The interwar period

World War I was a major macroeconomic shock for all the belligerent countries, particularly pronounced in the case of France. The human cost was very heavy: of

DOI: 10.4324/9780429202407-16 the 7.9 million men who were mobilised, 1.4 million died and 4.3 million were wounded.

Methodological debates

Debates on economic methodology were also revived in the interwar period, fol­lowing the contributions of Franςois Simiand (1873-1935) and Jacques Rueff (1896-1978). The idea that economics is a science, that its method is that of other sciences, gradually took hold among French economists. However, they drew dif­ferent conclusions.

In 1912, Simiand published La methode positive en sciences economiques, a collection of articles in which he rejected both traditional political economy, which he called abstract or pure, and historicism, which he equated with a mere descrip­tion of facts; to him, science must be developed on the basis of facts.^[265] His work “On wages, social evolution and money” (1932) is a remarkable illustration of his approach.

What is meant by unity of science? Sciences differ in their subject matter but their method is the same. John Stuart Mill had argued that economics, because experience is impossible, could only be an abstract science, based on the a priori method. Rueff rejected this argument because, although the economist, like many other scientists, could not conduct experiments, he certainly could make observa­tions. In contrast, Simiand viewed economics as an experimental science, which “aims at being based on facts and not on ideas; but [which] wants to go beyond the observation of facts and aims at establishing relations likely to explain these facts” (1932, I, x). Rueff considered economics as a rational science. The starting point of scientific reasoning is made up of axioms which are neither synthetic a priori judgements, nor experimental facts; they are conventions. From this it follows that experience or observation should not lead us to affirm that a theory is true or false. Thus, he applied to economics the statements made by Henri Poincare in La science et l'hypothese (1902), when analysing the various geometries.^[266] Therefore, for Rueff, there are several logically consistent price theories possible. The Wal­rasian theory appeared to him, however, more relevant to study an economy with privately-owned means of production than a theory of labour value; it would then be called Euclidean. But it could be that, in other circumstances, the labour theory of value would be more suitable and thus appear as Euclidean.

Later, in the introduction to his Theorie des phenomenes monetaires (1927), Rueff even considered political economy as a statistical science,^[267] using statistical data to develop his ideas, such as the rejection of quantitative theory.

Monetary issues

The attention of French-speaking economists has been focused on several mon­etary issues, to which they have made specific contributions. Thus, on the matter of exchange rates, Bertrand Nogaro (1880-1950) and Albert Aftalion (1874-1956) gave expectations a central role that hardly appeared in Rueff’s texts. Their frame­work of price analysis also differed: Charles Rist (1874-1955) followed the tra­ditional view that the value of money is determined by its supply and demand; Nogaro held to the idea that money prices are set in goods markets, while Aftalion developed a psychological theory of the value of money and exchange.

One significant contribution of the interwar period was Rueff’s reformulation of classical monetary theory. His starting point was Fisher’s transaction equation, which he interpreted as an identity. For the general price level to vary like the quan­tity of money, it is necessary that, for a given volume of transactions, the amount of bank deposits, M', varies along with the quantity of banknotes, M, while the velocities of the various means of payment, V and V', have to be constant. Rueff (1927) showed however that this did not actually happen.

Other important contributions were made to the theory of exchange rates. In his article titled “Le change, phenomene naturel”, Rueff relied on the theory of purchasing power parity (1922b). In his 1927 book La theorie des phenomenes monetaires, he replaced it with his theory of price disparities, which generalises the gold points mechanism to all commodities: for each good, a price can be defined at which it will be exported and a price at which it will be imported. Rueff showed that, in all the cases he studied, prices remained within the fluctuation zone he had defined.

Rueff relied on this analysis to explore the issue of war reparations. Keynes posed the problem in a very specific way, arguing that the Germans would have to pay reparations twice, as it were:

The expenditure of the German people must be reduced, not only by the amount of the reparation-taxes which they must pay out of their earnings, but also by a reduction in their gold-rate of earnings below what they would otherwise be.

(Keynes 1929, 4)

Rueff replied that the depreciation of the mark would reduce the gold value of German income, but that it did not matter because the prices of German prod­ucts would fall in the same proportion, leaving the purchasing power of Germans unchanged. So there is no problem of transfer, it is sufficient that the Germans pay taxes so that the State can pay the reparations.

Nogaro developed an original analysis of price determination: to him, the price of goods is not determined on the money market. His central idea was that “except in the exchange of one currency for another, the instrument of exchange is not demanded; and only exchange relations between goods and money exist” (1924, 161). The effects of a variation in the quantity of money on the commodity sup­ply and demand depend on how money is introduced into the economy. When a government finances its expenditure through money creation, it directly or indi­rectly spreads income, increases spending and causes prices to rise. But if money is issued in return for credits granted by banks to companies, demand is certainly increased, but so is the supply, since the credits allow companies to expand their production; as a result, prices would initially rise and then fall (Nogaro 1924, 168).

As for the exchange rate variations, he argued that they do not result from price variations but from speculation: when agents anticipate a depreciation of domestic currency, they buy foreign currencies, causing the former to depreci­ate. While the theory of purchasing power parity described a causality running from money to prices, and from prices to exchange rate, Nogaro considered that this causality inverted in the case of a crisis (1924, 216). Depreciation, he explained, does not necessarily improve the current account balance, since it does not guarantee that a country will be able to import less, in terms of volume; instead, it imports at a higher cost, resulting in increased prices of domestic products.

Aftalion criticised Nogaro’s analysis: to the former, depreciation of the currency is not always followed by a decline in the supply of goods, which the latter believed to be the case. A depreciation will increase prices only if it leads to an increase in demand and therefore an increase in income. Aftalion also introduced the role of expectations in the analysis of money: if an individual anticipates a fall in prices, he will postpone his purchases, thus causing a fall in prices, and vice versa.

The last important contribution to monetary analysis in the interwar period is probably Rist’s non-Ricardian interpretation of quantity theory. As a supporter of the quantity theory of money, Rist emphasised the importance of changes in the gold stock in explaining long-term price movements; but he rejected Ricardo’s interpretation and defended theses close to those of the Banking School. In par­ticular, he distinguished between inconvertible paper money, viewed as money, and bank notes convertible into gold, viewed as instruments of credit (Rist 1936). The issuance of paper money generates effective revenues, thus increasing the demand for products and raising prices, whereas an additional issuance of con­vertible notes is only an advance, which has a temporary effect on prices. Rist was a supporter of the gold standard, despite its shortcomings (1934): although price variations could be significant depending on the relative abundance of gold, he believed that it allowed for the regulation of international monetary relations between the major powers. Under the gold standard, central banks were used to adjusting the discount rate to maintain parity. But Marshall, Wicksell and many others went further and suggested that by changing the discount rate, it was pos­sible to influence prices. Obviously, Rist could not accept such an idea, since he believed that an issue of convertible banknotes would not affect prices. If changes in the discount rate are powerless to stabilise prices under the gold stand­ard, would they be more effective under another currency arrangement? Rist did not think so, since the influence of the bank rate under a paper money regime was small compared to the reactions caused by confidence and variations in the exchange rate.^[269]

Rational economics

The starting point of Jevons, Menger and Walras had been the analysis of individ­ual choice, while general equilibrium analyses had been Walras’ essential concern. The French economists returned to these two questions during the inter-war period, sometimes to complete the work of their predecessors, sometimes to propose new solutions. They then appeared as defenders of “economique rationnelle” (rational economics).

Rene Roy (1894-1977) - a graduate of Ecole Polytechnique - intended to con­struct aggregate demand functions (1930, 1933) based on Pareto’s law (1897, II, 304-5) and on the hypothesis of a hierarchy of needs: individuals seek to satisfy their least urgent needs only when their most pressing needs are fully satisfied. The demand functions thus obtained are decreasing; those concerning basic goods show an inflection point. The absolute value of the price elasticity is between 0 and 1. Roy evaluated it by studying the ‘natural experiments’ of changes in the prices of public services.

In Walras’ analysis, an individual who makes a choice does not take into account the reactions of others. Following Joseph Bertrand (1889), Emile Borel (1871-1956) challenged this hypothesis by analysing games where one’s gain depends not only on what the others do, but where the behaviour of an agent can reveal information that his adversaries can take advantage of (1921, 1923). Borel considered a two- player, A and B, zero-sum game. He wanted to determine if there is a method of play that would be better than the others, that is, that would give the player who adopts it a superiority over any player who does not. A and B have n ways of playing. Rather than always playing the same way, they assign a probability to these ways of playing. Since what A loses is what B wins, he chooses the probabilities so that B’s winnings, assuming he plays at his best, are minimal. B’s behaviour is assumed to be identical to A’s. Borel showed that, for n equal to 3, 5 and 7, these two limits were equal. Von Neumann^[270] demonstrated this proposition for the general case in 1928, and Ville exposed a simpler version of this theorem (1938). The merit of Borel is to have been the first to set the framework from which game theory was developed.

Important contributions to the analysis of equilibrium were also made. Franςois Divisia (1889-1964), first of all, raised the issue of ophelimity of money: how to explain that agents may wish to hold money at the end of each period, rather than buying commodities on the futures market? He proposed to consider a stationary equilibrium where the quantity of money held by an individual remains constant (1928, 411); relative prices, independent of the quantity of money, are determined in the real sector, while nominal prices are determined by introducing the circula­tory equation of money into the system. Thus, the classical dichotomy and the quantity theory of money work well in stationary states.

For his part, Robert Triffin (1911-1993) examined unresolved problems of monopolistic competition.^[271] He showed in his thesis (1940) that these difficulties stem from having been developed within the framework of partial equilibrium, which can logically only deal with pure competition and monopoly. However, to study monopolistic competition, one must reason in the framework of general equi­librium. The theoretical contribution of Triffin’s thesis was crucial, and the condi­tions in which it was written illustrated the changing relationship between national traditions on the eve of World War II.

Nevertheless, economists who promoted “rational economics” were not nec­essarily Walrasian. The Guillaume brothers^[272] epitomised this trend (1932, 1937): they criticised Walras for defining value as an essentially subjective and qualitative quantity. They constructed their “rational economics” by eliminating all subjec­tive elements so that value appears as a quantity that can be defined objectively and numerically. To do this, they relied on the value conservation principle. In their most basic model, they considered an economy where goods are not storable. Equilibrium is determined by writing two sets of equations. The first states that the quantity of each good produced is equal to the quantities of that good that are inputs into the production of other goods including the production of services, that is, the quantities of goods consumed by labour. The second postulates that the value of the product is equal to the value of inputs used to produce it. This homogeneous system makes it possible, if it has a solution, to calculate relative prices. However, they run into major difficulties when they try to introduce money and the banking system into their scheme. The point of this attempt is to show the possibility of constructing general equilibrium models based on the rational method that radi­cally differed from that of Walras.

Cyclical or permanent unemployment

Singular theories about the nature of unemployment also emerged during the inter­war period. In France, unemployment, which was poorly compensated, remained low until 1931. Yet it increased during the recessions of 1921 and 1927, but once these crises were over, full employment was quickly restored; unemployment was thus viewed as a cyclical phenomenon.

It used to be thought that during crises, prices fell faster than money wages and unemployment rose without it being clear whether this was due to rising real wages or falling output. During the crisis of 1921, a similar development was observed in England. But when prices stabilised, money wages remained stable while they should have continued to fall because of the high level of unemployment. Rueff emphasised this point: “It is very curious, and apparently contrary to all economic laws, that the level of wages could remain stable while the labour supply signifi­cantly exceeded the labour demand” (Rueff 1925, 435). He gave three reasons for this rigidity of money wages: the power of English trade unions, the generalisation of collective contracts and the policies of assistance to the unemployed. In 1931, the facts corroborated the analysis of unemployment Rueff had developed in 1925.

As in the previous period, a distinction can be made between temporary unem­ployment, which is a feature of cyclical crises, and unemployment which persists even though prices have stopped falling. This unemployment is, according to Rueff, characteristic of countries, such as England and Germany, where a relatively generous system of unemployment subsidies has been put in place. These facts form the basis of the thesis developed in his article “L’assurance chomage, cause du chomage permanent” (Unemployment insurance as the cause of permanent unemployment). The reference to the notion of cause gave rise to much debate. It is all the more surprising that Rueff appeared in some passages of his article to be more cautious in 1931 than in 1925. Observing that, in the past, “unemploy­ment has never varied without variations in the same direction in the wage-price ratio” (Rueff 1931, 219-20), he stressed that this does not imply the existence of a causal link between unemployment and real wages. How then can it be argued that unemployment insurance is the cause of permanent unemployment? It could just as easily be argued that unemployment benefit systems were created in response to high unemployment.^[273]

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