of his evidence), supplemented by his Evidence before the Indian Currency Committee, 1899. It was an odd state of affairs that one of the most fundamental parts of Monetary Theory should, for about a quarter of century, have been available to students nowhere except embedded in the form of question-and answer before a Government Commission interested in a transitory practical problem.
Marshall's theory was that if the Central bank rate of discount was held below the "natural" or "real" rate of interest, it encouraged businesses to borrow and invest, driving up the prices of commodities. The problem here is that there might be spare capacity and/or increasing returns. Moreover, nobody knows the natural or real rate. It itself depends on Expectations.
(4) The enunciation of the "Purchasing Power Parity" Theory as determining the rate of exchange between countries with mutually inconvertible currencies.
It was obvious this theory was false. That is why so many British people preferred to settle on the Continent where their pensions or rents would go much further.
In substance this theory is due to Ricardo, but Professor Cassel's restatement of it in a form applicable to modern conditions was anticipated by Marshall in the memorandum 1 appended to his Evidence before the Gold and Silver Commission (1888). It also had an important place in the conclusions which he laid before the Indian Currency Committee in 1899.
There were some Indian Marshallians. They opposed this theory & also wanted infant industry protection.
The following from an abstract of his opinions handed in by Marshall to the Gold and Silver Commission gives his theory in a nutshell: " Let B have an inconvertible paper-currency (say roubles). In each country prices will be governed by the relation between the volume of the currency and the work it has to do. The gold price of the rouble will be fixed by the course of trade just at the ratio which gold prices in A bear to rouble prices in B (allowing for cost of carriage)."
Russia did go on to gold at the end of the nineteenth century. However, most countries restricted convertibility or private sale of gold during the Great War and then, later on, during the Economically turbulent Thirties. Even America, under FDR, did so.
Fluctuations in the value of money aren't necessarily a bad thing. Sometimes, rents need to be inflated away. The landowning class no longer plays a vital role in the defence of the country or the safeguarding of the Social Order.
Marshall was firmly on the side of price stability.
" A great cause of the discontinuity of industry," he wrote, " is the want of certain knowledge as to what a pound is going to be worth a short time hence. . .
the solution is factoring (i.e. selling on future revenue) or hedging on futures' markets
. This serious evil can be much diminished by a plan which economists have long advocated. In proposing this remedy I want government to help business, though not to do business. It should publish tables showing as closely as may be the changes in the purchasing power of gold,
There will be either Laspeyres or Paasche bias- i.e. overestimation or underestimation because tastes change & new products become available.
and should facilitate contracts for payments to be made in terms of units of fixed purchasing power. . . .
why not just sell on the future income stream? After all a pound today is the same value as any other pound today.
The unit of constant general purchasing power would be applicable, at the free choiceof both parties concerned, for nearly all contracts for the payment of interest, and for the repayment of loans; and for many contracts for rent, and for wages and salaries. . . .
Friedman was a big fan of 'indexing'. But volatility isn't a bad thing in itself. It drives liquidity and 'creative destruction'.
Keynes highlights this remarkable passage which Marshall consigns to a footnote-
Every plan for regulating the supply of the currency, so that its value shall be constant, must, I think, be national and not international.
In which case a profligate country may inflate so as to gain economies of scope & scale to the detriment of more cautious neighbours. Indeed, they may have deflation as foreigners buy their currency as a 'store of value' (i.e. velocity of circulation falls).
I will indicate briefly two such plans, though I do not advocate either of them.
On the first plan the currency would be inconvertible. An automatic Government Department would buy Consols for currency whenever it was worth more than a unit, and would sell Consols for currency whenever it was worth less. ...
i.e. Open Market operations would target inflation. The problem is the timing might be wrong. Also there would be political pressure for a laxer stance.
The other plan is that of a convertible currency, each note giving the right to demand at a Government Office as much gold as at that time had the value of half a unit together with as much silver as had the value of half a unit."
This puts fractional reserve banking in peril & could trigger panics. The overall effect would be contractionary.
The Economist mocked at Symmetallism
i.e. a currency composed of gold welded to an equal value of sliver.
and the optional Tabular Standard; and Marshall, always a little over-afraid of being thought unpractical or above the head of the " businessman " (that legendary monster), did not persevere.
Back then, Economists had humility. They may not have had the Evangelical faith of their clerical ancestors, but were concerned with Ethics as much as with Efficiency.
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