Hansen as a Business Cycle Theorist

Alvin Harvey Hansen (1887—1975) arrived in September 1937 to join the Harvard Economics department, in which the younger and older generations were taking opposite positions on Keynes's General Theory.

Hansen came to Harvard as the Lucius N. Littauer Chair of Political Economy, joining the newly established Graduate School of Public Administration, which became known simply as the Littauer Center.³² He was recruited by John Williams, the school's first Dean, though with the approval of the Economics Department in which he would spend part of his time.³³ Hansen's duties at the center included running its seminar on fiscal policy.³⁴ Their hopes for the center are reflected in Williams having approached Henry Morgenthau (U.S.

There were very significant differences between Hansen and Samuelson— a Protestant upbringing in a farming community versus a secular Jewish family life in industrial Gary (although Samuelson had spent part of his very early years on a farm), as well as Hansen's education at a small-town college against Samuelson's at the metropolitan University of Chicago with its array of internationally known stars. But there were also significant sim­ilarities in their backgrounds. Coming from immigrant families, they were outsiders to the New England academic establishment, with its network of social connections, and lacked the extensive international connections of Leontief, Schumpeter, and Haberler. Both had a liberal arts education, and both had at one time focused on the humanities—in Hansen's case, it was literature and in Samuelson's, literature and history—before turning to economics. In Minnesota, Hansen and his family lived in modest cir­cumstances in a working-class neighborhood, and this may well have had echoes in the decision made by Paul and Marion, when it became clear that

g. See also chapter 8 this volume.

Paul's textbook would significantly raise their wealth, to live on his univer­sity salary so that their lifestyle would not be out of line with that of their colleagues. Samuelson clearly admired Hansen's modesty, and he became a lifelong friend of Hansen and his family—to the extent that Hansen's daughters remembered “Sammy,” as they called him, always being around at their home.

Hansen was, from the start of his academic career, a specialist in business cycles. His dissertation, Cycles of Prosperity and Depression (1921), focused on a single cycle: the dramatic crash of 1907. Using monthly data, he engaged in a type of statistical analysis that would have been appreciated by the economists, including Crum and Frickey, who were involved in the Harvard Economic Service. He decomposed data into seasonal, cyclical, and trend components, and used correlations to establish the place of different series in the cycle.^h What were the relations between the groups of time series relating to investment, industry, and banking, and what were the relations between cycles in Britain, the United States, and Germany? Samuelson was right to say that this was a statistical survey in the spirit of Mitchell.³⁶ However, it involved more than “naive Baconian empiricism,”³⁷ for Hansen used his data on the relationships between movements in credit, prices, and outputs to evaluate alternative theories of the cycle.³⁸

Starting from the presupposition characteristic of twentieth-century busi­ness cycle theory—that business should be seen “as a dynamic changing thing which must be studied as a process,” rather than as a static condition of prosper­ity interrupted by crises—he reached the conclusion that cycles of prosperity and depression were driven by money and credit.³⁹ Significantly, in view of his later work, he sought to explain both cycles and long period trends, and he considered the under-consumptionist J. A. Hobson to have effectively rebutted the charge that over-production was impossible.⁴⁰ He used the accelerator, to which Haberler had attached such importance, to argue the fact that though fluctuations in investment were much greater than fluctuations in consumption, that did not prove the ultimate cause of a crisis lay with investment; a slowing down in the growth of consumption could be sufficient to explain a large fall in investment.

During the 1920s, as Hansen established his reputation as one of the country's leading business cycle theorists, his work remained, like his the­sis, squarely in the institutionalist tradition. However, his views changed in

h. Persons (see chapter 6 this volume) was one of the economists with whose results he compared his own.

important ways.⁴¹ Turning to the ideas of Albert Aftalion, Arthur Spiethoff, and other continental European writers, he began to see fluctuations in investment driven by population changes and waves of innovations as the root cause of the cycle. He still thought monetary factors played a role, but they merely served to magnify other forces, rather than being an independent factor.

One element in this was Aftalion's theory that the price level is deter­mined by the level of money income in relation to the quantity of goods and services being produced. The important feature of this was that it focused on flows of income rather than on the stock of money. The other element was the idea, taken from Spiethoff, that there were certain investment opportunities available, and once these were taken up, investment would fall off, causing a downturn. The price system played a dynamic role, assisting the movement of resources into sectors with greater investment opportunities. A free enter­prise system tended toward full employment because price flexibility encour­aged a healthy level of investment and a high level of spending. However, though there was that tendency toward full employment, the business cycle was an inevitable feature of a dynamic, growing economy with rapid techno­logical change. Only if the economy matured and accumulation slowed down would the cycle become a thing of the past.

It was in the course of expounding these ideas that, as Samuelson noted, Hansen expressed a different view on Say's Law, arguing that it was impos­sible to have unemployment caused by a shortage of purchasing power.⁴² Perhaps part of the explanation lay in the fact that Business Cycle Theory (1927), the book in which Hansen expressed this idea, had originally been written for a competition to find the best critique of the work of two under- consumptionists, William Foster and Waddill Catchings.⁴³

Just as Hansen's empirical methods and the theoretical resources on which he drew fitted well with the ideas of those who were to invite him to Harvard, so, too, did his policy conclusions. Because movements of resources from one sector to another were essential in a dynamic economy, and because the price mechanism served to bring about such changes, any policy that pre­vented price flexibility was liable to impede progress.

These views conditioned Hansen's response to the Great Depression. It was a particularly deep depression, because it was the result of large mon­etary and technological shocks happening together.⁴⁵ Recovery required innovation and technological advance that would lower costs, raise profit­ability, and stimulate investment. If markets were left to themselves, recov­ery would eventually come. He thus opposed Roosevelt's National Recovery Administration, which, by allowing collusion, enabled certain sectors to iso­late themselves from market pressures. However, the depth of the Depression meant that there was a problem, for complete price flexibility would push the burden of adjustment onto vulnerable sections of society. There was, there­fore, a case for using monetary policy to prevent prices from falling, even if the end result was some inflation. Government investment posed a similar dilemma: it could lower unemployment, but the cost would be that it would take resources away from the private investments necessary for innovation and progress. A measure that could work, along with monetary policy, was unemployment insurance, for this would help stabilize purchasing power and prevent the Depression from worsening.

In the depths of the Depression, surveying business cycle theory in Econometrica, Hansen chose to focus on what he called “investment and sav­ings” analysis, represented by Hayek and Keynes. He was critical of both Hayek's view that “neutral money” would be sufficient to tame the cycle and Keynes's excessive faith in “the occult powers of counter [cyclical] mon­etary adjustments.”⁴⁶ Though it worked with a peculiar definition of income, he saw Keynes's theory as in essence the same as Aftalion's, and his main criticism was the way he used it: “as a kind of slot machine into which one may insert a question and draw out the correct answer.”⁴⁷ Hansen clearly believed that increased government spending could improve the situation, but it needed to be undertaken very carefully, because if the government issued bonds to finance investment, it weakened confidence and thereby dis­couraged private investment.

Though Hansen was still seeing the relationship between prices and costs as the crucial problem, he attached great importance to what he termed “the flow of purchasing power.” He wrote of “three faucets” though which purchasing power could enter the economy: business spending (con­struction and investment); consumer spending of hoards of money; and government spending.⁴⁹ He even recognized that if new funds were sent through any of these faucets, the effect on total income was likely to be higher than the amount injected. Though still talking in terms of the velocity of the circulation of money, he was clearly thinking in terms of the multiplier, worked out by Keynes's colleague, Richard Kahn, a few years earlier. However, though Hansen thought interest rates were important in influencing investment, this mechanism was limited because interest pay­ments were only one component of business costs, and it was reductions in costs that were necessary to restore business confidence. Increasing the investment (the business faucet) required both monetary measures and cost reductions.

The most significant feature of Hansen's thinking at this point is perhaps that, despite his emphasis on monetary policy and on cost reductions, he recognized that the flow of purchasing power was crucial, and that “busi­ness enterprises cannot be responsible for the maintenance of purchasing power.”⁵⁰ The main responsibility for preventing a collapse in purchasing power lay with central banks, but there might be times when they needed help from government. To this end he proposed various measures to establish funds that could be used to increase the flow of funds through the consumers' and government faucets.

It may be that we have reached a stage in the development of modern industry in which free enterprise and the price system cannot continue to function unless we develop new institutions, in cooperation with the central banks, to safeguard the maintenance of purchasing power as a whole. Without this, in a state of general collapse of producer con­fidence, each entrepreneur in self-defense contracts his operations—a policy which, if pursued by all, is suicidal to the general economy.⁵¹

The difficulty, as Hansen saw it, was to find a way to ensure that business as a whole did not experience losses without interfering with the risks facing individual businessmen.

Two years later, Hansen provided another appraisal of the multiplier, this time using the word and attributing it to Kahn and Keynes. He clearly accepted the idea, though he doubted that the proportion of income saved would be constant, calling into question their simple formula.⁵²⁴ However, he believed that it was important not to lose track of the important techno­logical forces contributing to economic progress, to which Schumpeter had

i. His point was that if the proportion of income saved were variable, calculating the multiplier as the sum of an infinite series was more difficult. drawn attention. He also made it clear that part of his difference with Kahn and Keynes concerned his attitude toward mathematical models, and that he was becoming more receptive to such work.

[T]here have been at least three developments with respect to the mathematical attack [on the problem of the business cycle], which should lead the “literary” business-cycle theorist to preserve an open mind as to its value. First, the devising and improvement of mathe­matical methodology have already progressed so that somewhat closer approaches to reality are now possible than was true earlier. Secondly, this new approach necessitates a rigorous statement of the postulates of the system and so leads to a reexamination of fundamental definitions and concepts which may have been inexactly stated or slurred over by the “literary” theorist. And, thirdly, the mathematical method, by its requirement of stating in definite form the assumed or agreed-on relationships among the variables, has pointed out a very specific lack of factual knowledge with respect to many fundamental relationships. With these results attained, we may await, at least without appre­ciable skepticism, the products which may flow from this newer mode of attack.⁵³

Samuelson would have endorsed wholeheartedly the second and third of those propositions.

By the time he came to Harvard, Hansen had accepted some of the ideas usually associated with Keynes, but this was hardly a conversion, for he was gradually integrating Keynesian ideas into a theory of the business cycle that had been evolving since the beginning of the 1920s. He might at times sound Keynesian, as when he used the analogy of the faucets through which spend­ing flowed into the economy, and the need to maintain aggregate purchasing power, but he was still talking about it in language taken from Aftalion; he insisted on seeing the cycle as an aspect of longer-run developments to which technological developments were central. These were to be important for Samuelson when he began to work on these problems.