Item 215 - Text of an article by J. M. Keynes entitled ‘Is the Rearmament Loan Inflationary?: A Justification of the Chancellor of the Exchequer’s Programme: A Plea for an Organised Policy’

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Text of an article by J. M. Keynes entitled ‘Is the Rearmament Loan Inflationary?: A Justification of the Chancellor of the Exchequer’s Programme: A Plea for an Organised Policy’


  • c. 7 Mar. 1937 (Creation)

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(Carbon copy of a typed original.)



A Justification of the Chancellor of the Exchequer’s Programme

A Plea for an Organised Policy
By J. M. Keynes

The Chancellor of the Exchequer having published his prospective borrowing plans for re-armament, the question properly arises whether this programme can be super-imposed on the present business situation without risking a state of inflation. The question is hotly debated. The Chancellor declares that a loan of £80,000,000 a year is not excessive in the circumstances. His critics dispute this conclusion. Clearly it is a matter of figures. The Chancellor would agree that £200,000,000 a year would be dangerous; his critics are disposed to accept £40,000,000 a year as safe. What calculations are relevant to the answer? I believe that we can carry the argument a stage further than mere assertions based on vague individual judgments.

What is Inflation?

To begin with, what do we mean by “Inflation”? If we mean by the term a state of affairs which is dangerous and ought to be avoided—and, since the term carries to most people an opprobrious implication, this is the convenient usage—than we must not mean by it merely that prices and wages are rising. For a rising tendency of prices and wages inevitably, and for obvious reasons, accompanies any revival of activity. An improvement in demand tends to carry with it an increase in output and employment and, at the same time, a rise in prices and wages. It is when increased demand is no longer capable of materially raising output and employment and mainly spends itself in raising prices that it is properly called Inflation. When this point is reached, the new demand merely competes with the existing demand for the use of resources which are already employed to the utmost.

The question is, therefore, whether we have enough surplus capacity to meet the increase in demand likely to arise out of an expenditure of £80,000,000 raised by loans and not by diverting incomes through taxation. Now the resulting increase in demand will be greater than £80,000,000; since we have to provide for increased expenditure by the recipients of the £80,000,000, and for further similar reactions. There are reasons, too detailed to repeat here, for supposing that the total effect on demand will, in existing conditions in this country, probably lie between two and three times the primary increase. To be on the safe side, let us take three times as our preliminary estimate, which means that the total increase in the national income resulting from the Chancellor’s borrowing will have to be in the neighbourhood of £240,000,000 at present prices,—an increase, that is to say, of about 5½ per cent. Have we sufficient surplus capacity to provide such an increase? Or will the Government demand merely serve to raise prices until resources, already in use, are diverted from their present employment? This is certainly not a question to be answered lightly.

The number of insured persons who are still unemployed is, indeed, as high as 12½ per cent. But although the new demand will be widely spread (since it will not be limited to the primary employment for armaments but will also spread to the secondary employments to meet the increased demand of consumers), we cannot safely regard even half of these unemployed insured persons as being available to satisfy home demand. For we have to subtract the unemployables, those seasonally unemployed etc., and those who cannot readily be employed except in producing for export. Unless we make a liberal allowance for overtime and more output from those already in employment, it would need more planning and transfer of labour than is practicable in the time to increase the national output in 1937 by 5½ per cent over what it was in 1936; although over (say) a period of three years it might be possible.

Thus it is not plain sailing. If we suppose the full rate of Government spending to begin immediately, without any improvement in the export industries or any reduction in other activities, unsupported by organised overtime, by careful planning and an interval for the planning to take effect, there is a risk of what might fairly be called inflation. Is the Chancellor’s claim that he can avoid inflation nevertheless justified? For the following reasons I believe that it is.

How to Avoid Inflation

In the first place, my ‘multiplier’ of three times may, in present circumstances, exaggerate the scale of the repercussions. As prosperity increases, saving probably increases more than in proportion; particularly when profits are rising. It may well be that the total increase in expenditure, resulting from loans of £80,000,000, will be no more than (say) £170,000,000 or 4 per cent of the national income—an improvement which it would be much easier to accomplish than 5½ per cent.

In the second place, some part of the new demand will be met, not by increasing home output, but by imports (which I have not allowed for in the above calculation). This means either that the imports will be offset by increased exports or, failing this, that there will be a diminution of net foreign investment. Probably there will be a bit of both. We can look forward to an increase of ‘invisible’ exports through the increased earnings of our shipping and our foreign investments and, perhaps, from visitors to the Coronation. But it remains particularly advisable to do anything possible to stimulate our staple exports. For it is there that our reserves of surplus labour are chiefly to be found. It is no paradox to say that the best way of avoiding inflationary results from the Chancellor’s loan is to increase both imports and exports. In any case, we can make a deduction of (say) 15 to 20 per cent on account of increased imports, which brings down the increase in the national output (apart from exports) necessary to avoid inflation to a figure between 3½ and 4½ per cent.

Thirdly, measures to ensure that all possible orders are placed in the Special Areas where surplus resources are available, will greatly help. It is a mistake to suppose that this is merely a form of charity to a distressed part of the country. On the contrary, it is in the general interest. Whether demand is or is not inflationary, depends on whether it is directed towards trades and localities which have no surplus capacity. To organise output in the Special Areas is a means of obtaining re-armament without inflation. I am not sure that this is properly understood. One feels that the War Departments are inclined to regard a Special Areas measure as a form of charity, doubtless praiseworthy, which interferes, however, with their getting on with the job in the most efficient way. On the contrary, it is only by using resources which are now unemployed that the job can be got on with, except at the cost of great waste and disturbance. The Special Areas represent our main reserve of resources available for re-armament without undue interference with the normal course of trade. They are not a charity, but an opportunity.

We are still assuming that new capital investment, apart from re-armament, will continue on the same scale as before. It seems possible, however, that there will be some reduction in new building. By an extraordinary and most blameworthy short-sightedness, our authorities do not think it worth while to collect complete statistics of new building, the figures for the County of London being omitted from the published aggregate. But new building may easily fall short of last year by £20,000,000, which would provide a quarter of the Chancellor’s requirements. There remains capital development carried out by the railways, public boards and local authorities, which should be to some extent controllable by deliberate policy. On the other hand, increased investment may be necessary in some directions, to provide new plant where marked deficiencies exist. Nevertheless a net increase in output of 3 per cent might see us through, after allowing for the other offsets we have mentioned; and that is an improvement we might reasonably hope to accomplish in the near future.

The Need for Careful Planning

I conclude that the Chancellor’s loan expenditure need not be inflationary. But, unless care is taken, it may be rather near the limit. This is particularly so in the near future. It is in the next year or eighteen months that congestion is most likely to occur. For ordinary investment is still proceeding under the impetus of the recent years of recovery. In two years[’] time, or less, re-armament loans may be positively helpful in warding off a depression. On the other hand, the War Departments may not succeed—they seldom do—in spending up to their time-table.

This conclusion is subject, however, to an important qualification. The Government programme will not be carried out with due rapidity, and inflation will not be avoided, by happy-go-lucky methods. The national resources will be strained by what is now proposed. It is most important that we should avoid war-time controls, rationing and the like. But we may get into a frightful muddle if the War Departments merely plunge ahead with their orders, taking no thought for general considerations affecting foreign trade, the Special Areas, and competing forms of investment.

I reiterate, therefore, and with increased emphasis the recommendation with which I concluded my former articles in the Times. It is essential to set up at the centre an organisation which has the duty to think about these things, to collect information and to advise as to policy. Such a suggestion is, I know, unpopular. There is nothing a Government hates more than to be well-informed; for it makes the process of arriving at decisions much more complicated and difficult. But, at this juncture, it is a sacrifice which in the public interest they ought to make. It is easy to employ 80 to 90 per cent of the national resources without taking much thought as to how to fit things in. For there is a margin to play with, almost all round. But to employ 95 to 100 per cent of the national resources is a different task altogether. It cannot be done without care and management; and the attempt to do so might lead to an inflation, only avoidable if a recession happens to be impending in other directions. The importance of collecting more facts deserves particular attention. For my estimates, given above, are of course no better than bold guesses based on such figures as are accessible. They are obviously subject to a wide margin of error.


† Sic.

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      Sent with 2/214.

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      Published in The Times on 11 March under the heading ‘Borrowing for Defence: Is it Inflation?: A Plea for Organized Policy’.

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      This description was created by A. C. Green in 2020.




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