Hawtrey and Some Economic Policy Issues

Hawtrey’s appointment as Director of Financial Enquiries in 1919 came as double-digit wartime and post-war inflation continued. The effective suspension of the gold standard and the issuance of Treasury notes to finance the war had contributed to a steep rise in the price level. The Interim Report of the Cunliffe Committee, delivered in August 1918, recommended the restoration of pre-war arrangements. These included a return to an effective gold standard, an end to government borrowing, the use of the Bank of England’s discount rate tool to control the demand for credit and limits on note issue. The final report in 1920 largely reiterated these recommendations. Hawtrey approved of the Committee’s recommendations. He did not challenge the gold standard as the basis for money and exchange markets and his analysis led him to support measures to stabilize prices.

Stopping inflation required an end to inflationary deficit finance. The government in mid-1919 was borrowing from the Bank of England at a three month rate (3.5%) lower than the Bank’s discount rate (5%). To make Bank rate ‘effective’ the government had to accept a higher rate. That move was made in October, but it was only the first step and further increases were required to stop inflation and the fall in the value of sterling in terms of gold. Hawtrey supported higher rates but believed that only a short period of dear money would be needed to break inflationary expectations after which rates could be brought down quickly. Bank rate was raised to 7% in April 1920 and over the next year inflation was reversed. Reviewing the results, Hawtrey saw confirmation of his analysis of credit policy (Howson 1975: 23-24). A similar deflationary policy was being pursued in the USA and the combined effect was simultaneously to exacerbate global deflation and prevent recovery in sterling’s exchange rate. Hawtrey, with a perhaps exaggerated belief in the financial power of London, advocated various mechanisms to send gold to the USA to trigger interest rate cuts there. He also began to strongly criticize the Bank of England for being too slow to cut interest rates as unemployment rose and deflation took hold in Britain.

Hawtrey supported the return to an international gold standard though he recognized it as a flawed standard, subject to variation in the ‘wealth value’ of gold. He also pointed to the danger of a sharp increase in the demand for gold from many countries seeking concurrently to return to the standard. To economize on gold he proposed a gold exchange standard and some form of international cooperation, primarily involving America and Britain.

Hawtrey was the main author of proposals for international monetary cooperation that were adopted at the Genoa Conference of 1922. The proposals aimed at facilitating a return to the gold standard while avoiding a deflationary rush to accumulate gold. Countries were to aim for price stability and to eliminate internal circulation of gold as domestic currency. Reserves for most countries were to be holdings of the monies of financial centres who would maintain the stock of gold reserves. Fluctuations in the value of gold, which Hawtrey diagnosed as the key cause of the pre-war trade cycle, would be mitigated with central bank management. The Conference approved the proposal and directed central banks to meet and develop the means to implement them, but the central banks did not follow through. Hawtrey frequently lamented the failure to act on the Genoa resolutions as the source of subsequent global economic weakness.

Hawtrey subsequently accepted the British goal of returning sterling to the pre-war parity in terms of gold (or, equivalently, the US dollar) on the grounds that it would make the standard more credible. One of his key concerns was sustaining London’s position as a financial centre. Stable exchanges, which at the time implied a gold standard, would strengthen London’s role in financing international trade. However, this was not a goal to be achieved at any price. In fact, he expected the pound to move to parity and, in his memorandum on the gold standard for Churchill, wrote that ‘no active measures need be taken’ (Moggridge 1972: 72-73). Hawtrey expected rising prices in the USA because of the abundance of reserves there, reducing the amount of sacrifice required of Britain. He also held that if the economic burden became too high, then the parity should be abandoned, a perspective that might seem at odds with his approval of returning to the pre-war parity because it enhanced credibility.

Following the return to gold in 1925 British unemployment persisted at a high level and Bank rate remained, in Hawtrey’s view, too high. He criticized the Bank of England for keeping Bank rate high and for holding on to gold reserves that they ought to have let go, a mechanism which would have promoted credit expansion in other countries as well. Looking back in A Century of Bank Rate published in 1938 he wrote: ‘It is, I think, not unreasonable to hold that a policy of cheap money and credit relaxation from the beginning would have had a favourable effect on economic activity throughout the world in 1925, and would have made the task of retaining the Bank of England’s gold quite easy’ (Hawtrey 1938: 141).

The October 1929 crisis in US financial markets came for Britain at a time of high unemployment. The financial turmoil culminated in Britain abandoning the gold standard in September 1931. Bank rate was raised to 6% to defend sterling and prevent an unrestrained fall in the exchange rate. It remained at 6% for five months and was then cut to 2% between February and June 1932. Hawtrey approved of the speed of the cut. With the advantage of hindsight, however, he concluded that ‘it was too late; cheap money by itself was insufficient to start revival. The vicious circle of deflation, broken for a moment by the suspension of the gold standard, had been joined again’

(ibid.: 145).

Based on the change in prices subsequent to the 1925 return to gold, Hawtrey argued for a depreciation of sterling of 30% and using Bank rate subsequently to stabilize it at that level. That would restore rough equilibrium between British costs and world prices. He warned against going further, the danger being an upward pressure on wages (Peden 2000: 255-260).

When economic activity did not recovery fully in response to low Bank rate, Hawtrey developed an analysis of a trade or credit deadlock: ‘[I]f the depression is very severe, enterprise will be killed. It is possible that no rate of interest, however low, will tempt dealers to buy goods’ (Hawtrey 1933: 29). An economy would not remain stuck below full employment naturally but only if the central banks made severe mistakes. Even if bringing interest rates to the lowest possible level proved ineffective, Hawtrey held that monetary policy would eventually be made effective if continued asset purchases by central banks increased the money supply sufficiently. This was a policy that could be pursued without limit.

Hawtrey was critical of the reconstruction of the international monetary order enshrined in the Bretton Woods agreement. He was sceptical about the fixed exchange rate regime, with adjustments allowed only with the approval of the International Monetary Fund (IMF). He also viewed it as imparting an inflationary bias in monetary policy and for failing to enshrine any commitment to monetary cooperation to stabilize the price level (Hawtrey 1946b).^[1]

In 1949, Britain used the IMF mechanism to devalue the pound from $4.03 to $2.80, a level that Hawtrey saw as far too low. Despite subsequent inflation of both prices and costs, the exchange rate remained too low, leading to overemployment and upward pressure on prices. With monetary policy restricted to defending the exchange rate, the value of money was left to erode and rather than being a fixed source of stability, the exchange rate was repeatedly tested in financial markets. This was a recurrent theme of Hawtrey’s writings in the 1950s and 1960s (see, for example, Hawtrey 1954).

Hawtrey’s analysis, throughout his long career, led him to the conclusion that price stability was the appropriate target for monetary policy. In a new Foreword to A Century of Bank Rate in 1962 he wrote: ‘[W]hen we look back on the monetary experience we have had since 1932, surely the moral to be drawn from it is above all the vital importance of maintaining stability of the value of the money unit’ (Hawtrey 1962b: xxi).

• [1] Hawtrey voiced his concerns while the Bretton Woods negotiations were underway. Keynes, who led theBritish team, had some sympathy but in the context of the day, Hawtrey’s concerns would impede moving forward. Lionel Robbins, who was also part of the British delegation, later wrote: ‘I remember gettingup one morning at Bretton Woods to find among my papers a minute by Sir Ralph (then Mr.) Hawtreywhich had been passed on to me by Keynes. I forget the exact words ... “What’s all this talk about thedangers of deflation?” said the writer; “Inflation, not ^flation, is the postwar problem”’. ‘Dear Lionel’,ran Keynes’s covering note, ‘I thought you would like to see what the old thing is saying. After all, he maybe right’ (quoted in Howson 2011: 980).