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Published online by Cambridge University Press: 07 November 2014
The first purpose of this article is to outline an approach to war finance which probably receives the approval of most economists, but which has seldom if ever been set down in black and white. This approach is that of a balance between the expansive and restrictive forces operating on money incomes. An alternative approach is the popular three-fold division of the subject into “taxation, borrowing, and inflation”; and it is argued at the end of the article that this approach is likely to be misleading. Certainly it is often misused. But before discussing the “three-fold division” it is convenient to see what light the “balance of forces” approach throws on the role of war loans and of central banking operations. The approach itself is probably more widely understood than are its implications in these directions.
No attempt is made to explain why taxation is generally preferable to borrowing or why inflation is to be avoided. That ground is by now sufficiently familiar. This article proceeds on the assumption that taxation will be used as far as it can be without damage to civilian morale and business incentive, but that a considerable amount of borrowing will be required nevertheless. The assumption is also made that inflation is undesirable. This is a point on which economists seem to have reached general agreement. Yet it is not beyond dispute; nor would the present writer wish to interpret the policy very rigorously.
1 It is well to recall Mr. Keynes's reflections on war finance in his Treatise on Money (London, 1930), vol. II, pp. 173–4Google Scholar: “At such a time it is necessary to direct productive resources of all kinds from one employment to another on a large scale and as rapidly as possible. It would be next door to impossible to achieve this except by invoking the assistance of the price mechanism, i.e. by placing credit facilities at the disposal of the new employments and allowing them to bid for productive resources against the old employments, thus allowing some measure of Income Inflation. Any government which, in the interests of financial ‘purism’, were to cut itself off from this expedient, would lose the war.
“I conclude, therefore, that to allow prices to rise by permitting a Profit Inflation is, in time of war, both inevitable and wise. But the object, we must remember, is to let prices rise more than earnings. … Thus we should endeavour to control earnings more strenuously than prices. … It is expedient to use the entrepreneurs as collecting agents. … High taxation of profits and of incomes above the exemption limit is not a substitute for Profit Inflation but an adjunct of it.”
2 The notion of full employment or maximum production is not clear or unambiguous, especially when war demands and war enthusiasms are at work. It will arise in some form in any discussion of war finance, whether discussion follows the line which is criticized below or the line which is being suggested here. We shall not concern ourselves here with the difficulties involved in the notion.
3 The Hon. Ilsley, J. L. (Canada, House of Commons Debates, 07 30, 1940, p. 2272).Google Scholar The same point was made, almost in the same words, in his speech on November 21, 1940 (ibid., p. 311).
4 The novelty here may not be very great. I understand that, during the last war, bonds were sold to workmen on the basis of ten monthly instalments in the expectation that there would be one war loan a year.
5 The Hon. Ilsley, J. L. (Canada, House of Commons Debates, 09 12, 1939).Google Scholar
6 Mr.Keynes, , in his Treatise on Money, vol. II, pp. 175–6Google Scholar, takes British finance in the last war as an example of this very danger. He says: “The war-period was also marked by an excessive preoccupation on the part of ‘sound’ financiers with the aggregate volume of bank-money. We have remarked above how it was universally believed at the time that inflation would be avoided if old ladies, who had had money on fixed deposit with their banks for years, could be induced on patriotic grounds to surrender these to the Treasury for war loans—for in that way any increase in the total volume of bank-money would be avoided! … Other patriots tried to think out ways by which the same volume of money turn-over could be conducted by means of a smaller volume of Currency Notes!” It is perfectly clear that the same pre-occupation is today widespread in Canada and the United States.
7 A friend of mine may have expressed a widespread point of view in writing to me as follows: “My only dissent concerns your treatment of the holy trinity, taxation, savings, and inflation. … Everything you state in the earlier portions of the manuscript can be restated in terms of the trinity. The trinity is not a good tool of analysis in plumsy hands,—but then what concept is?” In reply it may be pointed out that I am not abandoning the trinity entirely, but only one interpretation of the doctrine. I advocate Higher Criticism, not Atheism. And, while agreeing that everything can be stated in terms of the (perverted) doctrine, I hold that heresy is more likely to arise as a result of its use in clumsy hands than as a result of use of the balance of forces approach. An adherent of the (perverted) doctrine of the trinity need not believe that inflation comes solely or chiefly from an increase in the quantity of money; but he is very likely to fall into that error.
