A Tract on Monetary Reform: Chapter I - II. Changes in the Value of Money, As affecting Production

A Tract on Monetary Reform, by John Maynard Keynes is part of HackerNoon’s Book Blog Post series. You can jump to any chapter in this book here. Chapter I: II. Changes in the Value of Money, As affecting Production

II. Changes in the Value of Money, As affecting Production

If, for any reason right or wrong, the business world expects that prices will fall, the processes of production tend to be inhibited; and if it expects that prices will rise, they tend to be over-stimulated. A fluctuation in the measuring-rod of value does not alter in the least the wealth of the world, the needs of the world, or the productive capacity of the world. It ought not, therefore, to affect the character or the volume of what is produced. A movement of relative prices, that is to say of the comparative prices of different commodities, ought to influence the character of production, because it is an indication that various commodities are not being produced in the exactly right proportions. But this is not true of a change, as such, in the general price level.

The fact that the expectation of changes in the general price level affects the processes of production, is deeply rooted in the peculiarities of the existing economic organisation of society, partly in those described in the preceding sections of this chapter, partly in others to be mentioned in a moment. We have already seen that a change in the general level of prices, that is to say a change in the measuring-rod, which fixes the obligation of the borrowers of money (who make the decisions which set production in motion) to the lenders (who are inactive once they have lent their money), effects a redistribution of real wealth between the two groups. Furthermore, the active group can, if they foresee such a change, alter their action in advance in such a way as to minimise their losses to the other group or to increase their gains from it, if and when the expected change in the value of money occurs. If they expect a fall, it may pay them, as a group, to damp production down, although such enforced idleness impoverishes society as a whole. If they expect a rise, it may pay them to increase their borrowings and to swell production beyond the point where the real return is just sufficient to recompense society as a whole for the effort made. Sometimes, of course, a change in the measuring-rod, especially if it is unforeseen, may benefit one group at the expense of the other disproportionately to any influence it exerts on the volume of production; but the tendency, in so far as the active group anticipate a change, will be as I have described it. This is simply to say that the intensity of production is largely governed in existing conditions by the anticipated real profit of the entrepreneur. Yet this criterion is the right one for the community as a whole only when the delicate adjustment of interests is not upset by fluctuations in the standard of value.

 The interests of the salaried and wage-earning classes will, in so far as their salaries and wages tend to be steadier in money-value than in real-value, coincide with those of the inactive capitalist group. The interests of the consumer will, in so far as he can vary the distribution of his floating resources between cash and goods purchased in advance of consumption, coincide with those of the active capitalist group; and his decisions, made in his own interests, may serve to reinforce the effect of those of the latter. But that the interests of the same individual will often be those of one of the groups in one of his capacities and of the other in another of his capacities, does not save the situation or affect the argument. For his losses in one capacity depend only infinitesimally on him personally refraining from action in his other capacity. The facts, that a man is a cannibal at home and eaten abroad, do not cancel out to render him innocuous and safe.

But there is a further reason, connected with the above but nevertheless distinct, why modern methods of production require a stable standard,—a reason springing to a certain extent out of the character of the social organisation described above, but aggravated by the technical methods of present-day productive processes. With the development of international trade, involving great distances between the place of original production and the place of final consumption, and with the increased complication of the technical processes of manufacture, the amount of risk which attaches to the undertaking of production and the length of time through which this risk must be carried are much greater than they would be in a comparatively small self-contained community. Even in agriculture, whilst the risk to the consumer is diminished by drawing supplies from many different sources, which average the fluctuations of the seasons, the risk to the agricultural producer is increased, since, when his crop falls below his expectations in volume, he may fail to be compensated by a higher price. This increased risk is the price which producers have to pay for the other advantages of a high degree of specialisation and for the variety of their markets and their sources of supply.

The provision of adequate facilities for the carrying of this risk at a moderate cost is one of the greatest of the problems of modern economic life, and one of those which so far have been least satisfactorily solved. The business of keeping the productive machine in continuous operation (and thereby avoiding unemployment) would be greatly simplified if this risk could be diminished or if we could devise a better means of insurance against it for the individual entrepreneur.

A considerable part of the risk arises out of fluctuations in the relative value of a commodity compared with that of commodities in general during the interval which must elapse between the commencement of production and the time of consumption. This part of the risk is independent of the vagaries of money, and must be tackled by methods with which we are not concerned here. But there is also a considerable risk directly arising out of instability in the value of money. During the lengthy process of production the business world is incurring outgoings in terms of money—paying out in money for wages and other expenses of production—in the expectation of recouping this outlay by disposing of the product for money at a later date. That is to say, the business world as a whole must always be in a position where it stands to gain by a rise of price and to lose by a fall of price. Whether it likes it or not, the technique of production under a régime of money-contract forces the business world always to carry a big speculative position; and if it is reluctant to carry this position, the productive process must be slackened. The argument is not affected by the fact that there is some degree of specialisation of function within the business world, in so far as the professional speculator comes to the assistance of the producer proper by taking over from him a part of his risk.

Now it follows from this, not merely that the actual occurrence of price changes profits some classes and injures others (which has been the theme of the first section of this chapter), but that a general fear of falling prices may inhibit the productive process altogether. For if prices are expected to fall, not enough risk-takers can be found who are willing to carry a speculative “bull” position, and this means that entrepreneurs will be reluctant to embark on lengthy productive processes involving a money outlay long in advance of money recoupment,—whence unemployment. The fact of falling prices injures entrepreneurs; consequently the fear of falling prices causes them to protect themselves by curtailing their operations; yet it is upon the aggregate of their individual estimations of the risk, and their willingness to run the risk, that the activity of production and of employment mainly depends.

There is a further aggravation of the case, in that an expectation about the course of prices tends, if it is widely held, to be cumulative in its results up to a certain point. If prices are expected to rise and the business world acts on this expectation, that very fact causes them to rise for a time and, by verifying the expectation, reinforces it; and similarly, if it expects them to fall. Thus a comparatively weak initial impetus may be adequate to produce a considerable fluctuation.Three generations of economists have recognised that certain influences produce a progressive and continuing change in the value of money, that others produce in it an oscillatory movement, and that the latter act cumulatively in their initial stages but produce the conditions for a reaction after a certain point. But their investigations into the oscillatory movements have been chiefly confined, until lately, to the question what kind of cause is responsible for the initial impetus. Some have been fascinated by the idea that the initial cause is always the same and is astronomically regular in the times of its appearance. Others have maintained, more plausibly, that sometimes one thing operates and sometimes another.It is one of the objects of this book to urge that the best way to cure this mortal disease of individualism is to provide that there shall never exist any confident expectation either that prices generally are going to fall or that they are going to rise; and also that there shall be no serious risk that a movement, if it does occur, will be a big one. If, unexpectedly and accidentally, a moderate movement were to occur, wealth, though it might be redistributed, would not be diminished thereby.To procure this result by removing all possible influences towards an initial movement, whether such influences are to be found in the skies only or everywhere, would seem to be a hopeless enterprise. The remedy would lie, rather, in so controlling the standard of value that, whenever something occurred which, left to itself, would create an expectation of a change in the general level of prices, the controlling authority should take steps to counteract this expectation by setting in motion some factor of a contrary tendency. Even if such a policy were not wholly successful, either in counteracting expectations or in avoiding actual movements, it would be an improvement on the policy of sitting quietly by, whilst a standard of value, governed by chance causes and deliberately removed from central control, produces expectations which paralyse or intoxicate the government of production.* * * * *

We see, therefore, that rising prices and falling prices each have their characteristic disadvantage. The Inflation which causes the former means Injustice to individuals and to classes,—particularly to investors; and is therefore unfavourable to saving. The Deflation which causes falling prices means Impoverishment to labour and to enterprise by leading entrepreneurs to restrict production, in their endeavour to avoid loss to themselves; and is therefore disastrous to employment. The counterparts are, of course, also true,—namely that Deflation means Injustice to borrowers, and that Inflation leads to the over-stimulation of industrial activity. But these results are not so marked as those emphasised above, because borrowers are in a better position to protect themselves from the worst effects of Deflation than lenders are to protect themselves from those of Inflation, and because labour is in a better position to protect itself from over-exertion in good times than from under-employment in bad times.

Thus Inflation is unjust and Deflation is inexpedient. Of the two perhaps Deflation is, if we rule out exaggerated inflations such as that of Germany, the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned. The Individualistic Capitalism of to-day, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient—perhaps cannot survive—without one.

For these grave causes we must free ourselves from the deep distrust which exists against allowing the regulation of the standard of value to be the subject of deliberate decision. We can no longer afford to leave it in the category of which the distinguishing characteristics are possessed in different degrees by the weather, the birth-rate, and the Constitution,—matters which are settled by natural causes, or are the resultant of the separate action of many individuals acting independently, or require a Revolution to change them.

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Keynes, John Maynard. 2021. A Tract on Monetary Reform. Urbana, Illinois: Project Gutenberg. Retrieved May 2022 from 

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