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25 May 2022

From the NS archive: What is inflation?

26 January 1935: inflation and what is not.

By New Statesman

The inflation rate in Britain in 1935 was a modest 0.63 per cent, but whether it could be controlled while the economy was being stimulated was a question that, as now, exercised economists. In this piece, the writer compared Britain’s situation with that of France and America. Unlike France, Britain was off the gold standard, so “the question is whether an increased supply of money can yield higher industrial activity without causing an equivalent further depreciation in the external value of sterling”. Since putting additional money into circulation would drive inflation up, the answer, the writer suggested, was for the government to “use it for public expenditure”.


In a country working on the gold standard, as France is today, the question is whether a more liberal credit policy is capable of increasing production and employment without so raising internal costs and prices as to enforce the depreciation of the franc. In a country off gold, like Great Britain, the question is whether an increased supply of money can yield higher industrial activity without causing an equivalent further depreciation in the external value of sterling.

According to the advocates of “sound finance”, President Roosevelt seems to be always inflating, or about to inflate, or just to have inflated. He sells securities to the Federal Reserve banks, and uses the proceeds for public works or relief of the unemployed. Barefaced inflation! For the sums he gets from the banks in exchange for his securities are new money, which he proceeds to put into circulation in the hands of the public. Or he decreases the amount of gold in the dollar, and so broadens the basis on which the banks are allowed to create credit. Barefaced inflation again; for what clearer sign of inflation can there be than a fall in the external value of a country’s currency? Or he buys silver at an artificially high price, and authorises its use, side by side with gold, as part of the reserve held against the issue of currency. Yet more inflation; for once again the effect is to make additional money with the aid of something that could not be used to create money before.

And yet, after President Roosevelt has done all these things, the danger of inflation seems to be still in the future. Somehow these expedients cease, even to the orthodox, to seem quite so inflationary when they have been adopted: the real peril always looms a little ahead, in whatever the president is expected to do next, in the course of his attempt to bring American capitalism back to its old condition of prosperity. The terrible prospect just now appears to be that the president will either be driven by Senator Thomas, and other monetary “cranks”, to make full use of his powers in relation to silver, or will be compelled by Congress to resort to the creation of new inflationary money in order to pay the war veterans their contested bonus claims in cash. Inflation is always just round the next corner of the New Deal’s zigzag advance.

America is not the only country in which people seem to be in considerable confusion of mind about what is inflation and what is not. The United States went off the gold standard, and deliberately reduced the dollar’s gold value. Germany and Italy, on the other hand, have both clung firmly to the established gold parities of their respective currencies, but have at the same time pursued, with the aid of liberal government expenditure and “easy” bank advances, a credit policy which has considerably expanded their internal circulation of money. They have, indeed, been able to do this – Germany for a long time past, and Italy just of late – only by control and rationing of the supply of foreign exchange, which means in effect control and rationing of the country’s import trade, so as to keep it within the limits of what can be currently purchased with exports. But the German experience at any rate has shown that under these conditions a retention of the old exchange parity is reconcilable with a large expansion of the internal supply of both currency and credit.

[see also: Five ways the government failed to shield the UK from inflation]

It can, of course, be argued that Germany has really been off the gold standard for a long time past, and that Italy also is off it today. That may be so, if the phrase “gold standard” is rigidly interpreted. But the fact remains that, despite internal monetary expansion, marks and lire do, on the whole, retain their old values in foreign exchange. Can it then be argued that President Roosevelt has inflated because he has reduced the gold value of the dollar, but that Dr Schacht and Signor Mussolini have not? Hardly; for all three have taken artificial steps to increase the volume of the internal monetary circulation of their respective countries.

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Moreover, what are we to make now of M Flandin, who has just announced that in France “deflation is at an end”? The governor of the Bank of France is said to have resigned in orthodox horror at M Flandin’s proposals for stimulating French business by increasing the available supply of money; and anguished cries about the danger of inflation are being raised against the French prime minister’s new financial proposals. Yet M Flandin, it appears, has no intention of either reducing the gold value of the French franc or establishing any control over the foreign exchanges such as Germany has been applying with more and more severity ever since the crisis set in. If M Flandin is about to “inflate”, he apparently means to do this only by making the abundant gold already in France the basis for a more effective and expansible supply of internal credit. But can it be inflation at all simply to use the available gold to a greater extent, while leaving the gold value and convertibility of the currency exactly as they were? Apparently, the retiring governor of the Bank of France thought that it could; or why should he have retired in preference to implementing M Flandin’s policy?

Enough has, we hope, been said to show that the word “inflation” is one that, in these days of world crisis, has been very freely bandied about without any clear or definite agreement about its meaning. Perhaps no one would quite contend that any addition at all to the supply of money, under any circumstances, is bound to be inflationary; but there are at one extreme some of the unorthodox who seem to approach very nearly to that contention. At the other extreme are those who deny that any real question of inflation can arise until all the available productive resources are already in full use, so that any further addition to the supply of money can only raise prices, and not cause any additional goods or services to be forthcoming. Between these two extremes there are a dozen views possible; but it is usually more than difficult to discover what precise view any particular opponent of “inflation” holds.

But if it is far from plain wherein “inflation” consists, perhaps we can get a clearer notion of its opposite, “deflation”. “Deflation,” says M Flandin, “is at an end”; and in this country it is often said that the policy of the Bank of England was steadily deflationary up to 1931, and then ceased to be deflationary when we abandoned the gold standard. Deflation, as it has been practised in both France and Great Britain, seems to mean restricting the supply of credit in such a way as to lower internal costs and prices, with the object of bringing them into harmony with costs and prices in the rest of the world. The Bank of England was deflationary up to 1931, because it was trying to bring down British costs to a level consistent with the restored gold value of the pound sterling. The Bank of France has been steadily deflationary up to the present time, because it has been trying to cut French costs to a level compatible with the existing gold value of the franc, in relation to the gold value of pounds, dollars and other currencies important for French foreign trade. The idea behind deflation is that internal costs are bound, at any rate in the long run, to respond to measures of credit restriction, and that economic health can be restored only by making them respond to such effect as to bring them into line with the existing gold parities.

[see also: As UK inflation hammers the poor, we need a revolution in policy]

Deflation is therefore a policy that it is relatively easy to understand – though by no means equally easy to carry through to a successful issue. For costs are “sticky”, and some of them do not respond readily to even the most drastic measures of credit restriction. But inflation is quite another matter; and of inflation there is no generally accepted criterion. Everyone will agree that President Roosevelt has “depreciated” the American dollar and tried to expand the internal monetary circulation. But on the question whether he has inflated there will be the utmost variety of opinions. So will there be about what Dr Schacht and Signor Mussolini have been doing, or again, about what M Flandin is apparently proposing to do. On one point there will be agreement. Inflation involves an increase in the quantity of money in circulation. It involves, moreover a change in the relation between money and goods. No one, we suppose, would regard as inflationary an increased supply of money which allowed an increased supply of goods to be exchanged at exactly the same price-levels as would have existed if the supply of money had remained unchanged. But, of course, the stronger deflationists would vigorously deny the possibility of any such relationship between money and goods.

The root question is whether, at a time when productive resources are lying unused, an increase in the supply of money can bring these resources back into operation without sowing the seeds of future crisis. In a country working on the gold standard, as France is today, the question is whether a more liberal credit policy is capable of increasing production and employment without so raising internal costs and prices as to enforce the depreciation of the franc. In a country off gold, like Great Britain, the question is whether an increased supply of money can yield higher industrial activity without causing an equivalent further depreciation in the external value of sterling. In the United States, where the external value of the dollar seems to most people relatively unimportant, the question is rather whether the manufacture of additional money will give more than a temporary stimulus to increased production, and whether it may not create conditions that will lead to the need for more and yet more money to be issued if an enhanced level of output is to be maintained.

[see also: Are the Bank of England’s inflation experts fit for purpose?]

All these are in the last resort questions of the effect on the real costs of production, in terms of the real expenditure of labour and capital goods, of stimulating economic activity by means of an expansion of the supply of money. If the increase in money caused a precisely equivalent rise in internal prices and a precisely equivalent fall in the external value of the currency it seems clear that nothing would be gained except a transference of income from creditors to debtors. But, with productive resources lying unused, this is a most unlikely result; for it implies that the additional credit cannot have stimulated production at all.

Far more probably, the result will be some rise in prices, unevenly spread over different goods, but also some increase in production, the rise in prices and the fall in external currency value being definitely a good deal less than the increase in monetary supply. This, of course, assumes that more money is not merely made available, but actually taken up – which our own experience, and still more that of America, show to be by no means a foregone conclusion without a vigorous policy of government spending on public works or relief. If, however, the additional money does get into effective use, there is real gain, as long as it enables more goods and services to be produced and sold.

An expansionist policy of this sort is relatively easy when a country has unpegged its currency from any fixed international value, and when the government is prepared to follow an active policy of public spending. It has, therefore, the best chance in the United States, where both these conditions appear to be satisfied. In this country one of the two conditions is satisfied, but not the other; and for lack of the second the more liberal credit policy of the Bank of England since 1931 has produced only a modified effect. But in France neither condition appears to be satisfied; for M Flandin proposes both to stick to the present gold parity of the franc and to pursue a policy of rigid budgetary economy. Can he, in these circumstances, get more money into active circulation even if he makes it available? Hardly, unless his budgetary economy is meant to be a sham, so that the balancing of the ordinary budget at a low level is, in fact, more than offset by extraordinary loan expenditures out of other funds, such as M Marquet’s much-advertised public works schemes involved. For apart from this, who is to take up the additional credits? If, however, M Flandin is prepared to spend freely, although he may for political reasons choose to camouflage his expenditure, there is no reason why he should not bring about at least some expansion in French economic activity without being driven to lower the gold value of the franc.

Nor is there any reason why more active government spending in Great Britain should not be used to speed up economic revival without causing any further fall in the external value of the pound. But these results cannot be secured in the existing situation merely by increasing the available resources of the banks, which have already more money in hand than they can effectively employ under the prevailing conditions. In fact, the lesson of recent years is that inflation, in the sense in which it means an increase in the supply of money not balanced by an increase in the output of goods and services, is in a time of depression not a menace to be constantly afraid of, but quite a difficult thing to bring about. Short of making absolute presents of purchasing power to consumers, it is not easy to get additional money into circulation, unless the government itself is prepared to take it up, and use it for public expenditure.

Failing this, M Flandin’s proposed measures are far less likely to cause “inflation” than to produce no appreciable result of any kind. Failing this, President Roosevelt is likely only to add to the unusable resources of the Federal Reserve Banks. Failing this, the rate of recovery in Great Britain is likely to slacken off, however liberal the credit policy of the Bank of England may in theory be. For, in conclusion, whatever inflation may be or involve, it certainly is and involves much more than a mere increase in the available credit resources of the banks. It involves also that some creditworthy borrower must be ready to spend the additional resources which the banks are in a position to advance. But, until revival is actually in being, what fresh creditworthy borrowers are likely to come forward, unless the government itself steps into the breach with an active policy of public expenditure?

Read more from the NS archive here, and sign up to the weekly “From the archive” newsletter here. A selection of pieces spanning the New Statesman’s history has recently been published as “Statesmanship” (Weidenfeld & Nicolson).

[See also: What does stagflation mean for the cost-of-living crisis?]

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