Discussion Papers In Economics
And Business

Pigou’s theory of business cycle as an inquiry into unemployment:on the relative effects of the gold standard and the wage
rigidity in the twenties

Norikazu TAKAMI

Discussion Paper 07-33

Graduate School of Economics andOsaka School of International Public Policy (OSIPP)
Osaka University, Toyonaka, Osaka 560-0043, JAPANPigou’s theory of business cycle as an inquiry into unemployment:on the relative effects of the gold standard and the wage
rigidity in the twenties

Norikazu TAKAMI

Discussion Paper 07-33
September 2007

この研究は「大学院経済学研究科・経済学部記念事業」
基金より援助を受けた、記して感謝する。

Graduate School of Economics andOsaka School of International Public Policy (OSIPP)
Osaka University, Toyonaka, Osaka 560-0043, JAPANB13, B31, E24
history of economic thought, Pigou, unemployment

Pigou’s theory of business cycle as an inquiry into
unemployment:on the relative eﬀects of the gold standard and the wage
rigidity in the twenties
Norikazu TAKAMI†
In this paper I examine A. C. Pigou’s views on the unemployment policies, based on thepremise that, as he himself acknowledged, his theory of business ﬂuctuations was one integral
part of his whole thought about unemployment. In his Industrial Fluctuations (1927), Pigou
gave the most extensive treatment to the monetary policy among the measures against businessﬂuctuations. There he advocated more prompt and smooth action by the Bank of England inorder to eﬀectively stabilize the movement of general prices and the economy as a whole. In
order for its action not to be aﬀected by external monetary shocks, he suggested the withdrawal
from the gold standard should the public opinion and international diplomatic relations allow
it. Pigou, meanwhile, placed much less importance on wage adjustment as a palliative against
business cycle.
The recent studies direct attention to the fact that Pigou pointed out that after World War
I money wages were made rigid by such factors as contemporary institutional changes in labormarkets. This picture, however, lacks a more important element of his thought: the monetarycause due to the gold standard on the prewar parity. Putting his indirect remarks on thisinﬂuence together, I argue that Pigou was well aware of the monetary situation and seemed
to place greater importance on the monetary inﬂuence than the wage rigidity.

† dg067tn@mail2.econ.osaka-u.ac.jp

Pigou’s theory of business cycle as an inquiry into
unemployment:on the relative eﬀects of the gold standard and the wage
rigidity in the twenties
Norikazu TAKAMI, the Graduate School of Economics, Osaka University

1 Introduction
Keynes condemned Pigou in General Theory so unﬂinchingly and deﬁnitively that Pigou
had been seen for long as proposing in Theory of Unemployment (1933) the overall wage cut
as an ameliorative policy against unemployment. Hutchison (1978) and Aslanbeigui (1989),
however, showed their oppositions against this view, pointing to the fact that Pigou proposed
reﬂationary policies in the Times in the thirties. They demonstrated the agreement in thepolicy proposal between Keynes and Pigou.1 But it is undoubtable that Pigou proposed
wage adjustment, not just as a theoretical consequence, but as a practical policy; and thathe continued to do so until the end of his career. Then how much weight did he place on
wage adjustment? How much more, or less, eﬀective did he think wage adjustment was thanother ameliorative measures such as public works and monetary policy? In this paper wewill examine the relative importance Pigou attached to each measure based on his Industrial
Fluctuations (1927), which he himself noted was complementary to Theory of Unemployment;
and conclude that wage adjustment, in his system, was a less eﬀective measure.
Next we will be concerned with how Pigou applied this system of industrial ﬂuctuations
to the British economy after World War I. As Laidler (1999, 159–60) already notices, Pigou
pointed to the postwar change that the average rate of wage had been made much more rigid
than it was before the war. It is true, as Laidler suggests, that Pigou found this change responsible for the substantial part of the contemporary mass unemployment; but it is inadequate,
we argue, in grasping his thought on practical policy. Less explicit though it was than the
problem of wage rigidity, Pigou had left many indirect statements, as well, on the contemporary signiﬁcant fall in prices due to the ﬁnxed exchange rate under the gold standard. Basedon these evidences I will argue that Pigou had a consistent analysis on the causes for massunemployment, putting more weight on the price fall rather than wage rigidity in spite of his
clear statement above.
Sections 2 and 3 presents respectively the analytical aspect and the remedial aspect ofPigou’s theory on business ﬂuctuations. Section 4 examines the relation between the problem of wage rigidity in the twenties and the contemporary monetary disturbance in Pigou’s
writings. Then I conclude that Pigou consistently recognized the importance of monetary
policy.

1 Ambrosi (2003), who points out the macro-theoretical diﬀerence between Keynes and Pigou, acknowl-edges that Pigou supported reﬂation (Ambrosi, 2003, 117–8).

1

2 Causes of unemployment
Pigou’s theory of business cycle originates out of the purpose to analyze unemployment, as
stated in the preface of his earlier book, Wealth and Welfare (1912).2 This purpose is kept inIndustrial Fluctuations (IF hereafter), too, the evidence of which is that Pigou uses the rateof unemployment as the main barometer of business ﬂuctuations.
First in IF, Pigou notices the broad tendency that the aggregate supply of labor adjusts itself
to the long-term movement of the aggregate demand for labor; and thereby deﬁnes the directcause of the movement of unemployment (or business cycle) as “deviations in the movementof the demand schedule away from its general line of trend” (Pigou, 1927a, 22). That is tosay, when the demand for labor is stable,
the wage-rate would settle down at the level required to give employment to the wholeavailable supply of able-bodied labour. It is only ecause demand ﬂuctuates that convention in wage-rates acts as it does: the rate is adapted to the conditions of normal
times. (Pigou, 1927a, 245)
To Pigou, who holds that the absence of the movement in demand for labor means the absenceof unemployment in the long run, the theory of business ﬂuctuations subsumes the theory of
unemployment.
Pigou starts his analysis by relating the movement of demand for labor to the present valueof the anticipated yield entertained by businessmen (Pigou, 1927a, 26). The present value
depends on its numerator, the anticipated yield and its denominator, the rate of discounting.
The latter’s changes come about, in the short run, only through the variation in the quantityof money. Consequently, in the system of IF, direct causes of business ﬂuctuations are reduced
to the following two: (1) the anticipated yield entertained by businessmen and (2) the quantityof money.
Pigou divides the ﬁrst cause of business ﬂuctuations, the anticipated yield of businessmen
into two subdivisions. The ﬁrst of them is “real causes”, which consist in “changes that haveoccurred, or are about to occur, in actual industrial conditions” (Pigou, 1927a, 35). Among
real causes are included changes in the yield of crops, inventions and improvement in themethod of production, discovery of mineral deposits, industrial disputes, wars, and foreignbusiness ﬂuctuations (including changes in custom duties). The second of the subdivisions
is “psychological causes”. Psychological causes consist in the “errors” necessarily involved in
the forecasts for future conditions, the existence of which enlarges the ﬂuctuation beyond themagnitude real causes account for. Pigou attributes the fact that a competitive economy isliable to this error to the following reasons. First, industries highly organized, manufactures
carry less stock, while dealers undertake the oﬃce of forecast; and the way is still widely
opened for the error.3 Second, it is practically impossible to extrude the general public fromstock exchange; and their lack of judgment or information causes disturbances. Third, the factthat in a competitive economy independent agents make decisions on investment is a factor
to extend errors of forecast. Because each of the agents “usually pays too little attention to
2 “Several years ago I began to study the causes of unemployment.

It soon became apparent, however,that these causes are so closely interwoven with the general body of economic activity that an isolated
treatment of them is scarcely practicable” (Pigou, 1912, v).
3 Though Pigou doesn’t mention this, the role of dealers is indispensable in the system of R. Hawtrey.
According to Hawtrey, it is through the stock held by dealers that the rate of interest or the movementof prices aﬀects the level of output and employment. See Howson (1985).

2the fact that his rivals are likely to have formed the same opinion and to be acting on it”(Pigou, 1927a, 77). This circumstance makes diﬃcut the optimal intertemporal allocation of
productive factors. It is not practicable to devise “forward buying”, or future trade on all kindsof factors; nor is it possible for the single combined agent in a Trust or a Kartel to continually
perform business, in any case, because it will “presently break up again” (Pigou, 1927a, 81).
And fourth, while thus ﬁrms and investors are independent of one another, they are vulnerable
to other agents’ psychological states. Pigou takes notice of the possibility that a person may
be inﬂuenced by someone with whom he/she has no business or credit connection. “Perhaps
the buoyancy of a grocer”, he quotes from one author, “gives a lumber dealer no adequate
reason for altering his conservative attitude towards the business projects upon which he must
pass. . . . The fundamental conditions aﬀecting his own business may remain the same; but
his conduct is altered because he sees the old facts in a new emotional perspective.” (Pigou,
1927a, 86).4 It is much more certain, however, for the psychological inﬂuence to spread among
buyers and sellers and debtors and creditors. Thus excessive optimism or pessimism would
easily spread itself around the business world. The substantial part of a business ﬂuctuation,
he asserts, depends on psychological errors.
The second cause of business ﬂuctuations is, as noted above, the variations in quantity ofmoney that aﬀect the rate of discounting. In the latter half of the 1920s, “there were, inall, some thirty countries whose currencies were legally or de facto based on gold” (Pigou,
1927a, 104); and, therefore, disturbances in the international gold market brought aboutchanges in quantity of money within each of these countries. Consequently, for instance, when
“between 1871 and 1873 Germany absorbed a large quantity of gold in order to establish agold standard and in the years following 1878 the United States did likewise in connection
with a law making the inconvertible Government bank notes, which had been issued during
the Civil War, convertible into gold at the Treasury” (Pigou, 1927a, 193), the general prices in
Britain fell. Thus between countries on the gold standard a simple fact of credit expansion in
any foreign country might be a factor to disturb the monetary situation in a domestic economy
through ﬁxed exchange rate.
Money has not only the function of generating such autonomous changes, but also, Pigou
emphasizes, the function of expanding the ﬂuctuations initiated by some causes. If the present
value of the anticipated yield of businessmen were improved by whatever causes, they can resort
to, except internal reserves or issuing of debentures, bank credits as a ﬁnancial resource. In
the latter case, the aggregate quantity of money rises. Since it is likely that “income velocity
of monetary circulation” rises, the general prices is likely to rise, which brings about what
Pigou calls “forced levies”.5 Through this process, businessmen can levy the real resourcesfrom the general public more than the latter is willing to save. In addition, in the case ofrising prices the rates of wage and interest contracted in the past are changed into the rates inreal terms advantageous to businessmen, who are “in the main, borrowers and wage-payers”(Pigou, 1927a, 137). “Forced levies” and “doctorings of the terms of past contracts” willfurther the improvement of the anticipated yield through the psychological channel, resulting
in further rise of prices. Thus business improvement once started will continue to accelerate
itself; and “[u]ntil some external event, such as the refusal of bankers to create any morecredits, intervenes, there is no reason why this process should ever come to an end” (Pigou,
1927a, 172).
4 These sentences are quoted from Mitchell, Business Cycles, p.

455. In IF, Pigou relis on him in manyother places.
5 Laidler (1999, 89–90) says Pigou absorbed the idea of forced saving or forced levy, not from the Austrian
School, but from D. H. Robertson.

3

What has been thus far discussed is concerned with the movement of demand for labor.
Pigou doesn’t end his explanation here, but places some importance on wage adjustment
between employers and employees. The reason why he does so is that he thinks diﬀerent kindsof labor are more likely to be complementary than to be substitutive to each other.
Suppose that ten groups of workpeople in ten occupations contribute in about equal proportions towards making some ﬁnished commodity. Suppose, further, that the elasticity
of demand for the ﬁnished commodity is unity . . . Then a 10 per cent cut in the wagesof one of the occupations will involve a 1 per cent fall in the price of the commodity
and also a 1 per cent increase in the quantity of labour demanded in that occupation.
But it will also involve a 1 per cent increase in the quantity of labour demanded ineach of the other occupations. Hence, although, if a single group accepts a 10 per centwage-cut, employment in that group will expand only 1 per cent, should all the groups
accept a 10 per cent wage-cut employment in all the groups collectively will expand 10
per cent. . . . As regards industries which are not joint contributors to a common work,
if the mutual demand for one another’s products has an elasticity greater than unity, a
reduction of costs in one will stimulate output in the others. (Pigou, 1927a, 201–2)
Based on this general-equilibrium reasoning, Pigou rebuts “popular arguments” whose sights
are too small to correctly estimate the evil eﬀects of wage rigidity. Flexibility or rigidity ofwage-rates, Pigou concludes, has greater eﬀects than they suggests. Yet he assumes that in reallife the mutual distrust between employers and employees, as will be discussed below, prevents
wage adjustment from being ﬂexible, which generates more large movement of unemployment
than can practically be reduced.
To sum up, Pigou’s system of business ﬂuctuations can be characterized by its simplicity
and ﬂexibility. The channels through which to bring about changes in demand for labor are
distinguished into (1) real, (2) psychological, and (3) monetary ones; the impulses of these
diﬀerent channels aﬀect one another so as to create the further eﬀects continually. Furthermore, the movement of demand for labor thus brought about is hardly ameliorated by wage
rigidity. Analyzing the causes of business ﬂuctuations in this manner, Pigou passes on to theexamination on remedies by which to minimize the ﬂuctuations. The methods to which hedirects attention are monetary policies, public works, and wage adjustment.

3 Remedies to business ﬂuctuations
Pigou recognizes the social losses due to unemployment (Pigou, 1927a, 241–7). Unemployment is diminution of incomes “concentrated on the unfortunate few” and also deteriorates
psychological as well as physical capabilities of workers. Besides, the fear of unemployment
begets a “haunting sense of insecurity and danger” even to the mind of currently employedworkers. Meanwhile, excessive prosperity that lies on the other end of business cycle is not
a propitious condition to workers. Because “when, as often happens, the fat months imply
long hours of overtime, they will not yield any good eﬀects to set against the evil eﬀects of
the lean months, but will themselves add further evil eﬀects”. For Pigou, to stabilize businessﬂuctuations means the “relief [of workpeople] from the distresses of unemployment and thestrain of booms”.6 Thus it is with the aim of improving the predicaments of workers that
Pigou discusses the following remedies.
6 Keynes’s rhetorical imperative in the General Theory

to the eﬀect that we should aim at a constantboom might have been directed against such an orthodox view as Pigou’s that we should restrict a boom
as well as a slump. See Keynes (1936, 322–7).

4

3.1 Monetary policy
Keynes’s assertion that Pigou relies too much on real analysis might be valid when concernedwith Theory of Unemployment (1933), but not so when concerned with IF. It is safe to say
monetary policy is the most important subject in the latter volume. Pigou raises an issue that
until at least the middle of the 1920s the Bank of England had been aiming at stabilizing its
gold reserve rather than the general prices in Britain; and proposes that it take on the lattergoal proactively.
Pigou calls the conventional policy the Bank of England had been employing “reserve discount policy”; and characterizes it as follows (Pigou, 1927a, 278–9). First, this policy tries tokeep the proportion of the gold reserve to its liabilities (i.e. money supply) above a certain
level in order to secure against any danger of default. Second, In times of good business condition where the danger of default is remote, “people are ready to pay higher interest on a given
volume of loans”; and under this circumstance the Bank maximizes the proﬁt by reducing the
proportion of reserve down to the acceptable minimum. The reason why the Central Bank
makes it a principle to maximize proﬁt is to use this proﬁt as a resource to augment the gold
reserve. Thus in times of rising prices the rate of interest will be raised, not to restrict the risein prices, but to take advantage of the opportunities for proﬁt. The manipulation of interest
rate, as a result, is likely to lag behind the price movement under the “reserve discount policy”.
Pigou proposes to substitute for “reserve discount policy” “stabilising discount policy” aiming at stabilizing general prices. Yet he notices two diﬃculties involved in this shift of policies.
On the one hand, there needs to exist some discretion for the Central Bank to inspect andinterpret various statistics. To eﬀectively restrict the price ﬂuctuations, it has to devise apolicy in an earlier stage than it is possible to spot the realized price changes and to respondmechanically to them. Because “the seeds of expansions and contractions”, he says, “are sown
some little while before the movements in [bank] credit [, which tends to precede the pricemovements] occur, and it is the sowing of the seeds, and not their sprouting, if they havebeen sown, that discount policy is chieﬂy able to inﬂuence” (Pigou, 1927a, 283). Thus, when
making decisions on monetary policy, the Central Bank, instead of responding to the realized
movements of prices or bank credit, needs to interpret the movements of such “forecasters”,
or leading indicators, as “prices of speculative securities”, “the volume of new orders given
per month in important industries, or in the stocks of ﬁnished goods in dealers’ hands”, or“the percentage of workpeople out of employment” (Pigou, 1927a, 284–5).7 Yet in the contemporary policy debate there existed a general distaste for permitting to the Central Bank
discretion because it might involve “stupidity and perversity on the part of governing persons”(Pigou, 1927a, 295). Pigou, though paying attention to this, is in favor of stabilizing policyon the whole.8
The second diﬃculty with the shift from “reserve discount policy” to “stabilising discountpolicy” consists in the latter’s discrepancy with the current international monetary system, the7 According to Eshag (1963,

136n99), monetary policy based on leading indicators had been alreadyadvocated by such Cambridge economists as Hawtrey, Keynes, and Lavington before the publication of
IF (1927). But in 1924 in the article called “Correctives of the Trade Cycle” Pigou proposed the same
method (Pigou, 1924, 115–6). It might not be wrong, therefore, to say that Pigou started to recognize
the importance of the monetary policy based on leading indicators at about the same time as they did.
8 Pigou writes, “since the restoration of the gold standard, the Bank of England have recently, it would
seem, adopted in some considerable degree, a policy directed towards price stabilisation” (Pigou, 1927a,
278n2). This seems to imply that the general distaste for the discretion was gradually waning aroundthis time.

5

gold standard. The gold standard, though making for the ﬁxed exchange rate, makes a country
on it vulnerable to the disturbances from a international gold market. If the international gold
market is stable to some extent, the Central Bank can refuse to have its policy aﬀected bymoderate inﬂuxes into or eﬄuxes out of its reserve. But it doesn’t always stay stable. In
the following quote Pigou anticipates the situation where, facing the great disturbances in
the international gold market, Britain was forced to abandon the gold standard several years
later. If the value of gold strongly trends upward for a long time,[t]he Central Bank, to prevent prices [in the domestic economy] from falling, must reduce
its discount rate and create more and more credits on the basis of a steadily diminishinggold reserve. Obviously it cannot carry on this policy for long: if it presses it too far,it may ﬁnd itself without suﬃcient legal tender to meet its customers’ cheques, andcollapse in ignonimity. (Pigou, 1927a, 305)
That is to say, in such a condition the Central Bank has to pursue the two contradictory
goals, that is, (1) to enlarge the money supply in order to prop up the domestic economy,and (2) to maintain the proportion of the gold reserve in order to preserve conﬁdence in thecurrency. This is why Pigou declares as follows: “If a stabilising discount policy is adopted in awholehearted manner, the logical sequel as regards currency is [not] the gold standard plan . .
. It is a[n inconvertible] paper currency” (Pigou, 1927a, 296). He ﬁnds it possible to stabilize
the gold market for the time being by such international coordination as contemplated in
the resolutions of the Genoa Conference of 1922. Yet he doesn’t have complete faith in thismethod. Pigou suggests that there will come up the situation which will require a national
decision on international monetary system. “To make a choice between that policy [i.e. themaintenance of the gold standard helped by international coordination] and the other various
policies that are open to us is a task that cannot be attempted in a work of this kind. Economic
analysis can provide data for statesmen; but the attitude of public opinion and the current
political and diplomatic situation are dominant factors in determining what, on the whole,
it is best to do” (Pigou, 1927a, 305). This quote can be safely interpreted as proposing the
introduction of an inconvertible paper currency should the “political and diplomatic situation”
allow, since “economic analysis” clearly suggests what is best; and since Pigou supposes thepossible restrictive measures against overissue of currency after the assumed departure fromthe gold standard.9
What has been shown suggests that Pigou’s attitude towards monetary policy was closely intouch with realities of those days. He, though somewhat hesitating the drastic shift in view of
the rigid nature of the general opinion, preferred forward-looking policy aimed at stabilizing
a domestic economy to the mechanical “fool-proof” method of maintaining the gold reserve.
Even the depart from the gold standard was on the agenda of his discussion. Pigou guesses thequantitative impact and says that “if a policy of price stabilisation were successfully carriedthrough, the amplitude of industrial ﬂuctuations would be substantially reduced—it might be
cut down to half of what it is at present” (Pigou, 1927a, 219, my emphasis).

9 Pigou was one of the signatories to the Cunliﬀe Report (1918) and the Bradbury Report (1924), both ofwhich recommended the restoration of the gold standard on the prewar parity. Yet, according to Winch(1969, 154), in 1930 in his testimony before the Macmillan Committee Pigou looked back at the situationand said no other policies could not be accepted by the general public. There he mentioned, “I was astabiliser long before [serving at the Cunliﬀe Committee]”(ibid.).

63.2 Public works
Pigou also take note of the following defect of monetary policy. In times of serious depression
when borrowers anticipate unacceptably low proﬁt from any investment “[p]eople do not wantto borrow on any terms, and the banks cannot force them to do so” (Pigou, 1927a, 267). Thenmonetary policy is not valid unless the negative rate of interest is possible. In IF Pigou fails
to provide any way out; and says instead that monetary policy is eﬀective to restrict booms
so that it is just as eﬀective to restrict slumps, which Pigou assumes are resulted from theburst of booms.
In his later work, Theory of Unemployment (1933) Pigou, assuming the same framework
as in IF, brieﬂy discusses the measure eﬀective even to the serious depression. Here Pigou
introduces the new concept of “proper rate of interest” (Pigou, 1933b, 213) that should be therate under the “stabilising discount policy”, or that should stabilize the general prices. And
he says,[i]t is, indeed, always possible for the Central Bank, by open market operations, toforce out money into balances held by the public. But in times of deep depression,
when industrialists see no hope anywhere, there may be no positive rate of money
interest that will avail to get this money used. The proper money rate . . . may, inshort, be a negative rate, and, therefore, one which it is impossible to introduce. In
these circumstances attempts to uphold the standard monetary system [i.e. stabilising
discount policy in IF ], so long as reliance is placed on purely monetary defences, arebound to fail. If, however, at the same time that the banking system keeps money cheap
the Government adopts a policy of public works, the risk of failure is greatly reduced.
For this policy, providing, as it does, new openings for real investment, pushes up theproper rate of bank interest above what it would otherwise have been. Thus it may
turn a negative proper rate, to which it is impossible for any actual rate to conform,
into a positive one. (ibid.)
Here we notice that Pigou considered the public works as a complementary measure to monetary policy.
Through what channel Pigou thinks the public works would aﬀect the “proper rate ofinterest”? The public works normally involve the following two actions: (1) increasing bankcredit more than the private sector alone attains, and (2) putting into use the money thus
borrowed. To explain this with the exchange equation Pigou uses in Theory of Unemployment,
M v = I (M means the total money stock, v the income velocity, I money income), the former
action is represented by the increase in M , the latter by the increase in v. Pigou places more
importance on the movement of v than of M . The reason is that, since M includes the hoarded
money that is not put into the “income-expenditure circuit”, the increase in M realized by theincrease in new bank credit doesn’t always lead to the increase in money income, but might
only lead to the increase in the hoarding, which is represented by the decrease in v (Pigou,
1933b, 197). For Pigou the public works consist in the only eﬀective measure to raise themoney income in the times of serious depression.10

10 Pigou mentions elsewhere there is another situation where monetary policy is ineﬀective so that public

works are the only eﬀective measure. If a country is on the gold standard and the international market
is unstable, the cut of a domestic interest rate might incur a serious eﬄux of gold (Pigou, 1929, 186).
In such a circumstance public works is the only eﬀective measure against unemployment. According to
Howson (1985, 165) Keynes also makes the same point.

7

Obviously this assertion of Pigou’s that in times of depression income velocity is more
important than money stock is directed at R. Hawtrey. Hawtrey, one of the contributors to theso-called “Treasury View”, insisting the invalidness of public works,11 was a authority ﬁgurein monetary theory, arguing public works are relevant only insofar as they augment moneystock (Hawtrey, 1928, 112). Hawtrey, assuming that there is negligible amount of hoarded
money in reality so that changes in income velocity v are rare and insigniﬁcant, considered themoney stock M to be the all-important element. For him public works was “merely a pieceof ritual, convenient to people who want to be able to say that they are doing something, butotherwise irrelevant” (ibid.). Hawtrey had no doubt, on the other hand, that the increase inmoney supply by monetary policy could in any circumstance overcome unemployment. It was
this view of Hawtrey’s that Pigou implicitly criticized with the argument above.12
Pigou estimates the eﬀect of the price stabilization to be fairly large (“half of what [theamplitude of industrial ﬂuctuations] is at present”) as noted above. Here we’ve shown thatfor Pigou public works are the integral part of price stabilization policy; and so we cannot
doubt that he recognizes public works as an important remedy against unemployment. What
he criticizes was the so-called “Treasury View” and its contributor, Hawtrey. There is nothingfor Keynes to accuse Pigou of in this ﬁeld.

3.3 Wage adjustment
The next measure to come under examination in IF is wage adjustment. Yet Pigou considers
this measure to be of less importance than such measures as noted above.
Pigou had had since the earliest book, Principles and Methods of Industrial Peace (1905)
practical views that ﬂexibility of wage adjustment would depend on the states of the relations
between employers and employees; and that the states of the relations would depend on theeﬀectiveness of the machinery for negotiation. Thus for Pigou the relations between employers
and employees are not a given factor, but one to be improved. These views are maintained inIF.
Machinery for collective bargaining may be set up, and, partly as cause, partly as eﬀectof this, a spirit of goodwill and accommodation may be engendered. In representative
meetings of employers and employed not only mechanical indices of prices and so on,
but al considerations relevant to wages, may be periodically reviewed in a whole-hearted
eﬀort to secure a reasonable settlement. Where arrangements of this kind exist each side
will be ready to make concessions if the conditions seem to call for them, conﬁdent thatthe other side, in converse circumstances, will do likewise. Wage-rates will be renderedless rigid, the amplitude of industrial ﬂuctuations associated with given variations indemand will be pro tanto reduced, and economic welfare correspondingly augmented.
Here Pigou makes it clear that wage adjustment should be improved through the bettermentof the relations between employers and employees: the government could not directly play a
11 According to Clarke (1988, ch. 3), the “Treasury View” was a counterargument which the Conservative

Chancellor of Exchequer W. Churchill ordered to compose against the expansion policies advocated by
the Liberal Party in the 1929 election. This view was stated in the Budget speech in April 1929, andpublished as a White Paper in the following month. Although Hawtrey stayed in Harvard in 1928–9 sothat he could not be involved in the formulation of the Treasury View in the ﬁnal stage, he was counted
on as being “the one man who ought to know whether Keynes was talking nonsense.
12 The settlement of this dispute would require the actual amount of the hoarded money. Hawtrey also,
assuming its insigniﬁcance, questioned the theory of liquidity preference in Keynes’s General Theory.
See Laidler (1999, ch. 11).

8

role in this process.
In addition, Pigou doesn’t consider, it should be noticed, wage adjustment to be quantitatively important. His guess on the eﬀect of improvement of wage adjustment is “one-eighth[of what the amplitude of ﬂuctuations is at present]” (Pigou, 1927a, 225), which is much lessthan the eﬀect of price stabilization (half).
That Pigou had never called for the wage cut as a practical policy of government is madeclear further by the following quotes. In the preface in Lapses from Full Employment (1945),
the volume recasted for the general reader, he says, “Professor Dennis Robertson, who hasvery kindly read my proofs, has warned me that the form of the book may suggest that I
am in favour of attacking the problem of unemployment by manipulating wages rather thanby manipulating demand. I wish, therefore, to say clearly that this is not so.” (Pigou, 1945,v). The similar remark is found in Theory of Unemployment: “[this book’s] aim is to clarify
thought, not to advocate a policy” (Pigou, 1933b, v). Then what was his policy at the timeof the publication of Theory of Unemployment in 1933? It is expressly stated in his article in
the Times in the same year.
For prosperity to be restored either money costs must fall or money prices must rise.
The practical diﬃculties in the way of the former solution have proved so serious andthe friction to be overcome so great that the main body of instructed opinion has turned
towards the latter. (Pigou, 1933a, 13)
Pigou goes on to recommend the cheap money policy so as to raise general prices.

4 Wage rigidity in the 1920s
It is now evident that Pigou places much more importance on price stabilization than on
wage adjustment in IF. Nevertheless, Pigou brings up the apparently opposing view in thearticle called “Wage Policy and Unemployment” published in the same year as IF (1927),
to the eﬀect that the failure of wage adjustment causes a great deal of unemployment. As
Laidler (1999, 159–60) notices,13 Pigou asserted that after World War I the factors particularin this period had caused wage adjustment between employers and employees to be more rigid
than before the war, the result of which was mass unemployment (ﬁg. 1 shows the movementof unemployment in 1850–1926). Those factors consist in, Pigou identiﬁes, (1) a couple ofinstitutional changes in a labor market, and (2) structural disparities between two groups ofindustries.14
First, there were two following major institutional changes in the labor market after WorldWar I: (1) “direct State action” and (2) the “development of unemployment insurance” (Pigou,
1927b, 355). The ﬁrst of these, “direct state action”, as speciﬁed in Theory of Unemployment(Pigou, 1933b, 255), refers to the minimum wage regulation. In Britain the minimum wage
legislation (Trade Boards Act) was so amended as to enlarge the range of covered occupationsin 1918. Pigou, in 1922, treated the amendment of the Act critically, warning that it would
create the tendency for the wage rates of covered workers to stay higher than the competitive levels. Second, the development of public unemployment insurance, Pigou believes, haspromoted higher wages by solidify employees’ bargaining position. Before the war, since thetrade unions paid for their beneﬁts to the unemployed unionists out of their own funds, “heavy
unemployment means a heavy drain on union funds” (Pigou, 1933b, 254). This situation had
13 Aslanbeigui (1992, 422) brieﬂy mentions this.
14 In many other places Pigou relates mass unemployment in the 1920s to the post-war wage rigidity (Pigou

1933, 252–6; 1941, 93; 1945, 73; 1947, Pt. 2; 1952, 1003).

916

unemployment by year

14

12

10

8

6

4

2

0
1850

1860

1870

1880

1890

1900

1910

1920

1930

Fig. 1brought about a proactive restraint on the side of trade unions before the war. After the war,
however, when the public unemployment insurance was expanded to almost all the occupations, and when “unemployed members are cared for, in the main, at the expense of otherpeople, the union’s contribution being no larger when there are many unemployed than when
there are few, this check does not operate” (ibid.). By these two social legislations, Pigou
asserts, “wage-rates have, over a wide area, been set at a level which is too high [to realize
full employment]” (Pigou, 1927b, 355). Yet Pigou has no intention to call for the abolitionor the cutback of these legislations, which suggests that as regards these social legislations he
attaches more weight to their merit of helping the ill-situated people than to their demerit ofpromoting higher wages.
The second factor in promoting wage rigidity in the 1920s that Pigou points to is, as detailed in Aspects of British Economic History (1947),15 the structural disparity between two
groups of industries, namely the depressed export-related industries, “unsheltered industries”
and the better-oﬀ industries catering to the domestic market, “unsheltered industries”. In thereal terms the British exports in 1923 was around 80 per cent of what was in 1913. Pigou
attributes this fact to several causes, one of which is that, particularly in the textile industries,
new manufacturing countries such as Japan and India developed not only at home but in othercountries, ﬁrst, because they had been shut oﬀ from the supply of the European countries during the war and, second, because the agricultural countries, faced with the fall of prices of
their produce after the war, had to be content with cheaper products from these countries.
The unfavorable situation in the export industries also deteriorated dock and river transportindustries. Meanwhile the industries for the domestic market, being “sheltered” from suchﬁerce competition as the export industries had to bear with, enjoyed the relative prosperity.
Pigou thinks that the structural disparity, aggravated with slow labor movement, was, thoughitself the much-noticed cause for unemployment, a factor in promoting rigidity of the average

15 The fact that this volume was written in the 1940s might stir up the doubt that Pigou did not notice

the factor in promoting wage rigidity due to the structural disparity in earlier period. But according to
Howson and Winch (1977, 64) Pigou mentioned it at the Economic Advisory Council in 1930.

10

rate of wages in the economy as a whole. For, “it is diﬃcult to see”, he writes, “ how, inindustries that were themselves prosperous, work-people could have been brought to accept
wage reductions” (Pigou, 1947, 55). Thus his point here is that since the labor market was
divided between these two diﬀerently-situated groups of industries, in the economy as a whole
the average rate of wages had become insensitive even to the large increase in the aggregate
amount of unemployment. Under this circumstance forced transference of labor from the depressed industries to the relatively prosperous industries could make an ameliorative measure.
Pigou gives a cursory treatment to this measure in Theory of Unemployment (Pigou, 1933b,
283). Yet this treatment doesn’t include discussion on the feasibility or the possible ramiﬁcations of this measure, not to mention that he clearly state the disadvantage outweighing
the advantage in his later Lapses from Full Employment (1945), saying “[u]nemployment isalways an evil, but sometimes to reduce it might entail worse evils” (Pigou, 1945, 68).
Thus Pigou considers these two factors to cause wage rigidity after World War I. In fact,
leaving aside the violent ﬂuctuations immediately after the war, in spite of the fact that in thetwenties the general prices fell around 10 per cent and the rate of unemployment almost always
remained above 10 per cent, the money rate of wages remained unchanged over this period(Mitchell 1962, 345; Clarke 1996, ch. 4).16 For Pigou, who has faith in the eﬀectiveness of thecollective bargainings (see 3.3 above), this situation must have been surprising. He assumes
that “at least 5 per cent. of extra unemployment” (Pigou, 1927b, 356) be attributed to thewage rigidity particular to the post-war economy. The quantitative estimate of 5 per cent,however, seems to contradict Pigou’s own system in IF, which has been examined in section
3 above. He has placed much more weight on price stabilization than on wage adjustment in
IF. Why does he identify the worsening of wage adjustment alone as a factor responsible forthe substantial part of the increase in unemployment in the twenties? Why doesn’t he identify
the heavy price fall as a more powerful factor, so that his diagnosis could be consistent withthe system of IF ? The answer I suggest is that in the late twenties he didn’t have an option
to deal with the abrogation of the gold standard as a practical policy, so that he had tocontent himself with identifying the factor other than the price fall the gold standard forcedon Britain. Before taking on this problem let us discuss the direct cause for the abrupt risein unemployment in the early 1920s.
Pigou says the following in “Wage Policy and Unemployment”, the article which ﬁrst points
to the problem of wage rigidity in 1927. “It is a matter of common knowledge that the great
slump of 1920–1 had its origin in causes lying altogether outside wages, and was intimately
associated, whether, as some hold, as the direct eﬀect of a deliberate policy of monetary
deﬂation, or, as others contend, as a joint consequence of the bursting of a gigantic bubble ofunwarranted optimism, with a heavy fall in prices” (Pigou, 1927b, 358–9). He acknowledges
here that the upsurge in unemployment in 1920–1 was spurred, if not initiated, by the purely
monetary factor. Then why was “a deliberate policy of monetary deﬂation” taken? That is
because the government wholeheartedly committed to the restoration of the gold standard atthat time. Pigou depicts this situation at some length in Aspects of British Economic History,
1918–1925 (1947).
First let us look at the movement of unemployment in this period. By means of the statistics
adjusted with the estimate of 1918–19 by Pigou (ﬁg. 2), we can see how Pigou divides thisperiod into four parts. First, what Pigou calls the “Breathing Space” consists in the shortperiod between the Armistice and April 1919, when the unemployment rose. Second, thereconstruction boom persisted just one year from April 1919 to April 1920, during which the
16 According to Howson and Winch (1977, 59–60), L. Robbins and H. Henderson, too, pointed to the wage

rigidity at the Economic Advisory Council in 1930.

11

25

unemployment by month

20

15

10

5

0
1919/01

1920/01

1921/01

1922/01

1923/01

1924/01

1925/01

Fig. 2statistics show unemployment fell. Third, the rather prolonged slump, which started from
April 1920, is characterized with the unprecedented upsurge in unemployment. In June 1921
the rate of unemployment, aggravated further by the great strike in the coalmine, went beyond
the mark of 20 per cent. The great slump, Pigou asserts, continued around two years and ahalf till the end of 1922. Fourth and lastly, the downward momentum ran out of steam in
the end of 1922, leaving the economy in stagnancy. This stagnant state of economy, Pigou
supposes, extended beyond the period under discussion and lasted till “the Wall Street crashof 1929 heralded a second and greater Slump” (Pigou, 1947, 7).
Why did the slump starting from April 1920 build such momentum? Pigou’s answer isbifurcated into (1) the real and (2) the monetary causes. The real causes he points to includes(1) the fall of aggregate demand as the restoration demand quieted down, and (2) the depressedexport of Britain, which has been discussed above. By virtue of these real causes the aggregate
demand for labor would have to be somewhat contracted after the restoration boom. Moreessential in spurring the slump, however, were the monetary causes.
Pigou, who has criticized Hawtrey for his excessive reliance on the monetary phenomena
and for assuming the invalidity of public works as discussed in 3.2, in Aspects of British
Economic History criticizes him and emphasizes that purely monetary causes alone cannot
directly turn the business ﬂuctuation. Nevertheless he acknowleges that monetary causes arecapable of accelerating the ﬂuctuations much further than real causes alone are capable. He
depicts the process through which the government at that time threw the economy into chaosby committing to the restoration of the pre-war parity, the “sacrosanct” £1 = $4.86 (Pigou,
1947, 145–51).17 After World War I it did not seem within the range of practicable policy
for Britain to ﬁx the exchange rate to the pre-war parity because of the relative rise in theprices in Britain relative to those in the United States. Consequently the British government
oﬃcially prohibited the gold export, which had been refrained from voluntarily during the war.
When the restoration boom came soon, the Bank of England, now relieved from the duty of
17 (Garside, 1990, ch. 5) laid out the almost parallel explanation on the monetary circumstances in post-war

Britain.

12

maintaining the gold reserve, failed to swiftly respond to the price rise, resulting in the intense
price rise in the Boom year by around 40 per cent. After the turn of business ﬂuctuationin April 1920 there was in turn the sharp decline of prices. Yet the Bank of England didn’t
respond to the price fall. This second inaction of it was not a mistake, but a deliberate policy
with the aim which must be pursued even at the cost of the short-run stabilization.
Though in March 1919 the British Government deliberately broke that link, it only
did so with the ﬁrm intention of forging it again in the near future. Its avowed policy
was to re-establish our country on a gold basis at the pre-war parity as soon as thatshould prove practicable. This policy, which at the time was endorsed by nearly all
persons of authority, dominated the outlook of the Treasury and the Bank of Englandover the whole of our period, until in April 1925 it was ﬁnally carried into eﬀect. . .
. A necessary preliminary to the restoration of the Gold Standard was to bring theexchange back to the neighbourhood of par. When it began to run away, measures had
to be taken to arrest it; when it tended to stand still, further measures to improve it.
These measures took the form of operations on the discount rate and Bank dealings insecurities aimed at reducing the English, relatively to the American, price level. (Pigou,
1947, 148)
There were two reasons why Britain had to accept the extensive fall of prices. First theprice rise in the Boom year in Britain was also large relatively to the price movement in the
United States, leading to the depreciation of the sterling by 16 per cent in that year, thatis, from $4.65 to $3.91 to the pound. Thus in April 1920 the aimed parity was substantially
far from the current rate of exchange and the signiﬁcant relative fall in the British prices
would be needed. Second, around the same time as the downturn of the British economy theUnited States economy also saw its downturn. Yet in the United States the newly-formed
Federal Reserve system failed to eﬀectively act in response, Pigou asserts, because it had not
realized the cumulative eﬀect of deﬂation and the working of the interest rate (Pigou, 1947,196).18 Thus, in spite of the price fall, the rate of interest had not been lowered in the UnitedStates for a year, neither had it been in Britain, which had to reduce its prices ahead of theUnited States. As a result the British prices fell sharply, yet with the beneﬁt of which thesterling came back nearly to the prewar parity against the dollar by the end of 1922. The
exchange rate being more or less stable from that point of time, the rate of interest was kept
low. In July 1924, when “the goal of a restored Gold Standard was in sight” (Pigou, 1947,151), however, the Bank of England take the tightening measure to slightly raise the market
rate of interest. In the same month the rate of unemployment turned upward. To sum up,
the British government, while attaining the original goal of restoring the gold standard, by
the same process gave birth to the violent movement of prices and put its economy into thetremendous disorder.
Thus Pigou realizes that what enlarged the unemployment, aside from initiating the turn,in the post-war period was the purely monetary cause of the sharp deﬂation. Therefore, it
was the unemployment thus enlarged before the restoration of the gold standard that, Pigou
emphasized in the 1927 article, the wage rigidity prevented from declining at all. As is clear
from what has been seen, however, the cause for the enlargement of unemployment was byno means unrelated to the gold standard; on the contrary it was the deliberate credit crunchby the government in order to restore the gold standard. The pressure of deﬂation persisted,
18 According to Wheelock (1991, 14–17), the Federal Reserve system was formed just before World War I.

Although it came to play an active role in stabilizing the economy with the use of open market operationfrom around 1923, it did not until then.

13

of course, after the restoration in 1925. Through the latter half of the 1920s, according to(Clarke, 1996, ch. 4), the Bank rate was held around 5 per cent; the wholesale prices declinedby 17 per cent, and the cost of living by 6 per cent.Nonetheless, “few had the nerve”, writes
one historian, “even to consider voluntarily breaking with gold” (Garside, 1990, 132). Winch(1969, 137–8), too, notes that in the Macmillan Committee no one including Keynes, except
Ernest Bevin, stood up for abandonment of the gold standard. The reason why they objected
the abandonment was that “the earnings of the City depended on international monetarystability; and that the export trade was likely to be damaged by ﬂuctuating exchanges” (ibid.).
In addition the gold standard on the prewar parity seems to have had the symbolic signiﬁcanceamong the major industrialized countries that each of them restrict itself from the competitive
depreciation of currency. Let us recollect the quote from Pigou’s IF : “Economic analysis canprovide data for statesmen; butthe attitude of public opinion and the current political anddiplomatic situation are dominant factors in determining what, on the whole, it is best to do[as regards the international monetary system]” (Pigou, 1927a, 305). His economic analysis
with the domestic stability has clearly suggested that it be the best to abandon the gold
standard and restrict the price fall. This view of his wasn’t made less important so much as
more important and more urgent by the realization of the problem of wage rigidity particular
to the postwar economy.19
It was not a coincidence that Pigou argued for the cheap money policy in 1933 when Britain
had gotten oﬀ the gold standard. Pigou, as mentioned above, laid out the policy advice
in Times in 1933. There he proposes such monetary expansion measures as a reduction in
the rate of interest and sinking fund payments; and he praises the conversion in 1932 of the
War Loan into lower rate for having “brought home to the minds of lenders the fact thatthe day of high rates of interest on long-term loans has passed” (Pigou, 1933a, 14). These
measures had been impossible to apply under the ﬁxed exchange rate of the gold standard.
That said, these expansion measure still had substantial risks: chances were that they would
cause destabilization in the currency market, which might lead to the sudden depreciation of
the sterling and the capital ﬂight from Britain. Pigou acknowledges, therefore, that it would
be the better policy to postpone the decisive action until she could enlist the coordinationfrom the United States. Despite these risks Britain, he maintains, have to do something byherself under the situation in which unemployment exceeded three million.20 Thus Pigou’s
advocacy for the monetary expansion should be seen as pleading that the British government
take advantage of the policy discretion enlarged by the withdrawal from the gold standard.

5 Conclusion
We have seen Pigou’s analysis of unemployment from the viewpoint of its relation to his
theory of industrial ﬂuctuations. In his system on industrial ﬂuctuations Pigou divides thecauses of business ﬂuctuations under the following three headings: (1) real, (2) psychological,
19 Pigou

supported the restoration of the gold standard at the Cunliﬀe Committee in 1918 and the
Chamberlain-Bradbury Committee in 1924. Probably at that point of time he counted on the eﬀect
of wage adjustment. According to his own estimate of the elasticity of aggregate demand for labor withregard to money wages in Theory of Unemployment (1933), to reduce 5 per cent of unemployment would
require 3.33 per cent of wage reduction. There seems to have existed, according to Mitchell (1962, 344),
the decline of wages of such order.
20 Britain maintained the historically low level of Bank rate from 1932 through the thirties. In the meantime
the rate of unemployment, though always above 10 per cent, crawled back from extremely high level of1931 to the pre-1929 level; the aggregate production rose by 45 per cent. Cf. Cairncross (1995, 65) andGarside (1990, 134–9).

14

and (3) monetary causes. These three kinds of causes, he asserts, aﬀect one another to initiate
and cumulatively strengthen the pressure of either direction. Among the possible remedies
what intrigues Pigou most is the price stabilization and the monetary policy as an eﬀective
measure to realize it; he, on the other hand, placed much less emphasis on wage adjustment.
When dealing with the economy after World War I, Pigou adds to the system of businessﬂuctuation a new element, that is, the problem of wage rigidity. Before the war the slow but
steady wage adjustment was forthcoming when unemployment rose; but after the war, despite
the existence of mass unemployment, the average rate of wage was held rigid as the statistics
actually show. Pigou ascribes this change to the following facts: (1) that the expansion ofstate unemployment insurance after the war, he believes, had changed the balance of bargaining positions between employers and unions, and (2) that the structural diﬀerential between
industries which prevailed after the war prevented the average rate of wage from declining.
Though it was quite natural for a contemporary economist to point to this new phenomenon of
wage rigidity, it requires some explanation that Pigou didn’t pay attention to the substantial
fall in prices in the same period.
In Britain in the twenties under the gold standard, the rate of interest had to be held highin order to attract the short-term foreign deposits in Britain so she can maintain the prewar
rate of exchange; and this consisted in the pressure of deﬂation in the period. As regards
the gold standard Pigou in his Industrial Fluctuations (1927) was concerned with its possible
conﬂict with the domestic stabilization; he, in the meantime, avoided an unambiguous policy
proposal because of the actual complexities involving the gold standard such as the conﬁdencein currency. As shown by this cautious attitude of Pigou’s, the gold standard seemed to beunchallengeable to the contemporaries. Putting these together we can safely say that for
Pigou the wage rigidity in postwar Britain had a signiﬁcance in suggesting that, aside fromthe large-scale public works which political circumstances would not permit, the only eﬀective
measure against unemployment, namely wage adjustment, would no longer be counted on.
When Britain depreciated her currency in 1931, the situations had changed; and in 1933 Pigou
proposed that she take advantage of these situations and continue to apply credit expansion
policy. From what has been said we can conclude that Pigou consistently recognizes theimportance of price stabilization and, as an eﬀective measure, of monetary policy for the sakeof minimizing the amplitude of industrial ﬂuctuations and predicaments of workers due tothem.

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