Money and the Business Cycle

0:00Money and the Business Cycle by Gottfried Haberler Section 1 If I speak of the business cycle during this lecture, I do not think only or primarily of such financial and economic earthquakes as we have experienced during the last few years all over the world. It would perhaps be more interesting to talk about these dramatic events of speculation broker's loans collapse of the stock exchange, Wholesale bankruptcies, panics, acute financial crises of an external or internal sort, gold drains, and the economic and political repercussions of all this. I shall, however, resist the temptation to make what I have to say dramatic, and shall try instead to get down to the more fundamental economic movements which underlie those conspicuous phenomena which I have indicated.

0:50For a complete understanding of the business cycle, it is absolutely indispensable to distinguish between a primary and fundamental and a secondary and accidental movement. The fundamental appearance of the business cycle is a wave-like movement of business activity, if I may be allowed to use for the moment this rather vague expression. The development of our modern economic life is not an even and continuous growth. It is interrupted not only by external disturbances like wars and similar catastrophes, but shows an inherent discontinuity. Periods of rapid progress are followed by periods of stagnation. The attention of the economists was first caught by those secondary and accidental phenomena, glaring breakdowns and financial panics.

1:37They tried to explain them in terms of individual accidents, mistakes, and misguided speculations of the leaders of those banks and business firms which were primarily involved. But the regular recurrence of these accidents during the 19th century brought home to the economists that they had not isolated accidents before them, but symptoms of a severe disease which affects the whole economic body. During the second half of the 19th century, there was a marked tendency for these disturbances to become milder. Especially, those conspicuous events, breakdowns, bankruptcies, and panics, became less numerous, and there were even business cycles from which they were entirely absent. Before the war, it was the general belief of economists that this tendency would persist, and that such dramatic breakdowns and panics as the 19th century had witnessed belonged definitely to the past.

2:31Now, the present depression shows that we rejoice too hastily, that we have not yet got rid of the scourge of the capitalist system. But nevertheless, so much can be and must be learned from the experience of the past. If we want a deeper insight into the inner mechanism of our capitalistic system, which makes for its cyclical movements, we must try to explain the fundamental phenomenon, abstracting from these accidental events which might be absent or present. If we disregard these secondary phenomena, the business cycle presents itself as a periodic up and down of general business activity, or to put it now in a more precise form of the volume of production. The secular growth of production does not show a continuous uninterrupted trend upward, but a wave-like movement around its average annual increase. It does not make a great difference whether the downward swings of these business waves are characterized by an absolute fall of the volume of production, or just by a decrease of the rate of growth.

3:31In this lecture, I am not concerned with the ingenious devices which statisticians have invented to isolate the cyclical movements from other periodic or erratic movements on which they are superimposed, or which are superimposed on them. I assume first that we have such a thing as a business cycle, which is not identical with seasonal movements within the year and erratic irregular disturbances caused by wars, periods of government inflation and the like. It is necessary to state this because even the existence of the phenomenon under consideration has been doubted. Secondly, I assume that we have been able to isolate this movement statistically. Our chief concern will be with the explanation of this movement and especially with the role of money in the widest sense of the term, including credit and bank money.

4:19Section 2. There is hardly any explanation of the business cycle. I hesitate a little to say theory of the business cycle, because many people have developed a certain prejudice against this term, in which the monetary factor does not play a very decisive role. The following consideration shows that this must necessarily be so. Still abstracting from the previously mentioned accessory phenomena, one of the most outstanding external symptoms of the business cycle is the rise of prices during prosperity and the fall of prices during depression. On the other hand, there is an increase of the volume of production during the upward and a decrease during the downward swing, but not only more commodities are produced and sold, but also in other branches of the economy there is an increase in transactions, e.g. on the stock exchange, therefore we can safely say there is a considerable increase of the volume of payments during the upward swing of the cycle and a distinct decrease of this volume during depression. Now, it is clear that in order to handle

5:21In order to handle this increased volume of payments, an augmentation of the means of payment is necessary, means of payment in the widest sense of the term. One of the following things must happen. A. An increase of gold and legal tender money. B. An increase in banknotes. C. An increase of bank deposits and bank credits. D. An increase in the circulation of checks, bills and other means of payment, which are regularly or occasionally substituted for ordinary money. Money, e. an increase of the velocity of circulation of one or all of these means of payments. I do not claim that this enumeration is exhaustive or quite systematic. It is largely a matter of terminological convenience, as one likes to express oneself. One writer prefers to call bank deposits, on which checks may be drawn, money, bank money, credit money. Other writers restrict the term money to legal tender money, and speak then of bank deposits as as means to save money or to make it more efficient in making payments by increasing

6:22its velocity of circulation. Still others have an aversion against the term velocity of circulation and prefer to speak of changes in the requirement for money and means of payment. Without going more deeply into these technical details, it is, I hope, clear that there must occur in one way or another during the upward swing of the cycle an expansion of the means of Payment and, during the downward swing, a corresponding contraction. No serious theory, no explanation of the cycle, can afford to overlook, disregard, or deny this fact. Differences can arise only a.) in respect to the particular way in which the expansion takes place, whether it is primarily an increase in the quantity of credit money or legal tender money or gold, or just of the velocity of circulation of one of these, and b.) as to the causal sequence.

7:11As to the causal relation, broadly speaking, two possibilities seem to be open. One, one might assume that the impulse comes from the side of money, that the circulation is expanded by a deliberate action of the banks or other monetary authority, and that this sets the whole chain of events going, or two, one may hold the opinion that the monetary authorities take a passive role, that the initiative comes from the commodity The theories of the first group, which maintain that the The active cause of the cycle lies on the side of money, may be called monetary theories of the business cycle.

8:13In a wider sense, however, we may include in the group of monetary theorists also all those who admit that the impulse might also come from the commodity side, but hold that an appropriate policy of the monetary authorities, an effective and elastic regulation of the volume of the circulating medium, can forestall every serious disturbance. As you all know, the most frequently recommended criterion for such a policy is the stabilization of the price level in the one or other of the many meanings of this ambiguous term. You will all agree that it is impossible to discuss this problem exhaustively in one hour, so I shall confine myself to pointing out the insufficiencies of this type of monetary theory and of its recommendations for the remedy of the business cycle, which center around changes in the price level.

9:00I shall try then to indicate a more refined monetary theory of the cycle, which has been developed in the last few years, although it is not so well known in this country as it deserves to be. This refined theory seems to explain some features of the cycle, especially of the last one, which are not entirely compatible with the cruder form of the monetary approach, which identifies monetary influences with changes in the general price level. The traditional monetary theory, which is represented by such well-known writers as the Swedish economist Professor Kissel and Mr. Hawtrey of the English Treasury, regards the upward and the downward swing of the business cycle as a replica of a simple government inflation or deflation. To be sure, it is, as a rule, a much milder form of inflation or deflation, but at the root it is exactly the same. Mr. Hawtrey states this quite uncompromisingly in his famous dictum, the trade cycle is a purely monetary phenomenon, and is in principle

10:01the same as the inflation during the war and the deflation, that is to say the reduction of the amount of circulating medium, which was deliberately undertaken by certain governments to approach or to restore the post-war parity of their currencies. Hawtrey recognizes and stresses, of course, the difference in degree between the two types of Inflation and Deflation. Namely, that the expansion and contraction in the course of the business cycle is chiefly produced by maladjustment of the discount rate, which is not the way in which a government inflation is brought about. It is today an almost generally accepted doctrine that a lowering of the discount rate by the banking system, especially by the central banks, induces people to borrow more so that the amount of the circulating I know, of course, that this fair statement needs some qualifications. I trust, however, that before so competent an audience, it will suffice to say that this is literally true only if the influence of the change in the discount rate is not compensated by any other force which changes the willingness of businessmen to borrow.

11:16But given all these other circumstances, that is to say Ceteris Paribus, a change in the discount rate will have the indicated effect on prices. In any given situation there is one rate which keeps the price level constant. If the rate is forced below this equilibrium rate, prices have a tendency to rise. If the rate is raised above the equilibrium rate, prices tend to fall. Now, according to Mr. Hawtrey, there is a tendency in our banking system to keep the interest rate too low during an upward swing of the cycle, then prices rise, we get a credit inflation, and sooner or later the banks are forced to take steps to protect their reserves, they increase the rate and bring about the crisis and the depression. There is no time here to go into details, to discuss the ingenious explanation which Mr. Hattry offers for the fact that banks always go too far, that they swing like a pendulum from one extreme to the other, and do not stop at the equilibrium rate.

12:12The reason which Mr. Hattry gives for this is different from the one which Professor Irving Fisher and other writers of this group have to offer. What they all have in common is that the disturbing factors act through changes in the price level. It is through changes of the price level that expansion and contraction of credit and money act upon the economic system, and they all believe that stability of the price level is the sufficient criterion of a rational regulation of credit. If it were possible to keep the price level stable, prosperity would never be followed by depression. If the price level is allowed to rise, and the inevitable reaction to come, Now, it would be possible to end the Depression and to restore equilibrium if one could stop the fall of prices.

12:57Let me now indicate briefly why this explanation seems to me insufficient, or to put it in other words, I shall try to show that a. the price level is frequently a misleading guide to monetary policy, and that its stability is no sufficient safeguard against crises and depressions, because b. a credit expansion has a much deeper and more fundamental influence The principle defect of those theories is that they do not distinguish between a fall of prices which is due to an actual contraction of the circulating medium and a fall of prices which is caused by lowering of cost as a consequence of inventions and technological improvements. I must, however, mention that this particular criticism does not apply to Mr. Hawtrey, who by a peculiar interpretation of the term price level, recognizes this distinction, although he does not seem to draw the necessary conclusions.

13:55It is true, if there is an absolute decrease of the quantity of money, demand will fall off, prices will have to go down, and a serious depression will be the result. Normal conditions will return only after all prices have been lowered, including the prices of the factors of production, especially wages. This may be a long and painful process, because some prices, e.g. wages, are rigid, and some prices and debts are definitely fixed for a long time and cannot be altered at all. From this, however, it does not follow that the same is true if prices fall because of a lowering of costs. It is now generally accepted that the period preceding the present depression was characterized by the fact that many technological The natural thing, in such a situation, would be for prices to fall gradually, and apparently such a fall of prices cannot have the same bad consequence as a fall of prices brought about by a decrease of the amount of money.

15:00We could speak, perhaps, of a relative deflation of the quantity of money relative in respect to the flow of goods in opposition to an absolute deflation. Especially those writers who stress the scarcity of gold as a cause for the present depression are guilty of overlooking the radical difference between an absolute and a relative deflation. A scarcity of gold could result only in a relative deflation which could never have such disastrous results as the present depression. Of a more indirect way in which the smallness of the annual output of gold has perhaps to do with, I do not venture to say is the cause of the acuteness of present depression and the vehemence of the price fall. I shall say more later. Now, as I have said already, during the years 1924 to 1927 and 1928, we experienced an unprecedented growth of the volume of production.

15:54Commodity prices, on the other hand, as measured by the Wholesale Price Index, were fairly stable, as everyone knows. From this it follows, and direct statistical investigations have verified it, that the volume of the circulating medium had been increased. We could say there was a relative inflation, that is, an expansion of means of payment, which did not result in an increase of commodity prices, because it was just large enough to compensate for the effect of a parallel increase of the volume of production. There is now an obvious presumption that it was precisely this relative inflation which brought about all the trouble. If this were so, and it seems to me that it is very probable, it would be plain that the price level is a misleading guide for monetary policy, and that there are monetary influences at work on the economic system that do not find an adequate expression in a change of the price level, at least as measured by the wholesale price index, and in fact,

16:54there are such very far-reaching influences of certain monetary changes on the economic system. They may express themselves in a change of the price level or not, which have been wholly overlooked by the traditional monetary explanation, although the external symptoms of this influence have been well recognized, Section 4 These changes which I have in mind, and shall now try to analyze, are changes of what I shall call the vertical structure of production, brought about by changes in the supply of credit for productive purposes. If we have to analyze an economic system, we can make a horizontal or vertical cross-section through it. A horizontal cross-section would exhibit different branches or lines of industry as differentiated by the consumption goods which are the final result of these different branches.

17:48There, we have the food industry, including agriculture, the clothing industry, the show industry, etc. Industries which produce producers' goods, say the iron and steel industry, belong simultaneously to different branches in this horizontal sense, Because iron and steel are used in the production of many, or of all, consumers' goods. The old statement that a general overproduction is unthinkable, that we can never have too much of all goods because human wants are insatiable, but that serious disproportionalities might develop in consequence of a partial overproduction, this statement relates principally to the horizontal structure of production. Disproportionality, in this sense, means that for one reason or another, the appropriate proportion of productive resources devoted to different branches of industry has been disturbed, that e.g. the automobile industry is overdeveloped, that more capital and labor has been invested in this industry than is justified by the comparative demand for the product of this industry and for other industrial products.

18:51I hope it is now pretty clear what I mean by horizontal structure and horizontal disproportionalities of production. We make, on the other hand, a vertical cross-section through an economic system if we follow every finished good ready for consumption up through the different phases of production, and note how many stages a particular good has to pass through before it reaches the final consumer. Take, e.g., a pair of shoes and trace its Economic Family Tree. Our path leads us from the retailer via the wholesale merchant to the shoe factory, and taking up one of the different threads which come together at this point, say a sewing machine used for the fabrication of shoes, we are led to the machine industry, the steel plant, and eventually to the coal and iron mine. If we follow another strand, it leads us to the farm, which bred the cattle from which the leather was taken. And besides, There are many intermediate stages interpolated between these major phases of the productive

19:50process, namely the various transportation services. Every good has to pass through many successive stages of preparation before the finishing touches are applied and it eventually reaches the final consumer. It takes a considerable length of time to follow one particular piece through this whole process, from the source of this stream to the mouth where it flows goes out and disappears in the bottomless sea of consumption. But when the whole process is once completed, and every one of the successive stages is properly equipped with fixed and circulating capital, we may expect a continuous flow of consumers' goods. Now, in the equipment of these successive stages of production, the capital stock of a country which has been accumulated during centuries is embodied.

20:37The amount of accumulated capital is a measure of the length of the stream. In a rich country the stream is very long, and goods have to pass through many stages before they reach the consumer. In a poor country, the stream is much shorter, and the volume of output correspondingly smaller. If during a time of economic progress capital is accumulated and invested, new stages of production are added, or in technical economic parlance, the process of production is lengthened, it becomes more roundabout. If you compare If we compare the way in which we produce today with the methods of our fathers, or the productive process of a rich country with the one of a poor country, innumerable examples can be found. But what has this to do with the business cycle? Now, when I spoke of the vertical structure of production, and the influence of monetary forces upon it, I thought of a lengthening and shortening of the productive process.

21:31Obviously, just as there must be a certain proportion between the different horizontal branches of industry, there must also be a certain relation of the productive resources, labor and capital, which are devoted to the upper and lower stages of production respectively, to the current production of consumers' goods by means of the existing productive apparatus, and to the increase of this apparatus for the increased future production of consumers' goods. If e.g. too much labor is used for lengthening the process, and too small an amount for current consumption, we shall get a maladjustment of the vertical structure of production. And it can be shown that certain monetary influences concretely, a credit expansion by the banks, which lowers the rate of interest below that rate, which would prevail if only those sums which are deliberately saved by the public, From their current income came on the capital market, it can be shown that such an artificial decrease of the rate of interest will induce the business leaders to indulge in an excessive lengthening of the process of production, in other words, in over-investments.

22:42As the finishing of a productive process takes a considerable period of time, it turns out only too late that these newly initiated processes are too long. A reaction is inevitably produced, how, we shall see at once, which raises the rate of interest again to its natural level or even higher. Then these new investments are no longer profitable, and it becomes impossible to finish the new roundabout ways of production. They have to be abandoned, and productive resources are returned to the older, shorter methods of production. This process of adjustment of the vertical structure of production, which necessarily only implies the loss of large amounts of fixed capital which is invested in those longer processes and cannot be shifted, takes place during, and constitutes the essence of, the period of depression. Unfortunately, it is impossible to discuss here all the steps of this process and to compare them with the corresponding phases of the business cycle of which they are the picture and explanation.

23:45I hope that it will be possible to give you a clear idea of what happens in our capitalistic

24:19to the indispensable minimum. Instead of shoes and houses, they produce power plants, steelworks, try to improve the transportation system, in a word, build up a productive apparatus, which will turn out consumption goods only after a considerable period of time. Now, suppose that it becomes impossible to carry through this ambitious plan. Assume the government comes to the conclusion that the population cannot stand the enormous strain, In any such case, if they are forced to give up the newly initiated roundabout ways of production, and to produce consumers' goods as quickly as possible, they will have to stop the building of their power plants and steelworks and tractor factories, and instead of that try to produce hurriedly simple implements and tools to increase the output of food and shoes and housing.

25:15Now, what in a communistic society is done upon a decision of the Supreme Economic Council is, in our individualistic society, brought about by the collective but independent action of the individuals and carried out by the price mechanism, if many people, individuals or corporations, decide to save, to restrict for some time their consumption, the demand for, and the demand for, and the demand for, and the demand for, and the demand for, and the demand for, and the demand for, When production of consumers goods declines, productive resources are shifted to the upper stages of production, and the process of production is being lengthened. If we rely on voluntary saving, we can assume that during every year, approximately the same proportion of the national income will be saved, although not always by the same individuals.

26:06Then we have a steady flow of savings, and the adjustment of production does not take place in terms of actual shifts of invested productive resources, but in terms of a lasting deflection of the flow of productive resources into other channels. There is no reason why this should not go on smoothly and continuously. Violent fluctuations are introduced by the influence of the banks in this process. The effect of the voluntary decision of the public to save, i.e. to divert productive resources from the current production of consumption goods to the lengthening of the process, can be produced also by the banking system. If the banks create credit and place it at the disposal of certain businessmen who wish to use it for productive purposes, that part of the money stream which is directed to the upper stages of production is increased. More productive resources will be diverted from the current production of consumers goods to the lengthening of the process than corresponds to the voluntary decision of the members of the economic community. This is what economists

27:11speak of as forced saving. First, everything goes all right, but very soon prices begin to rise Because those firms who have got the new money use it to bid away factors of production, labor, and working capital, from those concerns which were engaged in producing consumption goods, wages and prices go up, and a restriction of consumption is imposed on those who are not able to increase their money income. If, through previous investment of voluntary savings, there is already a tendency for the price level to fall, the new credit, instead of resulting in an absolute rise of prices, may simply offset the price fall which would otherwise take place. But after some time, a reaction sets in which tends to restore the old arrangement that has been distorted by the injection of money.

28:01The new money becomes income in the hands of the factors which have been hired away from the lower stages of production, and the receivers of this additional income will probably adhere to their habitual proportion of saving and spending, that is, they will try to increase their consumption again. If they do this, the previous proportion of the money streams directed to the purchase of consumers' goods and of producers' goods will be restored. For some time it might be possible to overcome this counter-tendency and to continue the policy of expansion by making new injections of credit, but this attempt would lead to a progressive rise of prices and must be given up sooner or later, then the old proportion of demand for consumers' goods and producers' goods will be definitely restored.

28:50The consequence is that those firms in the lower stages of production, which had been forced to curtail their production somewhat, because factors have been hired away, will in turn be able to draw away productive resources from the higher stages. The new roundabout ways of production, which have been undertaken under the artificial stimulus of a credit expansion, or at least a part of them, become unprofitable. They will be discounted, and the crisis and depression has its start. It could be otherwise, only if the new processes were already finished, when the additional money has become income, and comes onto the market for consumers' goods. In this case, the additional demand would find additional supply.

29:38To the increased flow of money would correspond an increased flow of goods. This is, however, almost impossible, because as Mr. Robertson has shown, the period of production is much longer than the period of circulation of money. The new money is bound to come on the market for consumption goods much earlier than the new processes are completed and turn out goods ready for consumption. Section 5. This explanation of the slump, of which I have been able to indicate here only the bare outline, could of course be elaborated and has been elaborated. If this interpretation of the crisis and of the breakdown of a large part of the structure of production is correct, it seems then comparatively easy to explain the further events in more familiar terms.

30:26Such an initial breakdown must have very serious repercussions. In our highly complicated credit economy, where every part of the system is connected with every other directly or indirectly, by contractual bonds, every disturbance, at one point, spreads at once to others. If some banks, those nerve centers where innumerable strands of credit relations come together, are involved and become bankrupt, a wave of pessimism is bound to come. As a secondary phenomenon, a credit deflation is likely to be the consequence of the general distrust and nervousness. All these things upon which the traditional monetary doctrine builds its entire explanation will make things even worse than they are, and it may very well be that the secondary wave of depression, which is induced by the more fundamental maladjustment, will grow to an overwhelming importance.

31:18This depends, however, largely upon the concrete circumstances of the case in hand, upon the peculiar features of the credit organization, on psychological factors, and need not bear a definite proportion of the magnitude of the real dislocation of the structure of production. This is the place to say a few words about an indirect connection between the alleged insufficient supply of gold and the present depression. It is undoubtedly true that since before the war, the quantity of gold has not increased so much as the volume of payments. To maintain a price level roughly 50% higher than before the war was possible only by building a comparatively much larger credit structure on the existing stock of gold. After the process of inflation has once been completed, this should not cause troubles in normal times.

32:09In times of acute financial crisis, one confidence vanishes, and when runs and panics make their appearance, such a system becomes, however, extremely dangerous. If the means of payment consist principally of gold and gold-covered notes and certificates, there is no danger that suddenly a large part of the circulating medium may be annihilated. A world system of payments, however, which relies to a large proportion on credit money, is subject to rapid deflation if this airy credit structure is once shaken and crushed down. For example, the adoption of a gold exchange standard by many countries amounts to erecting a daring credit superstructure on the existing gold stock of the world.

32:55The structure may easily break down if these countries abandon the gold exchange standard and re-adopt an old-fashioned gold standard. It would be, however, entirely wrong to conclude from this that we have to blame the niggardliness of nature, that the situation would necessarily be quite different if by chance gold production had been much larger during the last 20 years. Other factors are responsible, principally the inflation during and after the war. By means of such a monetary policy, it is always possible to drive any stock of gold however large it may be out of the country. The natural thing is then to substitute a later gold exchange standard for the abandoned gold standard, which means, as I have said already, the erection of a credit structure on the existing stock of gold.

33:44Therefore, if the annual output of gold had been larger than it actually was, the difference would have been only this. The credit structure too would have become larger, and we would have started in for the last boom from a higher price level. If this is a correct guess of what would have happened, and it seems to me very probable, the economic consequences of the last period of credit expansion, 1927 to 1929, and the present deflation, would have been exactly the same. It is of vital importance to distinguish between these additional secondary and accidental disturbances and the primary real maladjustment of the process of production. If it were only a wave of pessimism and absolute deflation which caused the trouble, it should be possible to get rid of it very quickly. After all, a deflation, however strong it may be, and by whatever circumstances it may have been made possible and aggravated, can be stopped by drastic inflationary methods within a comparatively short period of time.

34:46If we have, however, once realized that at the bottom of these surface phenomena lies a far-reaching dislocation of productive resources, we must lose confidence in all the economic and monetary quacks who are going around these days preaching inflationary measures which would bring almost instant relief. If we accept the proposition that the productive apparatus is out of gear that great shifts of labor and capital are necessary to restore equilibrium, then it is emphatically not true that the business cycle is a purely monetary phenomenon, as Mr. Hawtrey would have it. This is not true, although monetary forces have brought about the whole trouble. Such a dislocation of real physical capital, as distinguished from purely monetary changes, can in no case be cured in a very short time. I do not deny that we can and must combat I cannot go into this matter here. I only wish to say that we should not expect too much of a more or less symptomatic treatment and, on the other hand, we must be careful not to produce again that artificial disproportion of the money streams directed toward consumption and production goods, which led to overinvestment and produced the whole trouble.

36:07The worst thing we could do is a one-sided strengthening of the purchasing power of the consumer, because it was precisely this disproportional increase of demand for consumers' goods which precipitated the crisis. It is a great advantage of this more refined monetary explanation of the business cycle over the traditional one to have cleared up these non-monetary real changes due to monetary forces. In doing so, it has bridged the gap between the monetary and non-monetary explanation. It has taken out the elements of truth contained in each of them and combined them into one coherent system. It takes care of the well-established fact that every boom period is characterized by an extension of investments of fixed capital.

36:53It is primarily the construction of fixed capital and of the principal materials used for this, iron and steel, where the largest changes occur, the greatest expansion during the boom, and the most violent contractions in the depression. This fact, which has been stressed by all descriptive studies of the business cycle, has not been used by the traditional monetary explanations, which run in terms of changes in the price level, and look at real dislocations of the structure of production, if they regard it at all, as an unimportant accidental matter. The explanation which I have indicated not only describes this fact, as does the so-called non-monetary explanation of the cycle, but explains it. If the rate of interest is lowered, all kinds of investments come into the reach of practical consideration. May I be allowed to quote an example given by Mr. Keynes in a lecture before the Harris Foundation Institute last year? No one believes that it will pay to electrify the railway system of Great Britain

37:55on the basis of borrowing at 5%, at 3.5% it is impossible to dispute that it will be worthwhile, so it must be with endless other technical projects. It is clear that especially those branches of industry are favored by a reduction of the rate of interest, which employ a large amount of fixed capital, as for example railroads, power plants, etc. In their cost account, interest rate changes play an important role, but there is an indisputable general tendency to replace labor by machinery if capital becomes cheap. That is to say, more labor and working capital is used to produce machines, railroads, power plants, comparatively less for current production of consumption goods. In technical economic parlance, the roundaboutness of production is increased. The crucial point, and also the point of deviation from Mr. Keynes' analysis is to understand well that a reaction must inevitably set in if this productive expansion is not financed by real voluntary saving of individuals or corporations but by ad hoc created credit and it is practically very important the last boom should have brought

39:04this home to us that a stable commodity price level is not a sufficient safeguard against such an artificial stimulation of an expansion of production in other words that a relative credit inflation in the above-defined meaning of the term will induce the same counter movements as an absolute inflation. I hope that I have been able to give you a tolerably clear idea of this improved monetary explanation of the business cycle. Once more, I must ask you not to take as a complete exposition what can be only a brief indication. A sufficiently detailed discussion of the case could be only undertaken in a big volume. Therefore, I beg I beg you to suspend your final judgment until the case has been more fully presented to you. Only one objection I should like to anticipate. It is true this theory suffers from a serious disadvantage.

39:52It is so much more complicated than the traditional monetary explanation. But I venture to say that this is not the fault of this theory, but due to the malice of the object. Unfortunately, facts are not always so simple as many people would like to have them.