3

‘In the long run we are all dead’
Rethinking economic policy

THROUGHOUT HIS LIFE, Keynes refused to compartmentalise his activities. It was the same man with the same active mind who turned – sometimes with dazzling and disconcerting speed – from books to the ballet, from mathematics to morality, from intellectual speculation to the financial kind, from rarefied economic theory to immediate practical policy (and back again). It is, admittedly, as an economist that he achieved greatness, and as an economist that his ideas retain their abiding interest. But his thinking should not be reduced to a simple formula – least of all a mathematical formula – with the label ‘Keynesianism’ stuck to it. For one thing, he changed his mind too often to make such doctrinal distillation profitable, though it is obviously reasonable to suppose that he regarded his later ideas as superior to those that he had meanwhile discarded.

Such qualifications aside, it does make sense to speak of a Keynesian approach to economic problems. At least from 1924, Keynes’s economic thinking exhibits a measure of consistency in policy terms; and, as early as 1932, he was seized of a vision with more fundamental implications for economic theory. This is what justifies us, in this chapter and the next, in exploring two stages of a process of rethinking the orthodoxies of the day, first with an emphasis on Keynesian economic policy and then on Keynesian economic theory.

Before there was Keynesianism or Keynesians, there was the historical Keynes: the man whom his contemporaries knew. His biographer raised one question that is surely worth attention, prompted by Keynes’s noteworthy last speech in the House of Lords in December 1945. ‘The speech was indeed an excellent one, compounded of penetrating analysis, tact and sagacity,’ commented Harrod, unsurprisingly. ‘But Keynes had been talking in this style about matters of grave importance to the well-being of the country for some twenty-seven years. Why had his words not been listened to with equal respect during all this long period?¹

Harrod’s question provokes others, which this chapter and the next will address. How exactly did Keynes himself, in his own lifetime, argue his case? How much can be recaptured, not just of what he conveyed on the printed page, but of how he exercised his personal influence over his own contemporaries? This may help us to understand how persuasive he seemed at the time (rightly or not) to those he succeeded in winning over; and, equally important, how unpersuasive he seemed to those who (rightly or not) could not stand him or his proposals. We can try to assess how far his arguments were specific to his own time and place – or how far they still have relevance for us today.

Many of Keynes’s friends and colleagues were themselves remarkable people. Virtually all of them, however eminent in their own fields, readily acknowledged his almost uncanny powers of argument and hence of persuasion. ‘When I argued with him, I felt that I took my life in my hands, and I seldom emerged without feeling something of a fool,’ wrote one.² This was the intellectually formidable philosopher Bertrand Russell, eleven years older than Keynes. A similar sense of awe is conveyed by another academic titan of the next generation, Lionel Robbins, fifteen years younger than Keynes, who had fiercely argued with him over pre-war economic policy but became a close wartime colleague. Robbins left in his diary a memorable vignette of Keynes in action, speaking to a joint Anglo-American session at the Bretton Woods conference.

At such moments, I often find myself thinking that Keynes must be one of the most remarkable men that have ever lived – the quick logic, the birdlike swoop of intuition, the vivid fancy, the wide vision, above all the incomparable sense of the fitness of words, all combine to make something several degrees beyond the limit of ordinary human achievement … He uses the classical style of our life and language, it is true, but it is shot through with something which is not traditional, a unique unearthly quality of which one can only say that it is pure genius. The Americans sat entranced as the God-like visitor sang and the golden light played around.³

Such magic can be potent but ephemeral. The spell that is cast may not last very long, especially not outlast the death of the spellbinder. How much did Keynes’s influence owe to his own charismatic powers? How far might his own death be expected to diminish the influence of the ideas that he left behind? Alternatively, why has the influence of Keynes’s ideas so resiliently survived his own death, more than sixty years ago?

There are many places that one might look for answers. But one source is so compelling in its verisimilitude that it repays particularly close scrutiny, despite its chronologically limited scope. For we are lucky to have an almost verbatim record of Keynes expounding his current ideas for an intelligent lay audience, and doing so at a critical moment. This came about because, in the autumn of 1929, an official committee was set up by the minority Labour Government to report on finance and industry, with official stenographers transcribing every word over the course of more than twelve months. Here we can catch Keynes in motion, in action, and in earnest, seeking to persuade others of the validity of his analysis of deep-seated problems that stretched back into the 1920s and that looked ahead into the 1930s. We are surely justified in dwelling on this uniquely well-documented episode for what it can disclose more generally about the course of his thinking about economic policy.

In 1929 Britain’s existing economic troubles were both paralleled and exacerbated by the dramatic crash of share prices on Wall Street – October seems to be the cruellest month in such matters. The crisis was not helped when the Republican President Hoover was prodded into declaring that ‘the fundamental business of the country, that is production and distribution of commodities, is on a sound and prosperous basis’.⁴

This was the context for the appointment in Britain of the Committee on Finance and Industry, under the chairmanship of a judge, Lord Macmillan. The Chancellor of the Exchequer later explained that it had been set up ‘largely because of the impression made on public opinion by Mr Keynes’s proposals’ and the Treasury came round under the pressure of events to accepting that, if it had to put ‘an economist of the Keynes school’ on the Macmillan committee, this single, token, isolated, marginal, maverick member might as well be Keynes himself.⁵

To the alarm of ‘the authorities’, Keynes quickly succeeded in taking charge of the committee’s agenda, as the day-by-day, line-by-line record shows. It was important that he found two powerful allies among the other members. One was Reginald McKenna, a former Chancellor of the Exchequer under Asquith, and now, as head of the Midland Bank, Britain’s biggest high-street bank, already a critic of Bank of England orthodoxy. The other was the massive figure of Ernest Bevin, the undisputed boss of Britain’s biggest trade union, which he was largely responsible for creating: a self-taught man who had set out to master economics with the innate self-confidence and intuitive common sense with which he was later to set out to master international affairs as Foreign Secretary. With both his old patron McKenna and his new sympathiser Bevin, Keynes enjoyed productive relationships based on mutual respect for the diverse experience that each of them brought to the table.

Keynes did not come to this table unprepared. He came to do battle for the ideas that he had been formulating for several years. These took the form of proposals to tackle the high postwar level of unemployment by applying ‘the stimulus which shall initiate a cumulative prosperity’.⁶ Specifically, in the general election of May 1929, the plans in the pamphlet that he and Hubert Henderson wrote, ‘Can Lloyd George Do It?’, were central. They aimed at cutting British unemployment (currently 1.14 million) by creating half a million jobs through loan expenditure of £100 million (perhaps to be continued for two further years). To put these figures in perspective, the total size of the budget at this time was about £800 million or, as we now calculate it, 20 per cent of Gross Domestic Product (GDP). As Keynes correctly guessed (in the absence of official statistics), £100 million was about 2.5 per cent of national income (roughly corresponding to GDP). This compares with a discretionary fiscal stimulus, as calculated for most G20 countries in 2009, in the range of 1–2 per cent of GDP, with the United States at the high end, Canada and Germany just above average and the United Kingdom just below.⁷

Keynes did not put this forward as the ideal policy. He was not a socialist; he did not believe in a command economy; he had no doctrinaire reason to advocate state intervention; his whole education as an economist taught him that it was generally best to leave things to be sorted out by the free play of market forces. But what if the market seemed to be failing to perform as the textbooks prescribed? What was the best option under such conditions? The orthodox answer was to show patience. Keynes’s answer was to opt for second-best expedients.

Here is an issue at the nub of the whole debate about Keynesian economic policy. The key text is the one that is so often cited by hostile critics, selectively quoting Keynes’s A Tract on Monetary Reform (1923). This was published well before Britain went back on the Gold Standard, at a time when its author was a loyal follower of Marshall in economic theory and a dutiful adherent of the axiomatic canons of Free Trade. Yet when the Tract dealt with the quantity theory of money (which had so taxed Lydia) it did not stop with its flat endorsement of the theory itself: ‘Its correspondence with fact is not open to question.’⁸ Instead, Keynes went on to explore what was meant by the doctrine that a change in the quantity of currency in circulation would ultimately have no effect upon the quantity of consumption, since money prices would simply adjust. ‘Now, “in the long run” this is probably true,’ Keynes conceded, before briskly commenting: ‘But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.’⁹

Joseph Schumpeter made a memorable comment on this aphorism of his great rival: ‘He was childless and his philosophy of life was essentially a short-run philosophy.’¹⁰ Perhaps there is a homophobic sub-text here; but even if the remark is regarded as simply ignorant, it is obviously personally inappropriate to Keynes, who wanted children of his own and took the needs of notional grandchildren as the criterion of good economic policy. It is surely Schumpeter who comes out worse in the long run. We can now see that, as an economist of conservative inclinations, he refused to accept that there was anything much to be done by government when faced with the slump. He preferred to repose confidence in an ultimately benign process of ‘creative destruction’, a Schumpeterian vision that has (quite rightly) informed our understanding of the dynamics of modern capitalism.

In the Keynesian vision, however, such inaction is itself irresponsible. It may be that the author of the Treatise on Probability remembered its argument that our powers of prediction are so fallible, and our immunity from unintended consequences so frail, that it is simply not prudent to look too far ahead. Under such circumstances, it may be rational to base our actions on a relatively short run over which we have more control. But the fundamental point is surely that the best can be the enemy of the good.

Keynes laid down a basic principle as early as the Tract: ‘When, therefore, we enter the realm of State action, everything is to be considered and weighed on its merits.’¹¹ And in the real world we are faced with second-best options, all of which may be far from ideal, but some of which may be better than remaining inert through misguided doctrinal purity. Our choices ought to be the best that we can make at the time, with a natural likelihood of error. Thus Keynes was to write in 1933, at the time of the abortive world economic conference and at the beginning of the New Deal: ‘We do not know what will be the outcome. We are – all of us, I expect – about to make many mistakes.’¹² This was all the more reason for trying to do something, not an excuse for doing nothing.

Little wonder, then, that Keynes had emerged as the leading critic of ‘the authorities’ in Britain. For the Treasury and the Bank of England were united in upholding what Keynes called laissez-faire. They adhered to a deliberately non-interventionist model of the economy. Like the House of Lords – as celebrated in Gilbert and Sullivan’s Iolanthe – they did nothing in particular, and did it very well. The Treasury doctrine, handed down since Gladstone in the late nineteenth century, was to preserve a system that was ‘knave-proof’, that is, immune from the base political temptations to which opportunistic politicians like Lloyd George were all too susceptible. The Treasury’s role was to balance the books, as the national housekeeper, not to try to manage the economy, as the national breadwinner.

Three interlocking principles were therefore inviolable: balanced budgets, Free Trade and the Gold Standard. Each purposely restricted the initiative of government under a system that was intended to be self-acting and self-regulating. The trouble was that the First World War had simultaneously run the budget into deficit, introduced the thin end of the tariff wedge and taken Britain off gold for the duration. Hence the prime aim of the authorities to go back on to gold, which was the British version of getting back to the sort of ‘normalcy’ with which the Republican presidential candidate in 1920, Warren Harding, had reproached radical critics and offended linguistic pedants.

In all of this the Treasury worked hand-in-glove with the Bank of England. Its governor for a uniquely long term, from 1920 to 1944, was Montagu Norman: a remote and aloof figure, subject to neurotic breakdown, but commanding a respect bordering on mystique as the bankers’ banker. The robust instincts of Winston Churchill, Chancellor of the Exchequer from 1924 to 1929, led him to question the prevailing orthodoxy. ‘I would rather see Finance less proud and Industry more content,’ he growled. But he buckled in face of the stern advice from Sir Otto Niemeyer (as Keynes’s old rival in the Treasury had now become) about the criteria that should guide the authorities. ‘The real antithesis is rather between the long view and the short view,’ Niemeyer told Churchill. ‘Bankers on the whole take longer views than manufacturers.’¹³

Keynes was unlikely to be persuaded by such appeals to the inherent virtues of the long run. Moreover he detected a sort of leftover Victorian piety and smugness, almost Pecksniffian, for which Bloomsbury had no time. Keynes had already given his own opinion in the Tract that ‘many conservative bankers regard it as more consonant with their cloth, and also as economising thought, to shift public discussion of financial topics off the logical on to an alleged “moral” plane, which means a realm of thought where vested interest can be triumphant over the common good without further debate’.¹⁴ But, argue as he might, the authorities remained united in telling Churchill that he had to go back to gold in 1925. ‘The Gold Standard,’ Norman confidently claimed, ‘is the best “Governor” that can be devised for a world that is still human, rather than divine.’¹⁵

It was natural that the Macmillan committee should begin its work by summoning the governor of the Bank of England as its first witness in November 1929. Characteristically at such a moment of stress, Norman took to his bed, sent his deputy and did not appear in person until four months later. Meanwhile this delay gave Keynes his chance to educate the committee, notably in a series of five sessions of ‘private evidence’ in which he expounded his own thinking. He conducted these meetings with his customary aplomb, virtually as a seminar.

In doing so he was singularly well prepared. Through fortuitous timing, he was able to expound the themes of his new book, eventually published in October 1930 as A Treatise on Money, in two volumes totalling over 700 pages. Dealing with both the pure and the applied theory of money, this was the big academic book that was needed to establish his professional credentials. Schumpeter wrote with congratulations on the completion of a work that he looked forward to reading. But how many members of the Macmillan committee would have said the same? ‘I have written this out at great length in technical language,’ Keynes told them in February 1930, before offering them, in effect, a beginners’ guide to the Treatise.¹⁶

The book’s philosophy can be seen from a passage added at a late stage. ‘It has been usual to think of the accumulated wealth of the world as having been painfully built up out of that voluntary abstinence of individuals from the immediate enjoyment of consumption which we call thrift,’ it claims. ‘But it should be obvious that mere abstinence is not enough by itself to build cities or drain fens.’ This no doubt seemed a sensible observation in Cambridge, a city built by draining a fen. So what had actually done the trick and created the wealth of nations? ‘It is enterprise which builds and improves the world’s possessions,’ the Treatise tells us, with a rhetoric that loads the terms to suit the dynamics of the analysis. ‘If enterprise is afoot, wealth accumulates whatever may be happening to thrift; and if enterprise is asleep, wealth decays whatever thrift may be doing.’¹⁷

The chapter on historical illustrations, from which this is quoted, challenges the conventional values of its day. At the time, saving remained prized and honoured as the key to economic recovery. Keynes’s serious point is to distinguish saving (or thrift), which is essentially negative, from the real motor of economic growth, investment (or enterprise). This is why thrift is out, and with it the conventional bankers’ resort to deflation in times of crisis. By the same token, it is why enterprise is in, and with it a more tolerant view of what society has owed to historical episodes of inflation. Thus England experienced ‘the sensational rise of prices’ of the years 1560 to 1650 with happy results – ‘We were just in a financial position to afford Shakespeare at the moment when he presented himself!’¹⁸ How different the country’s more recent history, when in 1925 the return to the Gold Standard was accompanied by a credit squeeze ‘with the object of producing out of the blue a cold-blooded income deflation’.¹⁹

Keynes sought to convey the novelty of his insights to his students on the Macmillan committee. But there was another professor at the table: Theodore Gregory of the London School of Economics (LSE), put there by the authorities as an expert on the banking system and as an obvious check on any Keynesian unorthodoxy. Gregory, however, was no doctrinaire and, content to bide his time, had a good point when he maintained that ‘there is not a very wide margin of difference between him and myself on some of the analytical points he has raised’. As he said, ‘I think the main difference will come over points of policy rather than over theoretical points.’ It was Keynes who sought to sharpen their differences by claiming, ‘I think it makes a revolution in the mind when you think clearly of the distinction between saving and investment.’²⁰

The fact is that the Treatise was not as incompatible with orthodox economic theory as its author imagined it to be at the time. Little wonder that Schumpeter considered it Keynes’s best book. Its rhetoric was challenging but its great analytical strength – as Keynes’s presentation of it to the Macmillan committee brought out – was its lucid account of the mechanisms by which the monetary system was supposed to work, especially the Gold Standard. ‘An extraordinarily clear exposition,’ the chairman congratulated Keynes, and McKenna chipped in: ‘An extraordinarily clear exposition, and thoroughly understood by us.’ It was left to Gregory to add defensively: ‘It may be a very beautiful and perfect series of assumptions – but they were in fact assumptions which worked.’ McKenna conceded: ‘Pre-War, they worked.’ Gregory, civil but determined, then reiterated his point: ‘I accept everything that Mr Keynes has said, but I should like to emphasise that this is not only a beautiful series of assumptions, but assumptions which translated into action have worked.’²¹

But had they worked? Did they still work? How effectively were these beautiful assumptions translated into action? Why was Finance so proud of them and Industry so discontented? These were now the key issues, with the official unemployment figures in Britain hovering around 10 per cent throughout the 1920s, averaging 16 per cent in 1930 and over 21 per cent by 1931.

Professor A. C. Pigou was Marshall’s successor as Professor of Political Economy at Cambridge, thus holding the most prestigious economics chair in the country. As such, he would have his two days before the Macmillan committee in due course. Less than six years older than Keynes, he seemed already of an older generation, stiff in his manner, cautious in his scholarship. Keynes later took him as representative of the ‘classical school’, devoting seven pages of the General Theory to a demolition of Pigou’s The Theory of Unemployment (1933). Of all the economists whom Keynes might have chosen as the straw man of orthodox economics, to be publicly knocked down, he chose Pigou, the bearer of the Marshallian flame, his colleague in the Cambridge Economics Faculty and a Fellow of King’s College like Keynes himself.

It was a small world. Pigou had been more generous when he reviewed Keynes’s Treatise, saying that it provided ‘an account of the modus operandi of bank rate much superior, as it seems to me, to previous discussions’.²² True enough, and from an impeccably orthodox source. For at this time Keynes’s real achievement was not any theoretical innovation of his own but his lucidly cogent analysis of how the conventional theoretical mechanisms worked – or failed to work – in practice.

Many people in Britain, with the benefit of hindsight, came to agree that going back on to the Gold Standard in 1925 had not been very clever. Churchill later talked of it as ‘the biggest blunder of his life’.²³ What distinguished Keynes was that he had publicly identified this policy disaster with the benefit of foresight. ‘The Economic Consequences of Mr Churchill’ (1925) had set out the case. He made it clear that he was not against the Gold Standard as such but ‘against having restored gold in conditions which required a substantial readjustment of all our money values’. British prices would have to come down to make the pound sterling actually worth as much as $4.86 in purchasing power. So Churchill was accused of ‘committing himself to force down money wages and all money values, without any idea how it was to be done. Why did he do such a silly thing?’²⁴

It was essential to appreciate the process that was set in train. By what mechanism could dear money (or credit restriction) bring down real wages? ‘In no other way than by the deliberate intensification of unemployment.’²⁵ Here were the real-world consequences of the long views taken by the bankers and commended by Niemeyer and the other Treasury knights. Niemeyer had not been afraid to take a hard line that he admitted was ‘necessarily put in a doctrinaire way’.²⁶ The return to gold might face British industry with temporary difficulties, now that exports were uncompetitive at the new exchange rate; but prices were surely flexible, were they not?

This was inescapably an issue with a social dimension. ‘The gold standard, with its dependence on pure chance, its faith in “automatic adjustments”, and its general regardlessness of social detail, is an essential emblem and idol of those who sit in the top tier of the machine,’ wrote Keynes.²⁷ He had sat there himself; he knew whereof he spoke. Perhaps in our day the clever people in the top tier of the IMF, when demanding similar adjustments from developing countries, have done so with a similar blithe obliviousness of the consequences.

If Keynes spoke with less passion on this subject to the Macmillan committee in 1930, it was for a good reason. Admittedly, he always found it difficult to be dull. But he badly wanted to be listened to by the committee, not as a polemical policy advocate, but ‘as a scientist’ who would first identify the problem before specifying what remedies were appropriate.

The problem was that savings and investment were out of kilter. It was interest rate that had the job of bringing them into equilibrium, finding a point at which the rate was low enough to encourage investors but high enough to reward savers. In a slump, it was enterprise that needed stimulation through low interest rates, so it was reasonable to suppose that the rate of interest would always fall accordingly, since ‘there are always plenty of useful things to do at a price if you can borrow cheap enough’.²⁸ But this was only true of a closed system, where interest rate had this flexibility. In an international system, however, interest rate had a second task – one that took priority in the eyes of the central bank. This was to maintain the value of the currency itself, by setting interest rates at a high enough level to protect the foreign exchange reserves. So a country’s internal need for cheap money might be trumped by its external necessity to impose dear money.

In theory, equilibrium could still be achieved. All that was required was that domestic prices make the adjustments necessary to keep in line with international prices. This could be achieved either by a process of inflation through a low interest rate, to raise domestic prices, or by deflation through a high interest rate, to bring prices down. An inflationary adjustment presented no problem, since there would naturally be little resistance to wage increases, for example. A deflationary adjustment was more difficult, requiring painful cuts, but had proved historically feasible. Small adjustments in both directions had thus been relatively easy to make before 1914, especially for a creditor country like Britain with big reserves that could themselves absorb some of the shock. In particular, the balance of payments – like any balance sheet – could be made to balance, in this case through a rise or fall in the residual level of investment overseas.

In the cold, hard world of the 1920s, however, the shock-absorbers were largely absent. The wartime erosion of Britain’s overseas investments was one obvious difference. Rebuilding them was now acknowledged as a strain on the balance of payments, but London’s financial prestige was felt to be at stake, with its continuing pretensions to act as the world’s banker. The Gold Standard was the symbol of all this; the necessity of going back on gold was the bankers’ article of faith. It meant that ‘the pound could look the dollar in the face’, as the saying went, or that the pound would be ‘as good as gold’, just as it had been before 1914. ‘In truth,’ Keynes had whispered in the Tract, ‘the gold standard is already a barbarous relic.’²⁹

In 1925, when Churchill took his heroic step, or did ‘such a silly thing’, $4.86 was the only parity seriously considered. It was simply the pre-war parity; going back meant going back to 1914. The only problem was that wages now had to be forced down – not perhaps to their 1914 level but, say, 10 per cent below what was customary by the mid-1920s. This applied especially to British export industries, and even more to those export industries where wages comprised a large part of total costs. That meant coal. The long miners’ strike of 1926, leading in the same year to Britain’s only General Strike, was thus one of the economic consequences of going back on the Gold Standard at $4.86.

The Treasury model of the economy was based on the premise that all prices, including wages, were flexible. It followed that all internal prices could be expected to accommodate to a single external price, the exchange rate. For if prices were indeed flexible, the exact exchange rate set at any particular time did not really matter very much.

In theory Keynes accepted that an adjustment process could sort out any problems. His Treatise showed how it could be done – perhaps how it should be done. This was the general case; but he also outlined a special case, which was obviously applicable to Great Britain in 1930, when ‘its international disequilibrium is involving it in severe unemployment’. Under those conditions, ‘the Government must itself promote a programme of domestic investment’.³⁰ Everyone knew that he was the joint author of ‘Can Lloyd George Do It?’ As expected, therefore, he justified the same general approach to the Macmillan committee, and did so in a dialogue with the chairman at the end of February 1930.

‘Does it come to this – that because we are not a closed nation the Bank rate cannot achieve the results?’ Macmillan asked, showing the capacity of a good lawyer to pick up a new brief. ‘There is also another reason,’ Keynes replied. ‘It could if we were a fluid system. For in that case, when we had a surplus of home investments over savings, the Bank rate could always force wages down to a level where exports would be adequate.’ Macmillan took the point – ‘It would be the principle of hydraulics.’ ‘Yes,’ said Keynes; ‘that is the beauty of the Bank rate.’ To which Macmillan naturally responded with the key question: ‘Why is it not fluid now?’³¹

It was a question that Keynes had been thinking about, in one form or another, for several years. It had certainly been on his mind since The Economic Consequences of the Peace (1919), and there are arguably some adumbrations in Indian Currency and Finance (1913). His objections to the reparations demanded of Germany arose essentially out of the impracticability of making such international transfers across the exchanges – an issue on which revisionist historians who take a more benign view of the Versailles Peace Treaty have yet to prove Keynes wrong.

The crude idea of making Germany ‘pay’ till the pips squeaked was flawed for more than moral or political reasons. It ignored the fact that it was not a heap of gold that would be transferred but rather a stream of goods that Germany would arbitrarily be required to export – or rather, provide free of charge. This would in fact require the German economy to become the mightiest in Europe, through an export miracle to be achieved despite the lack of any market incentive through payment! Such fantasies naturally ran up against the stubborn realities of the transfer problem. Keynes commented in 1928: ‘Those who see no difficulty in this – like those who saw no difficulty in Great Britain’s return to the Gold Standard – are applying the theory of liquids to what is, if not a solid, at least a sticky mass with strong internal resistance.’³²

The authorities’ ingrained assumptions about fluid or flexible prices account for much of their early hostility to Keynes’s reasoning. They simply expected prices to behave as their model predicted. Thus in 1925 Niemeyer had dismissed Keynes’s arguments in forthright terms – ‘To me they seem sheer lunacy’ – and had done so in the confidence that current economic trends were on his side. He predicted that prices, and hence unemployment, would duly fall as the orthodox theories prescribed, in which case ‘a good deal of Mr Keynes’ argument will fade away’.³³

Both of Niemeyer’s predictions were wrong. Arguments about whether sterling was really overvalued in 1925 can actually be resolved by a simple test: whether the Bank of England needed to maintain a dear-money policy, year after year, in order to defend this parity. It did. This was naturally unpopular and, in Governor Norman’s rueful phrase, meant that the bank was ‘continuously under the harrow’.

In March 1930 Norman was finally ready to face his ordeal of examination by the Macmillan committee. Alas, he faced a committee already indoctrinated by Keynes. Worse still, Keynes himself would inevitably dominate the questioning. But even in the opening questions, led by Macmillan, the governor seemed unable to engage with the issues. His view that the ‘actual ill-effects were greatly exaggerated and that they are more psychological than real’ revealed some sense of distance from the coalfields. ‘If a machine gets jammed it will not work,’ Macmillan persisted, regurgitating his recent lessons from Keynes, but getting nowhere. Then Ernest Bevin, with his trade unionist experience, weighed in to make a link between wage reductions and the Gold Standard, but was repeatedly fobbed off by Norman. ‘No, I do not think so.’ ‘I do not think as a necessary consequence.’ ‘No, I do not, Sir.’

Keynes took up the questioning. He naturally challenged Norman on his view that the workings of bank rate relied on psychology rather than hydraulics. Did this not repudiate orthodox theory? ‘I did not mean to repudiate it, as I understand it,’ said Norman. Keynes then gave him the benefit of a recapitulation of the orthodox theory, challenging Norman to indicate any dissent, but provoking only the response: ‘I could not dispute it with you.’ This hapless display finally provoked Professor Gregory to intervene. ‘I thought we were trying to work out the theory of how the Bank rate is supposed to operate under present conditions,’ he said impatiently, ‘but if I am told that it does not work that way I am merely asking for an alternative explanation of how it does work.’³⁴ Nothing was forthcoming.

It was at this point that the authorities got seriously worried about the Macmillan committee. They had not liked the idea of open discussion of these mysteries in the first place. The private secretary to the Chancellor of the Exchequer had warned at the outset ‘that we have had one continuous policy as a guiding principle and a system which is knave-proof’, whereas ‘the critics, especially Keynes, have changed their ideas and their theories nearly every year’. As a dutiful civil servant, he asked the minister: ‘Is there not some danger of giving the impression that the Governor is being put in the dock?’³⁵ Norman’s performance bore out such fears. One result was that the Treasury made sure that its own evidence was far, far better prepared, not least against Keynes’s expected sniping at what was becoming known as the ‘Treasury View’.

Keynes was simply having too much success in setting the agenda. But it would be wrong to suppose that he had hijacked the Macmillan committee, with a flight towards public works as the sudden new destination. For one thing, the other members were not ciphers and Keynes knew that he had to allow for a variety of opinions around the table. There were protectionist members. His ally McKenna favoured relaxation of monetary policy; his other ally, Bevin, thought devaluation might be better. In fact Keynes’s private evidence had enumerated a range of possibilities for action – all of them accepting that wages were ‘sticky’ and that the deflationary adjustment process had therefore failed.

Keynes told the committee that there were seven possible remedies, given Britain’s current predicament. One was indeed abandoning the parity of $4.86 – undoing the bad decision of 1925. But this could no longer be undone easily, since events had acquired their own momentum, and Keynes now regarded devaluation as a last resort. A second possibility was what later became known as incomes policy. This would involve a ‘national treaty’ to bring down all wages immediately to the required level, rather than leaving such adjustment to the slow and haphazard workings of the market. Keynes regarded this as equitable in theory but impracticable: a verdict that subsequent Keynesian experiments with incomes policies, especially in the 1960s and 1970s, in both Britain and the USA, have done little to qualify.

A third remedy was bounties to industry. This was functionally equivalent in so far as it meant subsidising wages in vulnerable industries, especially those most keenly subject to competition from overseas, thus spreading the pain across the whole community rather than letting one group of workers suffer. Like incomes policy, it had a political rather than an economic rationale, but unlike incomes policy was never subsequently to become serious politics. A fourth remedy – ‘rationalisation’ – was so vague that almost anybody, including Montagu Norman, could readily agree to it. It was a vogue word for schemes to cut unit costs, especially through economies of scale, and in so far as it meant greater efficiency it was a fine panacea. Everyone nodded, if only through weariness.

Next on Keynes’s list came tariffs. Their possible relevance to a slump was timeless – what country has not heard the protectionist cry when facing hard times? ‘British jobs for British workers’ and ‘Buy American’ are the sort of slogans that have been around for a long time. Fears of exporting jobs to lower-paid workers overseas are not new. The belief that protectionist tariffs can increase home employment has often sounded plausible – except to economists. Moreover, in Britain tariffs were by far the most politically charged of Keynes’s seven possible remedies, because Free Trade had become a sharp dividing line between the political parties for more than a quarter of a century. Thus Conservatives were generally sympathetic to tariffs, especially when they were given an imperial twist; while both Liberals and Labour had always been entrenched upholders of Free Trade. For Keynes even to broach the idea was not only shocking but also evidence of his genuine open-mindedness.

His reasoning becomes apparent in relation to his sixth policy option. This was, of course, home investment or public works. Keynes came clean in calling it ‘my favourite remedy – the one to which I attach much the greatest importance’. It was the option available to a country under the special case of the Treatise, when a jam or hitch in the workings of the Gold Standard mechanism thwarted the achievement of equilibrium by the natural process of market adjustments. But actually it was simpler than that: ‘It always seems to me that this argument is quite agreeable to common sense.’ Moreover, as Keynes put it, ‘I think the first impetus forward must come from action of this kind, that it must be Government investment which will break the vicious circle.’³⁶

As he had since 1924, he presented a line of argument that we can fairly identify as Keynesian. But in 1930, it should be noted, the argument took the Gold Standard as a given, thus justifying resort to public works – and much the same reasoning justified tariffs too, as another special case, only valid under such conditions. Both, then, were presented as second-best options, given both a fixed exchange rate and the inflexibility of prices.

Finally, Keynes proposed international measures as his seventh remedy for the Macmillan committee. Since high interest rates were the problem, and since they were high because of international pressure, the obvious solution was international agreement by all countries simultaneously to bring down interest rates. Like Free Trade, this seemed a simple means of increasing the wealth of nations to the benefit of all – simple but not easy. In the 1930s Keynes largely despaired of gaining agreement from enough countries to make this sort of remedy feasible. Instead of wasting time in chasing the unattainable, he encouraged each country, and especially Britain and the United States, to seek its own salvation through expansionist measures, whether or not protectionist. Only in the 1940s, as we have seen, was he to play a key role in creating a sort of international Keynesianism, with institutions that accepted full employment alongside free trade as goals.

‘What I am trying to do is to do justice to all the remedies that have been put forward,’ Keynes told the committee. ‘I think I said at the beginning that there was something to be said for all of them.’³⁷ By and large, this is what he did: making the best case in good faith for the relevance of each, while not concealing his own preference. This was consistent with his long-standing view that every option deserved to be considered. It was consistent too with his quest for second-best options, under changing conditions, rather than a doctrinaire attachment to the ideal. And it was, of course, a gift to his critics who, now as then, have always delighted in discrediting Keynes on the grounds of his alleged inconsistency.

Paralleling Keynes’s membership of the Macmillan committee, he was also appointed in 1930 as a member of the government’s new Economic Advisory Council (EAC). In this forum, too, much the same diverse policy options were canvassed, by Keynes as by other EAC members. And it was in this capacity that Keynes explained to the Prime Minister, Ramsay MacDonald, that ‘the peculiarity of my position lies, perhaps, in the fact that I am in favour of practically all the remedies which have been suggested in any quarter. Some of them are better than others. But nearly all of them seem to tend in the right direction.’ The conclusion he drew was consistent in its scorn for ‘long-run’ strategies of inertia: ‘The unforgivable attitude is, therefore, for me the negative one, – the repelling of each of these remedies in turn.’³⁸

It is easy to understand why Keynes had clashed with Treasury orthodoxy in the late 1920s. ‘To all well-laid schemes of progress and enterprise, they have (whenever they could) barred the door with, No!’, so ‘Can Lloyd George Do It?’ claimed. In this avowedly political pamphlet, the Conservative philosophy was contemptuously caricatured: ‘You must not try to employ everyone, because this will cause inflation. You must not invest, because how can you know that it will pay? You must not do anything, because this will only mean that you can’t do something else.’³⁹

This identified a mindset rather than a particular argument as the obstacle. ‘But we are not tottering to our graves,’ ran the peroration. ‘We are healthy children. We need the breath of life. There is nothing to be afraid of. On the contrary. The future holds in store for us far more wealth and economic freedom and possibilities of personal life than the past has ever offered.’⁴⁰ Nobody has a copyright on the rhetoric of hope and audacity and those who detected a Keynesian note in President Obama’s inaugural address in January 2009 have a point.

Conservative rhetoric, by contrast, had found no finer exponent than Winston Churchill. His statement on Budget day in 1929 had endorsed ‘the orthodox Treasury dogma, which is steadfastly held, that whatever might be the political or social advantages, very little additional employment and no permanent additional employment can in fact, and as a general rule, be created by State borrowing and State expenditure’.⁴¹ With his knack for spotting the telling quotation, Keynes had seized on Churchill’s words, the better to expose this dogma as fallacious. The ‘Treasury View’ quickly became a term of art, in much its modern sense (or perhaps a sense that can be traced back to the early-nineteenth-century economist David Ricardo). It is the proposition that any increase in government spending on public works will ‘crowd out’ an equivalent amount of private investment, and thus fail to reduce overall unemployment.

The Treasury knew in advance that Keynes would attack its eponymous dogma. The urbane figure of Sir Frederick Leith-Ross could be seen at virtually every meeting of the Macmillan committee in early 1930, spying out the ground for his colleagues in the Treasury. He thus heard Keynes’s opinion of ‘the so-called “Treasury View”’ in March – ‘that it is a pure logical delusion, without any foundation at all in sound thinking’. Keynes said that this was because the proposition failed to distinguish between savings and investment, in the way that his own analysis did in the Treatise. But he did not demand the adoption of his own peculiar terminology to sustain his central point: ‘The Treasury view only demonstrates that home investment is not a cure for unemployment, by first of all assuming – in effect – that there is no unemployment to cure.’ At full employment, crowding-out may indeed be an inflationary hazard; but only then. So he called the Treasury View ‘the natural result of standing half-way between common sense and sound theory; it is the result of having abandoned the one without having reached the other’.⁴²

The Treasury knew better than to debate at this level. ‘The fact is that Keynes, like other economists, lives in a world of abstractions,’ the clubbable ‘Leithers’ reported back to his colleagues. ‘He speaks of “Industry”, “Profits”, “Losses”, “Price level” as if they were realities.’⁴³ There is a good point here, of course. How far can any proposition in economic theory be applied to the intractable difficulties of a world where everything turns out to be much more complex and muddled than under the conditions airily specified, for the sake of simplicity, in economic theory?

When Keynes asked why an impoverished country could not solve its problems by simultaneously mobilising unused savings and unemployed workers, the rhetorical appeal was beguiling. Yet the Treasury surely had a point too. It was only doing its job in advising ministers that these eloquent pleas should be tempered with some necessary caution; that it is necessary not to alarm public opinion, especially about the scale of expenditure; that ministers should investigate any public works proposal for what we would call its ‘shovel-ready’ status; and that any hopes of easy success should be tempered by the Treasury’s own hardwon experience (which ministers should be aware has often been frankly rather disappointing).

Leith-Ross, a man of the world, was shrewd enough to spot the weak points in the authorities’ case. ‘Mr J. M. Keynes says that, despite the general reduction of price levels since 1925, there has been no appreciable reduction during the same period in the rates of wages paid to labour in the United Kingdom,’ he wrote, with evident puzzlement, to his Treasury colleague R. G. Hawtrey, an old friend of Keynes. Leith-Ross expostulated to Hawtrey, who was paid to know things like this, that ‘it appears to be so surprising that I should be glad if you would go into it’.⁴⁴ Hawtrey duly turned up the relevant indexes, checked the figures: alas, it was so, and Keynes was right in what he had told the Macmillan committee. Not until March 1930, therefore, did the Treasury wake up to the news that British prices and wages were disobeying the laws of economic theory about their axiomatic flexibility.

So neither in theory nor in practice did the authorities have as good a hand to play as they had once supposed. The Treasury View was altogether too tendentious; and the brute facts seemed to vindicate Keynes rather than the Treasury, still less the Bank of England, in the argument about prices, wages and unemployment. This being so, it was clearly politic to adopt a less trenchant tone in the Treasury evidence. Luckily the post of controller of finance and supply services at the Treasury was no longer occupied by the abrasive, doctrinaire Niemeyer but by the emollient, pragmatic Sir Richard Hopkins. When he went in May 1930 to meet the committee, over whom Keynes had established an alarming intellectual ascendancy, it was Hopkins’s moment.

The Treasury team were working well together. Well-briefed by ‘Leithers’, and well-prepared himself, ‘Hoppy’ executed an adroit tactical retreat from an exposed position. Instead, his brief was to plead not only administrative feasibility but confidence as the real problems – ‘so far from setting up a cycle of prosperity’ or inducing ‘a general willingness to invest in these vast Government loans I should have thought that the loans would have to be put out at a very high price, and that the process might be accompanied by despondency on the part of general business, rather than otherwise’.⁴⁵ Hopkins’s forte was his non-adversarial tone, his refusal to rise to gladiatorial display. ‘I would like time to think it over’ and ‘I should like time to consider this’ constituted his line in repartee. ‘I am a layman with regard to control of the Bank Rate and control of the currency,’ he pleaded on the first day of his evidence, avoiding the pitfalls that had ensnared Norman two months earlier.⁴⁶

On the second and final day of his evidence, Hopkins finally faced Keynes’s questioning. They were well matched. ‘I think the Treasury view has sometimes been rather compendiously and not very accurately stated,’ Hopkins began, helped from the chair by Macmillan, who queried whether it had been ‘a little misunderstood?’ Yes, Hopkins readily agreed, ‘a little misunderstood’. Disowning dogma, Hopkins dwelt instead on two much more durable objections to any proposals for public works: not only whether they are shovel-ready but also whether they will command public confidence. ‘It seems to me,’ mused Hopkins, ‘that a feeling might widely arise that this was a project of extravagance and waste.’⁴⁷ The fact is that exactly such a feeling was entertained by his own colleagues. We can literally see this because the official Treasury copy of the Liberal pamphlet ‘We Can Conquer Unemployment’, preserved in the National Archives, has been defaced. To Lloyd George’s message, ‘We Mobilised for War, Let us Mobilise for Prosperity’, three words have been added by the Treasury wits – ‘EXTRAVAGANCE, INFLATION, BANKRUPTCY’.

Nothing so gross escaped Hopkins’s lips in his evidence. He put the problem at one remove, by pointing to the effect of such negative sentiments, whether or not warranted, in undermining confidence. ‘If Mr Bevin could assure you that the schemes would be popular, then you would say that they would cure unemployment?’ asked Keynes. ‘No,’ parried Hopkins. ‘You are asking me to say that if I thought that the public sentiment would endorse the large plan to which we are referring, then it would cure our situation.’ Keynes pounced: ‘Yes?’ Hopkins was not allowing everything to turn on this – ‘But I went on to say that there were other difficulties.’