Keynesian Confusions

August 15, 1955

The British Government has announced a retrograde step in economic policy. This is worth study both on its own account and for the light it throws on American errors.

Richard A. Butler, Chancellor of the Exchequer, moved in the right direction when on last Feb. 24 he raised the interest rate that the Bank of England charges ordinary banks a full point, to 4½ percent. This was part of a courageous effort to curb inflation. But now he is taking measures that move away from economic freedom and yet do not promise to be very effective in halting inflation. He has raised the required down payment on installment purchases on such items as motorcars and household appliances from 15 percent to 33½ percent. The purpose of this is to halt a so-called buying spree of the British public, and to correct Britain’s international balance of payments by forcing British manufacturers to find an export market rather than a home market for some of these goods.

As for correcting the balance of trade, the restriction on installment credit is irrelevant to real causes. Foreign trade, left to itself, will balance itself. It will balance itself for the simple reason that sellers insist on being paid for the goods they sell. What is unbalancing British trade now is exchange control. If the pound were set free it would seek the level that would balance imports and exports. A decline in the pound, for example, would raise the cost of imports, so discouraging and contracting them. It would increase the profit margin on British exports or reduce their foreign-money cost, so encouraging and expanding them. Ironically, Chancellor Butler now gives as his reason for postponing free exchange rates the very unbalance of trade that is caused by the existing ban on free exchange rates.

Britain’s new curb on installment credit (like our own Federal Reserve requirement for a 70 percent margin in the buying of stocks) is at once discriminatory, unnecessary, and futile. Installment credit, like stock-market credit, is derivative credit. If interest rates are raised generally, the whole volume of credit will be contracted or held from expanding. If, on the other hand, money is kept generally too cheap, credit must continue to expand. Governments cannot flood their countries with credit and build effective dikes around special kinds of buying.

It is argued that the recently announced British steps are necessary because the February rise in the Bank of England discount rate to 4½ percent has proved ineffective. Bank loans, instead of dropping, rose by $448 million more in the first six months of this year compared with the first half of 1954. But this means merely that the British bank rate is still not high enough in relation to the demand for credit. (Our own recent Federal Reserve rate of 1¾ percent was even more inflationary in relation to our own money market.) If Chancellor Butler tried a Bank of England rate of 5 or 5½ percent he might find it effective enough.

Instead of taking this well-tested traditional step, Butler has preferred an unsound alternative. He has announced that the government will frown on capital expenditures for construction of new plants or equipment, and will postpone all such expansion plans in the nationalized industries (except for coal mines and atomic power plants). This action, like the even more drastic action of Sweden in curtailing investment in plants and equipment in private industry, rests on confused Keynesian theory. Direct government discouragement of new capital investment is the worst possible way to “combat inflation.”

Such discouragement must lead in the long run to higher rather than lower production costs, to less rather than more consumer goods, and to lower real wages than would otherwise prevail. The nation that follows such a policy will soon find itself handicapped in export competition with more progressive countries.

The dead hand of Keynesianism, and the fetish of “full employment,” still vitiate the policies of the leading nations of the West.