The Treasury View in the interwar Period: An Example of Political Economy?
The Treasury view of the interwar period is unusual among economic doctrines in that it
derives its name from a government department rather than from a professional economist, or
a group of economists. The best known expression of the Treasury view is to be found in
Winston Churchill’s budget speech in 1929 (Hansard 1929):
The orthodox Treasury view . . . is that when the Government borrow(s) in the money market
it becomes a new competitor with industry and engrosses to itself resources which would
otherwise have been employed by private enterprise, and in the process raises the rent of
money to all who have need of it.
There were, the chancellor explained, circumstances in which government borrowing could
be justified, but then the onus was on the government to prove that the expenditure was
necessary or ‘that the spending of the money by the Government would produce more
beneficial results than if it had been left available for trade and industry’. Churchill pointed
to recent government expenditure on public works such as housing, roads, telephones,
electricity supply, and agricultural development, as well as guarantees for exports and
colonial development, and concluded that, although expenditure for these purposes had been
for the purpose of curing unemployment the results have certainly been disappointing. They
are, in fact, so meagre as to lend considerable colour to the orthodox Treasury doctrine which
has been 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.
These carefully drafted words reflected the official Treasury’s view on proposals
associated with the Liberal leader, David Lloyd George, and with John Maynard Keynes, for
an employment policy based upon large-scale borrowing to finance public works. It is
generally acknowledged that the theoretical basis of the Treasury view was set out by Ralph
Hawtrey, the Treasury’s only economist in the interwar period, in an article in Economica in
1925 (Clarke 1988, pp. 51-3, 63; Howson and Winch 1977, p. 27; Moggridge 1992, p. 463).
Hawtrey argued that normally government expenditure financed by borrowing from the
public would merely crowd out an equivalent amount of private investment by raising interest
rates, unless additional bank credit was created. Hawtrey believed that, provided that
business showed a normal degree of enterprise, the creation of bank credit alone would be
sufficient to increase employment, and that public works would be unnecessary (Hawtrey
1925). It should be noted that in the 1920s a deliberate expansion of bank credit was
commonly described as inflation, which was then defined as an expansion of the money
supply to spend relative to the supply of things to purchase. It was only in the 1930s that the
term ‘reflation’ came into use.
The Treasury view that borrowing to finance public works would tend to crowd out
private investment was central to economic policy debates as the world moved into
depression, and Keynes’s efforts to demolish it played a significant part in the development
of his General Theory of Employment, Interest and Money in the 1930s (Clarke 1988;
Moggridge 1992; Skidelsky 1992). Even in the 1920s there was very little support among
professional economists for the Treasury view, most pre-Keynesians, notably A. C. Pigou,
being primarily concerned with the high level of real wages, low productivity, and the
apparent inability or unwillingness of many workers to respond to structural changes in
demand (Casson 1983).
During the period of Keynesian ascendancy in the British economics establishment
after World War II, the Treasury view seemed to have been thoroughly discredited. Donald
Winch, for example, while conceding that the weakness of Britain’s balance of payments
position, and her return to a fixed and overvalued exchange rate in 1925, provided some
justification for the Treasury view, concluded that the real difficulty had been that officials
had been unable to cope with Keynes’s theoretical arguments on an intellectual level (Winch
1969, pp. 109-13). In the 1970s, however, the experience of ‘stagflation’ made it respectable
for economists to argue that public expenditure could crowd out private investment, even at a
time of rising unemployment. Moreover, the availability to researchers, under the 30 years
rule, of Treasury and Cabinet papers made it possible to study the Treasury’s arguments in
greater detail than had been possible on the basis of published statements, although the full
story of the formulation of the treasury view could only be pieced together once a key file
(PRO 1929a) was belatedly transferred to the Public Record Office in 1986 (Clarke 1988, pp.
47-69). Writing in a new economic environment, and with new evidence at their disposal,
even economic historians who were not unsympathetic to Keynes were prepared to argue that
there was some merit in the Treasury’s case, in so far as it pertained to practical politics and
administration, and financial confidence (Middleton 1982, 1985; Peden 1984).
I do not intend to repeat these arguments here. Instead I wish to address two
questions: first, what connection was there between the Treasury view and the doctrines of
professional economists? And, second, to what extent was the Treasury view modified in the
interwar period in response to the experience of unemployment and criticism by professional
economists? The answers to both questions suggest that the Treasury view of 1929 was as
much a product of traditions of public finance and of the City of London as of Hawtrey’s
economic theory. It is, I admit, difficult to be dogmatic about the relative importance of
public finance and economic theory, since the rules of public finance were based, at least in
part, on what Keynes called ‘defunct economists’ (1973a, p. 383). Moreover, Hawtrey
himself developed his theory within the context of traditional public finance. However, while
we know that Treasury officials, and indeed Churchill, read Hawtrey’s Economica article of
1925 to support their argument in 1929 that Lloyd George had an inflationary purpose behind
his public works proposals (Clarke 1988, pp. 53, 63), it would be a logical fallacy to argue
that they took the view they did in 1929 because of Hawtrey’s article. The Treasury had,
after all, opposed Lloyd George’s ideas about borrowing for public works, so as to reduce
unemployment in 1921 (Peden 1993; Skidelsky 1981). Post hoc, ergo propter hoc is bad
logic, but pre hoc, ergo non propter hoc is sound enough.
It is difficult to trace the intellectual origins of Treasury thinking. Officials were
primarily concerned with advising ministers, and did not normally quote academic
authorities. For example, the only such authority referred to in Churchill’s ‘Treasury view’
speech in 1929, and again in a white Paper (HMSO 1929) which amplified his argument, was
the work of economic history, first published in 1903, Archdeacon Cunningham’s The
Growth of English Industry and Commerce in Modern Times. The reference was concerned
with the experience of the depression of 1847, which, according to Cunningham, was caused
by over-investment in railways. Cunningham noted how a railway under construction
diverted capital from other branches of industry and produced no immediate productive
return, whereas the employment created by its construction raised imports and turned the
exchanges against sterling (Cunningham 1917, pp. 826-8). Cunningham himself quoted
extensively from the analysis of James Wilson, Capital, Currency and Banking, which was
based on articles in the Economist in 1845 and 1847, and may fairly be said to be describing a
traditional City view of the functioning of capital markets. Prior to the 1930s, Treasury
officials had little direct contact with professional economists. On the other hand, Montagu
Norman, the governor of the Bank of England, made it his business to make sure that the
Chancellor and senior officials were acquainted with the City’s views, by making frequent
visits to the Treasury, and the Treasury was much more likely to consult City men than
academic economists on questions relating to policy.
Hawtrey was the Treasury’s main point of contact with professional economists in the 1920s.
In 1919 he was released from routine administration by being appointed Director of the
Treasury’s Financial Enquiries Branch. The Financial Enquiries Branch amounted to no
more than a little room inhabited by Hawtrey and an assistant, but, although Treasury
officials would ask for Hawtrey’s advice from time to time, there was no pressure of business
and he was free to contemplate problems of economics and to write books on the subject. His
books were taken seriously by professional economists; indeed, Keynes hailed Hawtrey’s
Currency and Credit, when it appeared in 1919 as ‘one of the most original and profound
treatises on the theory of money which has appeared for many years’ (Keynes 1920), and it
was widely used as a textbook in the 1920s.
Although Hawtrey’s influence on Treasury
For example, the decision in principle to return to the gold standard was taken in 1919 on the advice of
the Cunliffe Committee, which had 11 bankers but only one academic economist, (Professor A. C.
Pigou) on it. The decision to return in 1925 was largely taken on the advice of the Chamberlain-
Bradbury Committee, on which Pigou was again the only economist, with the other experts being a
Treasury official, a former Treasury official and a partner in Baring Brothers (Boyce 1987, pp. 31, 66).
David Laidler has suggested that Hawtrey influenced the monetary explanation of cyclical fluctuations
developed at Harvard and Chicago in the interwar period (Laidler 1993).
economic thinking is said to have waned in the 1930s, as senior officials encountered
professional economists in person on the Economic Advisory Council’s Committee on
Economic Information (Howson 1985; Howson and Winch 1977), one of the most senior
officials advising on financial policy, Sir Frederick Phillips, could still say in 1937 that
Hawtrey understood professional economists in a way he did not, so that as well as giving
advice on his own account Hawtrey made intelligible what other economists were advising
(Peden 1979, p. 23).
Despite his reputation as an economist, Hawtrey appears to have developed his
crowding out theory somewhat in isolation from the mainstream of economic thought
(Deutscher 1990). Although he counted Keynes as a friend from before 1914, and
corresponded with other economists in the interwar period, including Pigou, Dennis
Robertson and Friedrich Hayek, and was elected as honorary secretary of the Royal
Economic Society in 1937, Hawtrey approached economics from the point of view of a
Treasury official. He only once held an academic appointment, in 1928-29, when he went on
leave for a year to teach at Harvard. He had studied mathematics at Cambridge, where he
was nineteenth Wrangler in his year, but he had scored low marks in the political economy
paper in the Civil Service examination in 1903, having crammed the subject by attending
lectures. He later recalled that J. H. Clapham, the economic historian, had been the first
person to instruct him in economics, and Clapham’s influence may be seen in the way in
which Hawtrey tended to elucidate a subject by concrete historical examples as well as by
theoretical analysis. The Edwardian Treasury did not provide a forum in which Hawtrey
could debate theoretical issues: indeed, Hawtrey recalled that at the time he entered the
Treasury, in 1904, officials were not generally interested in economics, which was not
regarded as more important to their work than, say, a knowledge of local government
(Hawtrey 1966). What Hawtrey picked up in the Treasury before 1914, particularly from Sir
John Bradbury, the joint permanent secretary dealing with finance, was City and Bank of
England views, as represented by Walter Bagehot, on the behaviour of financial markets. In
Lombard Street, Bagehot criticized political economy of the period in which he wrote (c.
1870) for its neglect of time in its analysis of trade, and described how the supply of
‘borrowable’ money did not always match opportunities for investment. Moreover, for
Bagehot the supply of loanable funds was not fixed, for he described how funds flowed in
from abroad, when interest rates rose (1910, pp. 5, 48, 126, 133, 155-8).
Hawtey’s interest in economics went back to his schooldays at Eton, when he had
read a number of works on the subject, including Mill’s Principles of Political Economy
(1848). Nevertheless, there is evidence that he was less than wholly conversant with the
current literature when he wrote his first book, Good and Bad Trade, which was published in
1913. The only reference to another economist in it was to Irving Fisher, and that reference
was added after Hawtrey had finished the first draft. Moreover, although Good and Bad
Trade was an analysis of the trade cycle, Hawtrey denied that his theory was derived from
that of Alfred Marshall (Deutscher 1990, pp. 8, 247). Presumably, in the course of writing
the ten books that he published in the interwar period, Hawtrey became more familiar with
the literature. Nevertheless, the position he adopted in 1913, that is to say the one derived
from the City via Bradbury, was still recognisable in his Century of Bank Rate, published in
1938. As Hawtrey told Keynes in 1937: ‘I have adhered to my fundamental ideas since
1913’ (Keynes 1973b, p. 55). Good and Bad Trade differed from previous analyses of the
trade cycle by emphasizing monetary factors, rather than variations in harvests, the impact of
inventions, or swings in speculative moods. Pigou, indeed, criticized Hawtrey for implying
that the causes of trade fluctuations were exclusively monetary in origin (Pigou 1913). It
would be wrong to see Hawtrey as merely adopting or expressing ‘orthodox’ views of pre-
In particular, as Deutscher (1990, pp. 36-8) has shown, Hawtrey was at best lukewarm
in his response to the quantity theory of money. He was critical of Fisher’s formalization of
the relationship between the quantity of money in circulation (M), the velocity or rate of
turnover of that money (V), the general level of prices (P), and the total number of
transactions (T), as MV=PT. Hawtrey argued in the 1919 edition of Currency and Credit that
the quantity theory of money was limited to comparing equilibrium positions, and that
changes in the quantity of money did not cause proportionate changes in prices, because an
initial change would bring about changes in other factors, whereas one of the conditions of
the theory was that all other factors be held constant. Hawtrey generally insisted that
monetary policy worked through interest rates directly, particularly on traders’ willingness to
hold stocks on credit, and not through changes in the quantity of money.
With regard to government borrowing crowding out private investment, Hawtrey’s
views were originally expressed in 1913 in Good and Bad Trade. The Minority Report of the
Royal Commission on the Poor Laws had recommended in 1909 that there should be public
investment in useful, but commercially unprofitable, works such as land-reclamation and
forestry. Such works would be concentrated in years when the demand for labour was low,
so as to stabilize employment and take advantage of low interest rates. Hawtrey commented
The writers of the Minority Report appear to have overlooked the fact that the Government
by the very act of borrowing for this expenditure is withdrawing from the investment market
saving which would otherwise be applied to the creation of capital.
Hawtrey believed that money which was saved would be spent ‘sooner or later’ on fixed
capital or invested abroad. Government expenditure would thus, in his view, merely divert
the demand for labour, either from industries that were concerned with the construction of
fixed capital or industries that relied upon export markets. There was an assumption here,
common enough at the time, that overseas investment stimulated demand for British exports,
an assumption still held by the Treasury in 1929 (Hawtrey 1913, pp. 260-1; HMSO 1929, pp.
Hawtrey’s 1913 version of the ‘Treasury view’ could be seen as merely echoing the
doctrines of classical economists, such as Adam Smith – ‘what is annually saved is as
regularly consumed as what is annually spent’ – or David Ricardo – ‘to save is to spend’ –
(Corry 1958, pp. 38, 41). Indeed, Pigou, reviewing Good and Bad Trade, described
Hawtrey’s crowding out hypothesis as ‘a fallacy’ (Pigou 1913) that he believed he had dealt
with in his own Wealth and Welfare (1912), in which he had supported the counter-cyclical
proposals of the Minority Report. Even so, in his Economica article in 1925, Hawtrey
defended his position with a deductive argument that was more subtle than that of the
classical economists. He started with the condition that government borrowing was to be
from the ‘genuine savings’ of the non-bank public, and not from the banks or from people
who had borrowed from banks. Within that constraint, he argued, government could attract
idle balances held by the non-bank public by issuing a gilt-edged loan, but normally
expenditure from the loan would be at the expense of future expenditure by the private sector.
Hawtey believed that the public as a whole would always keep an unspent margin of its
income in the form of cash balances, and that therefore an increase in the investing public’s
holdings of government issues must, on his initial condition relating to ‘genuine savings’,
normally lead to an equal diminution in other capital issues. He believed that the unspent
margin would vary as a proportion of the public’s income according to changes in the
velocity of circulation of money, but that it was only when business confidence was
exceptionally low that a gilt-edged loan could increase the velocity of circulation by
attracting idle balances – unless one relaxed the condition that borrowing was not to involve
an expansion of bank credit.
If the government did borrow from banks, or from people who financed purchases of
gilt-edged stock by borrowing from banks, matters would be different. Then government
borrowing would create the bank credits that would enable the public to maintain their cash
balances and the investment market to carry a greater amount of securities, and consequently
loan-financed public works would give additional employment. However, as already noted,
Hawtrey believed that expenditure on public works was unnecessary, the expansion of credit
alone being sufficient to stimulate the economy, provided that business showed a normal
degree of enterprise. In his view, government borrowing would have the same effect if it
were to meet a budget deficit arising from tax cuts, but, with due respect to prevailing rule of
public finance (see below), he did not advocate such a course of action.
In his article, Hawtrey did concede that loan-financed public works might be
necessary if business did not respond to a reduction in Bank rate to 2 per cent, as in the
depression of 1894-96. However, in the second half of the 1920s, when the Bank of England
and the Treasury gave priority to defending sterling’s newly restored gold exchange value of
$4.86, Bank rate ranged between 4 and 6.5 per cent (Howson 1975; Moggridge 1972), and
the responsiveness of business to low interest rates was as yet unknown. More significantly,
in the context of the late 1920s, Hawtrey believed that it would be possible to finance public
works in Britain by diverting funds that would otherwise have gone into overseas investment.
If sterling’s exchange rate remained unchanged, the extra funds would lead to an expansion
of credit, and therefore of employment, albeit at the expense of investment and employment
in other countries. He thought that it was remarkable that advocates of public expenditure as
a remedy for unemployment never seemed to consider drawing upon the international
investment market (Hawtrey 1925, p. 46). In the event, diversion of funds from overseas to
home investment came to play a major part in Keynes’s arguments in support of public works
(Keynes 1972, pp. 115-21; Keynes 1981a, pp. 221-3, 807, 811).
Public finance and economic theory
In order to understand the impact of economic theory on policy it is necessary to understand
the framework of public finance within which policy would have to be implemented.
Interwar Treasury officials tried to maintain the tradition, established by Sir Robert Peel and
William Gladstone between the 1840s and the 1860s, of an impartial state, standing apart
from competing economic interests. The three key characteristics of this tradition were: first
the balanced budget convention, ensuring that any attempt by politicians to buy popularity
through public expenditure would be offset by the odium incurred by raising taxes. Second,
the gold standard, whereby sterling had a fixed value in terms of gold, and therefore with all
other currencies that were also on the gold standard, ensuring a considerable degree of
independence for the Bank of England from political pressures. And third, free trade, which
ensured that no group of producers could bargain for political favours. Both the gold
standard and free trade acted to maintain Britain as an open economy, and it was generally
believed in the Treasury that, if British industry encountered competition in home as well as
in international markets, it would maintain a competitive edge in both.
The gold standard had been largely in suspense during World War I, and was formally
suspended in the spring of 1919. However, a return to gold was the object of Treasury policy
from that year until it was achieved under Churchill’s chancellorship in 1925, and it was only
as a result of overwhelming international speculation against sterling that the gold standard
was to be suspended in September 1931. The Conservative party, which was in power for
most of the interwar period, favoured tariffs, but an electoral reverse in 1923 on this question
had induced a sense of caution in the party leadership. Indeed, Churchill, only recently
restored to the Conservative party whip before being appointed chancellor in 1924, was as
committed to free trade in principle as his officials, at least down to the post-1929 depression.
Thereafter the need to curb Britain’s balance of payments deficit in 1931, and to prevent a
free fall by sterling after the suspension of the gold standard, provided strong arguments in
favour of a general tariff, which was adopted in 1932, when Neville Chamberlain was
The demise of the gold standard and free trade in 1931-32 can only have strengthened
the Treasury’s determination to maintain the doctrine of balanced budgets, although the
difficulties of balancing the budget during the depression, and later during the period of
rearmament on the eve of the war, led to a good deal of fiscal ‘window dressing’ (Middleton
1985). However, most public works were financed outside the budget as then conventionally
defined (the chancellor’s budget being solely concerned with accounting to Parliament for
central government expenditure and revenue). Parliament did authorize central government
borrowing for specific purposes: for example, investment by the Post Office, then a
government department, in telephone lines. However, the rule for central government
borrowing, as maintained by the Treasury as late as 1935, was that the money return on such
investment should be sufficient to pay off both capital and interest on the loan (Peden 1979,
p. 72). There was no published figure for a public sector borrowing requirement, and subject
to central government supervision, local authorities (which were chiefly responsible for roads
as well as public sector housing) and public utilities, such as the Central Electricity Board,
which was responsible for the rapidly expanding national electricity grid, raised loans outside
the chancellor’s budget, albeit with a government guarantee.
What was at issue in 1929, therefore, was not whether there should be a budget
deficit, but rather what would be the effects of public sector borrowing outside the
chancellor’s budget. Lloyd George had made what was essentially an electioneering pledge
to abolish ‘abnormal’ unemployment by sharply increasing loan expenditure on public works
over the next two years, without inflation, and while maintaining the gold standard and free
trade (Liberal Party 1929, p. 62). Treasury officials had good reason to suspect Lloyd
George’s commitment to sound finance: only eight years earlier, while still prime minister, he
had considered a deliberate policy of inflation as a means of reducing unemployment (Peden
1993), and Bradbury had probably had Lloyd George in mind when, in a famous phrase, he
described the gold standard in 1925 as ‘knave proof’ (Grigg 1948, p. 183). Treasury
officials, as guardians of orthodox public finance, were unlikely to look at economic theories,
including Hawtrey’s, in isolation from politics, especially when Lloyd George was associated
with a particular proposal for public expenditure. It is true, of course, that the Treasury’s
views rested on an implicit model of the economy, in which factors of production, unshielded
from international competition, were flexible, in contrast to fixed principles of public finance,
but most Treasury officials on the finance side of the Treasury were more familiar with
public finance than they were with economics (Clarke 1990).
One problem facing Treasury officials in drafting their arguments in early 1929 was
that Hawtrey was away in Harvard at the time. The most important officials who had to
advise Churchill were Sir Richard Hopkins, the controller of the Treasury’s finance and
supply services departments, who was responsible for financial policy and control of public
expenditure; F. W. Leith-Ross, his deputy in the finance department, and P. J. Grigg, the
chancellor’s principal private secretary. None of them had formal training in economics,
apart from any preparation they might have done for the economics paper for the Civil
Service examination. Hopkins had studied classics in part I of the tripos at Cambridge, and
history in part II, with first-class honours in both. He had been chairman of the Board of
Inland Revenue before moving to the Treasury in 1927, and certainly had a firm grasp of
public finance, but it was apparently only after he went to the Treasury that he read a wide
range of works in economics (Peden 1983). Leith-Ross had got a first in both Mods and
Greats in Literae Humaniores at Oxford, and had served in the Treasury since 1909.
Although he was to be given the title of chief economic adviser to His Majesty’s Government
in 1932, Leith-Ross had learned most of what he knew about financial policy while working
on reparations questions after World War I. He himself admitted that the title of chief
economic adviser was a misnomer, most of his work in that post being concerned with
economic diplomacy (Leith-Ross 1968, pp. 145-6). Treasury papers suggest that Leith-Ross
looked to Hawtrey for economic advice, but that he did not always accept it. Grigg had taken
first-class honours in mathematics in both parts of the Cambridge tripos, and had entered the
Treasury in 1913. As private secretary to successive chancellors from 1921, Grigg had
considerable experience of helping to draw up a balanced budget, which may explain why he
could never see in Keynes’s various proposals for public works, tariffs or devaluation
‘anything but different manifestations of a thesis that nations, unlike private individuals, can
live so as both to have their cake and eat it’ (Grigg 1948, p. 257). Adam Smith could not
have put the point more succinctly.
It is probable that Hopkins, Leith-Ross and Grigg had all at some time read The
Wealth of Nations, and were familiar with the final chapter on the want of parsimony in
government, in peace as in war (Smith 1904). World War I had certainly dramatically
increased the burden of the national debt on the chancellor’s budget, and, contrary to the
generally accepted view that interwar public expenditure was rigidly constrained by Treasury
parsimony, the elasticity of expenditure growth relative to GDP growth (measured at current
prices) was higher in the period 1924-37 than it was to be in 1960-76, although the latter
period is generally accepted as being one of rapid growth in public expenditure (Middleton
1982, p. 50). In these circumstances, Treasury officials may well have been more concerned
to maintain traditional rules of public finance that curbed the state’s propensity to spend
money than they were with economic theory.
The Treasury view of 1929
It would seem to have been in this spirit that Leith-Ross and Grigg turned in 1929 to
Hawtrey’s (1925) article (which Grigg described as being of ‘extreme obscurity’).
(1988) has carefully pieced together the story of how the Treasury view emerged, and I
depart from his account only in emphasizing the extent to which the Treasury view in 1929
did not accurately reflect Hawtrey’s views.
It was known that Lloyd George was soon to launch an initiative on unemployment in
what would be an election year. In February, some Conservative ministers were sufficiently
concerned about their party’s prospects to discuss in Cabinet the advisability of stealing the
Liberal leader’s thunder, either by raising a government-guaranteed loan for public works in
the British Empire (to encourage exports and emigration) or by building roads at home. The
Treasury view of 1929 was thus originally formulated for use by Churchill in Cabinet, that
draft being prepared by Hopkins’s most senior subordinate in the supply services department,
Gilbert Upcott, indicating that the question was seen as partly about the control of public
expenditure, as well as by Leith-Ross’s principal subordinate dealing with financial policy,
The Cabinet was told in February 1929 that ‘unless the Government are prepared to
take steps to bring about an inflation of banking credits’, public expenditure could only create
PRO (1929a), Grigg to Churchill, 2 March.
employment if the government could find ways of spending money that would create more
employment than private enterprise would with the same money (PRO 1929b). In March,
after Lloyd George had launched his programme, Churchill asked his officials what would
happen if £100 million of new credit were created by government borrowing from the Bank
of England on ways and means. Leith-Ross replied that the result would be to increase prices
in Britain, thereby encouraging imports and production for the home market, but
discouraging exports. Some of the extra credit would be used for purchasing shares on the
then booming New York Stock Exchange. With the sterling-dollar exchange rate already
hovering about the level at which it would be profitable to export gold from London, the
Bank of England would then have to protect its reserves by raising Bank rate, as it had
already done the previous month, from 4½ to 5½ per cent, until ‘the expansion of credit (and
improvement of industry) that had occurred had been nullified. We should therefore soon be
precisely where we were, except that we should have lost some gold.’ It might be possible to
defer an increase in Bank rate by increasing the fiduciary issue – the amount of notes
unbacked by gold that the Bank of England was allowed to issue under the Currency and
Bank Notes Act 1928 – thereby releasing gold for supporting the exchange rate, but Hopkins
thought that such action would frighten foreign holders of sterling into withdrawing their
balances from London.
‘Inflation’ was thus held to be incompatible with maintenance of the
When Lloyd George’s claims appeared in print in the middle of March as a pamphlet,
We Can Conquer Unemployment (Liberal Party 1929), Churchill advocated the publication of
a rebuttal. The latter appeared in May, shortly before the election, in the form of a White
Paper incorporating comments by the ministries of Labour, Transport and Health, and the
Post Office, as well as by the Treasury, on the Liberal proposals (HMSO 1929). The general
drift of the White Paper was that the Liberal schemes were impracticable in the time allotted
to them, and that they would not provide as much employment as was claimed. The
Treasury’s contribution developed arguments drafted earlier for Churchill’s use in Cabinet
and in his budget speech. The Liberal proposals were costed at £125 million in each of the
next two years, compared with the actual provision of £254 million for state capital
expenditure in the previous four years. It was noted that the Liberal pamphlet claimed that
the necessary funds could be raised from idle savings or by diverting money from overseas
investment. The Treasury conceded that not all savings were currently being invested, but
argued that most balances that had accumulated in the banks were funds that firms wished to
keep liquid while business was slack, and which were not, therefore, available for the long-
term borrowing necessary to finance capital expenditure by the state. As for overseas
investment, the Treasury doubted whether the kind of controls that had been applied to
capital movements during World War I could be applied in peace, and noted that an attempt
to divert overseas investment by competing with high interest rates in New York would force
up rates in Britain. In these circumstances, the Treasury concluded, ‘a very large proportion
of any additional Government borrowings’ could only be financed, ‘without inflation’, by
diverting money which would otherwise have been used ‘soon’ by industry at home. The
PRO (1929a), Leith-Ross to Churchill, 12 March.
Treasury’s preferred solution was for private enterprise to improve its efficiency and to adjust
to changes in demand (HMSO 1929).
It will be noticed that the Treasury view of 1929 took little or no account of the last
part of Hawtrey’s article in Economica (1925), that is his belief that a government loan could
raise money from the international investment market rather than from funds available for
home investment. Hawtrey had argued that such an operation would be the equivalent of the
importation of capital, which, under the gold standard, would bring about an expansion of
credit. However, Hankey had admitted that in a highly industrialized country, where both
import and export trades were sensitive to price movements, the effect of credit expansion
would be to increase imports more than it increased employment (Hawtrey 1925, p. 46), and
it is understandable if Treasury officials felt that there was little of practical value in the
On his return from Harvard, however, Hawtrey expanded on his theory relating to the
import of capital. In two memoranda
in June he argued that the only obstacle to an
expansion of credit was the loss of gold that would ensue. The threat to the gold standard
could be avoided if the government borrowed funds that would otherwise have gone into
overseas investment, or if the government borrowed gold or foreign exchange abroad.
Contrary to Leith-Ross’s assumption that the effects of credit expansion would quickly be
cancelled by the operation of the gold standard, Hawtrey now argued that, while part of the
resulting credit expansion would raise demand for imports, part would raise demand for
home-produced goods for which there was no foreign substitute, thereby raising national
income and employment. Hawtrey still regarded public works as an unnecessarily
complicated way of achieving what could be achieved by monetary policy acting as a
stimulus to private investment, but he was willing to see public works and monetary policy
acting in tandem. His favoured monetary policy was for the government to raise a loan on
the London market and to apply the proceeds to paying off Treasury bills. The loan, he
believed, would absorb ‘investible savings’ that would otherwise have gone abroad, while the
reduction in Treasury bills would force the banks to find other outlets for their funds, in the
form of commercial bills or advances to traders. Clarke (1988, p. 145) comments that
Hawtrey was being consistent in specifying the conditions under which ‘crowding out’ took
place, and that Hawtrey was not certain that these conditions prevailed when there were
unemployed resources. In the 1928 edition of Currency and Credit, Hawtrey had written that
a rise in prices and an increase in production were ‘to great extent alternatives’ (original
To judge from his marginal comments on Hawtrey’s memorandum dealing with debt
policy and unemployment, Hopkins was not impressed by the applicability of Hawtrey’s
ideas to the real world. In particular, he felt that the main practical objection to the funding
of Treasury bills would be that the gilt-edged market was not in a very favourable condition,
and the 4½ per cent stock that Hawtrey contemplated could only be sold at a discount.
PRO (1929c), ‘The Liberal unemployment plan’, 13 June; and ‘Debt policy and unemployment’, 29
Hopkins certainly felt no need to pursue Hawtrey’s idea urgently. It was not until October
that he secured comment on it from Sir Otto Niemeyer, his predecessor as controller of the
Treasury’s finance department, and now a leading figure at the Bank of England. Niemeyer
thought Hawtrey’s ideas were ‘very odd’, and pointed to the practical objection that the banks
could not find alternative short-term investments to Treasury bills, such as commercial bills,
on the scale that Hawtrey contemplated (PRO 1929c, folios 78-9). It is difficult to avoid the
conclusion that Hawtrey’s importance in the formulation of the Treasury view can easily be
Treasury officials liked to think of themselves as practical men, as opposed to
professional economists, whom they tended to see as abstract theorists. Regarding their own
sphere of public finance, they saw themselves as maintaining the credit of the British state, in
the sense that historically it had been able to raise loans on international money markets at
lower rates of interest than had many foreign governments, All would have been familiar
with the dictum of what, in their formative years at the Treasury, had been the leading
academic study of public finance that: ‘a nation cannot, any more than an individual, keep
adding continuously to its liabilities without coming to the end of its resources’ (Bastable
1892, p. 581). The nation’s resources, in this context, meant its taxable capacity, for it was
from tax receipts, plus any money return from state capital investment, that the interest on
loans for public works would have to be paid. Hence officials’ belief that loans had to be
seen by money markets to be for productive purposes. In looking for the likely reactions of
money markets, Treasury officials, like the Bank of England, were disposed to be guided by
what was happening in the market rather than by estimates of national savings or overseas
investment. For example, they believed that the tendency of capital movements could only
be gauged by discount rates in the money market, and by pressure on the exchange rate
(HMSO 1929, pp. 47-8). As it happened, the debate in 1929 on the Treasury view coincided
with pressure on sterling brought about by the movement of funds to New York to join in
stock exchange speculation there.
The Treasury view in the 1930s
The terms of the debate were quickly changed. The general election of June 1929 resulted in
the formation of a minority Labour government with a commitment to doing something about
unemployment. By June 1930 the government had approved public works schemes totalling
£110.1 million, of which, however, only £44.3 million had started, owing to the inevitable
delays in planning and implementing road works and the like (Middleton 1983, p. 361).
However, the minister responsible for unemployment policy, J. H. Thomas, the Lord Privy
Seal, was at one with the Treasury in believing that the fundamental problem lay with the
export trades, and the schemes he favoured were those designed to lower costs rather than to
provide relief for the unemployed. He agreed with the Chancellor of the Exchequer, Philip
Snowden, that there was to be no ‘inflation’, no subsidies to inefficient industries, and no
interference with free trade. Consequently, Snowden had no difficulty in persuading the
Cabinet not to adopt ambitious public works schemes put forward by Thomas’s junior
colleague, Oswald Mosley, the chancellor of the Duchy of Lancaster (Skidelsky 1975, pp.
Meanwhile, the Macmillan Committee on Finance and Industry had been set up to
inquire into how the banking system affected the economy, giving Keynes, who was a
member of the committee, the chance to engage in debate on the Treasury view with
Hopkins, who was a witness. Hawtrey had appeared earlier as a witness, and had put to the
committee his ideas on diverting overseas investment, so as to strengthen Britain’s reserves
and make possible an expansion of credit, but significantly he appeared in a personal
capacity, and it was made clear that he did not speak for the Treasury. Hopkins took
exceptional care in preparing the Treasury’s official evidence, consulting Niemeyer as well as
Leith-Ross, Phillips and Hawtrey. As Clarke (1988, pp. 148-56) shows, Hopkins retreated
from the Treasury view of 1929 in so far as it related to the supply of loanable funds, and
avoided debating the theoretical aspects of Keynes’s ideas. Hopkins conceded that, on
Keynes’s assumptions, public works that did not produce a money return sufficient to pay the
capital and interest on a loan might still pay for themselves partly by diverting capital from
abroad, partly by mobilizing idle balances, partly by diminishing the cost of unemployment
relief, and partly by increased revenue from increased economic activity, but he doubted if
these effects could be calculated. He took his stand on the practical objections that the 1929
White Paper had raised to a rapid expansion of public works. In particular, he pointed out
that, if a large public works programme seemed to investors to be wasteful, financial markets
would expect the value of government stock to fall, and investors would turn to overseas
issues, thereby increasing pressure on the exchange rate, which in turn would lead to a rise in
Bank rate (Keynes 1981b, pp. 166-79). Crowding out, in other words, would occur because
of the way in which money market would perceive loan-financed public works, not because
of the right and wrongs of abstract theory.
Keynes’s theoretical position became more sophisticated from 1931, with the
development of the concept of the multiplier. In 1933, in The Means to Prosperity, he
advocated a reduction in taxation and an increase in loan-financed public works, predicting
that the chancellor’s budget would benefit after a time lag, as national income rose (Keynes
1972, pp. 335-66). Once more, Treasury officials met theory with public finance. Hopkins
pointed out that the lag between income being earned and tax being paid was, on average, 20
months in the case of income tax, and 32 months in the case of surtax (the tax then paid on
higher incomes), and during this period the budget would remain unbalanced. Phillips, who
had replaced Leith-Ross as Hopkins’s principal subordinate on the finance side of the
Treasury, noted: it is no good saying that the works will produce the savings for investment,
for ex hypothesi the borrowing precedes the works (PRO 1933).
In this case, after prolonged
debate with his Cambridge colleague, Dennis Robertson, Keynes had to admit that the
Treasury was right, and that ‘dishoarding’ (i.e. the mobilization of idle savings) and credit
expansion were necessary preparation for the process, described in the General Theory,
whereby increased investment was accompanied by increased savings. Without that
preparation ‘congestion of the capital market’, i.e. crowding out, would occur (Middleton
PRO (1933), note by Hopkins, 13 March, and ‘Questions for Keynes’, 20 March.
1985, pp. 167-8). In practical terms, relating to the need to expand credit, this brought one
back to a position not very far from Hawtrey’s in 1925, but the Treasury continued to pursue
a cautious monetary policy, funding debt as opportunity occurred (Howson 1975).
Hawtrey had thought that loan-financed public works might be necessary as an
employment policy if private investment did not respond to a fall in Bank rate to 2 per cent.
Such a fall occurred in 1932, and Bank rate stayed at that level until the eve of war in 1939.
Nevertheless, Treasury officials continued to believe that public works as a remedy for
unemployment were in themselves quite futile. In 1935, when Lloyd George was again
pressing loan-financed public works as an employment policy, Treasury advice was that an
expansion of borrowing by local authorities would be useful for keeping up the impetus of
recovery from the slump, and in 1937 Phillips endorsed plans for the creation of a reserve of
public works for use in the next depression. However, he also advised that any programme of
public works that forced government to borrow repeatedly in the market ‘might give rise to
serious apprehension as to the state of the national finances’. Such apprehension would make
it difficult for the Bank of England ‘to produce that lowering of the rate of interest which
must always remain the principal weapon in the hands of the authorities during times of trade
depression’ (Peden 1984, pp. 176-8). This opinion was very much in line with Hawtrey’s
Century of Bank Rate.
The need to rearm against Germany forced the Treasury to accept large-scale loan-
financed expenditure from 1937, helping to offset the effects of the recession of 1938. Even
so, Phillips, writing in April 1939, stated only that unemployment ‘probably would have been
worse’ than it actually was without rearmament, and advised concerning statements in
Parliament about borrowing and inflation:
I agree with Mr Hawtrey that the real stimulus comes from reflationary finance. If there were
no reflationary finance, the government works would tend merely to replace private works
without much effect on employment. But this is the famous or infamous ‘Treasury view’,
still a most bitter subject of controversy which it would be a great mistake to raise (Peden
1980, p. 6).
Treasury officials learned to talk about ‘reflationary finance’ rather than ‘inflationary
finance’, and to be cautious about public controversy about economic theory. However, the
Treasury view was still to be found in Whitehall as the interwar period drew to a close.
To return to my original questions: it would seem that the connection between the Treasury
view and the doctrines of professional economists was an indirect one. Hawtrey himself had
developed his ideas in 1913 somewhat in isolation from professional economists, and few
professional economists subscribed to them in the interwar period. His ideas were used by
the Treasury only in so far as they were in accordance with the traditions of public finance.
Indeed, this paper raises the question of whether the history of economic thought should be
confined to the history of the ideas of professional economists, or whether it should be
extended to economic ideas to be found in the City and Whitehall. Hawtrey himself appears
to have absorbed City views via Bradbury, and Treasury officials in general were more likely
to be concerned with the views of the City than they were with economic theory. In 1930
Hopkins distanced himself from the theory associated with the Treasury view of the previous
year, without, however, abandoning objections to loan-financed public works based on
administrative practicalities and the likely reactions of money markets. As late as 1939, the
thinking underlying the deficit financing of rearmament, and its impact on unemployment,
owed more to Hawtrey than to Keynes, and was not fundamentally different from the
thinking that had underlain the Treasury view ten years earlier.
There is a danger of ambiguity when we think about the functions of institutions, like
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Nigel Lawson that ‘the promotion of jobs and employment is not the Treasury’s principal
responsibility’ (Budd 1996, p. 93). Their responsibility was maintenance of sound finance,
rather than management of the economy as a whole, and it was not until 1944 that
government came to accept maintenance of a high and stable level of employment as one of
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