A Tract on Monetary Reform

by John Maynard Keynes

Rome may have understood the principles of commerce imperfectly in the third century and not perfectly in the twentieth; but that does not save her citizens from experiencing their applications. Signor Mussolini might peruse with interest the annals of Aurelian, who, “ignorant or impatient of the restraints of civil institutions,” fell by the hand of an assassin within a year of his deflation of the currency, “regretted by the army, detested by the Senate, but universally acknowledged as a warlike and fortunate prince, the useful though severe reformer of a degenerate State.”

Ricardo, speaking in the House of Commons on the 12th of June 1822,[44] gave his opinion that: “If in the year 1819 the value of the currency had stood at 14s. for the pound note, which was the case in the year 1813, he should have thought that, on a balance of all the advantages and disadvantages of the case, it would have been as well to fix the currency at the then value, according to which most of the existing contracts had been made; but when the currency was within 5 per cent of its par value, he thought they had made the best selection in recurring to the old standard.”

[44] The great debate of June 11 and 12, 1822, on Mr. Western’s Motion concerning the Resumption of Cash Payments, well illustrates, more particularly in the speeches of the opener, Mr. Western, and of the opposer, Mr. Huskisson, the regularity of the evils which follow a deflationary raising of the standard, and the unchanging antithesis between the temperaments of deflationists and devaluers, though I doubt if any present-day deflationists could make a speech at the same time so able and so unfair as Mr. Huskisson’s.

The same is repeated in his Protection to Agriculture[45] where he approves the restoration of the old standard when gold was £4 : 2s. per standard ounce, but adds that, if it had been £5 : 10s., “no measure could have been more inexpedient than to make so violent a change in all subsisting engagements.”

[45] Works, p. 468.

II. Stability of Prices versus Stability of Exchange.

Since, subject to the qualification of Chapter III., the rate of exchange of a country’s currency with the currency of the rest of the world (assuming for the sake of simplicity that there is only one external currency) depends on the relation between the internal price level and the external price level, it follows that the exchange cannot be stable unless both internal and external price levels remain stable. If, therefore, the external price level lies outside our control, we must submit either to our own internal price level or to our exchange being pulled about by external influences. If the external price level is unstable, we cannot keep both our own price level and our exchanges stable. And we are compelled to choose.

In pre-war days, when almost the whole world was on a gold standard, we had all plumped for stability of exchange as against stability of prices, and we were ready to submit to the social consequences of a change of price level for causes quite outside our control, connected, for example, with the discovery of new gold mines in foreign countries or a change of banking policy abroad. But we submitted, partly because we did not dare trust ourselves to a less automatic (though more reasoned) policy, and partly because the price fluctuations experienced were in fact moderate. Nevertheless, there were powerful advocates of the other choice. In particular, the proposals of Professor Irving Fisher for a Compensated Dollar, amounted, unless all countries adopted the same plan, to putting into practice a preference for stability of internal price level over stability of external exchange.

The right choice is not necessarily the same for all countries. It must partly depend on the relative importance of foreign trade in the economic life of the country. Nevertheless, there does seem to be in almost every case a presumption in favour of the stability of prices, if only it can be achieved. Stability of exchange is in the nature of a convenience which adds to the efficiency and prosperity of those who are engaged in foreign trade. Stability of prices, on the other hand, is profoundly important for the avoidance of the various evils described in Chapter I. Contracts and business expectations, which presume a stable exchange, must be far fewer, even in a trading country such as England, than those which presume a stable level of internal prices. The main argument to the contrary seems to be that exchange stability is an easier aim to attain, since it only requires that the same standard of value should be adopted at home and abroad; whereas an internal standard, so regulated as to maintain stability in an index number of prices, is a difficult scientific innovation, never yet put into practice.

There has been an interesting example recently of a country which, more perhaps by chance than by design, has secured the advantages of a relatively stable level of internal prices at the expense of a fluctuating exchange, namely India. Public attention is so much fixed on the exchange as the test of the success of a financial policy, that the Government of India, under severe reproaches for what has happened, have not defended themselves as effectively as they might. During the boom of 1919–20, when world prices were soaring, the exchange value of the rupee was allowed to rise by successive stages, with the result that the highest level reached by the Indian index number in 1920 exceeded by only 12 per cent the average figure for 1919, whereas for England the figure was 29 per cent. The Report of the Indian Currency Committee, on which the Government of India acted somewhat clumsily without enough allowance for rapidly changing conditions, was avowedly influenced by the importance in such a country as India, especially in the political circumstances of that time, of avoiding a violent upward movement of internal prices. The most just criticism of the Government of India’s action, in the light of after-events, is that they went too far in attempting to raise the rupee so high as 2s. 8d.,—a rate not contemplated by the Currency Committee. Prices outside India never rose so high as to justify an exchange exceeding 2s. 3d. on the criterion of keeping Indian prices stable at the 1919 level. On the other hand, when world prices collapsed, the rupee exchange was allowed to fall with them, again with the result that the lowest point touched by the Indian index number in 1921 was only 16 per cent below the highest in 1920, whereas for England the figure was 50 per cent. The following table gives the details: