Pump Priming

This was the way Hansen was thinking when Samuelson met him. Hansen recognized Keynes as a reformer with an eclectic attitude toward eco­nomic theory, but he remained critical. An idea of the view of Keynes that Samuelson might have learned from Hansen is given in a lecture he gave in John Williams’s course on money and banking in May 1938, in which he discussed the General Theory.

The charge that Keynes’s arguments lacked novelty was also applied to the notion that the level of employment depended on the rate of interest, along with prospective profits and the marginal propensity to consume. Incomes would fall if saving was not matched by sufficient investment. According to Tobin’s notes,

In rich community, marginal efficiency of capital low; propensity to consume low; but rate of interest can’t keep falling because of liquidity­preference. Hence there is not adequate volume of new investment to maintain full employment.⁹

This echoed, very precisely, the interpretation of the General Theory offered in his first review. Hansen then went on to say that Keynes emphasized the rate of interest, whereas Spiethoff thought it was more important to consider factors affecting the prospective rate of profit: expanding markets, increasing population, inventions, and giant industries.

This ambiguous attitude—interested and sympathetic, finding impor­tant insights that could be integrated into existing thinking, including Schumpeter's view of economic development—may have been what attracted Samuelson to Hansen. Though Samuelson had joined in debates about the General Theory with his fellow students, he resisted its message. Brought close to his teachers Schumpeter, Leontief, and Wilson by his mathematical skills, he sided with their criticisms of Keynes. He had successfully used mathemat­ics to cut through the complex and imprecise verbal reasoning he encountered in consumer theory, and he was beginning to do the same with the theory of international trade, but the business cycle theory taught by Schumpeter and Haberler provided no such opportunities. Hansen provided a middle path, offering theories that took account of the arguments Schumpeter was mak­ing about the importance of technological progress while acknowledging the technical criticisms that Leontief was leveling against the General Theory. But at the same time, Hansen had accepted many of the points about effec­tive demand and the multiplier that his fellow students were learning from Keynes's book. He was eclectic and open-minded. Just as important, though Hansen was a “literary” economist, he had come around to the view that, even though his own talents in this direction were limited, mathematical methods might have something important to contribute.

Clearly, Samuelson and Hansen got on very well, and perhaps their com­mon background as children of immigrants contributed to that. In addition, it seems a near certainty that Wilson, who believed that Samuelson's pros­pects as a narrow mathematical economist were very limited, was encourag­ing him to enlarge his portfolio of skills to include more general economics. Working on the problem of the business cycle—the most important problem facing the United States, especially as recovery aborted in the summer of 1937—provided just such an opportunity. Though he continued to work on mathematical economics, discussing his papers with Wilson and Haberler, Samuelson began working with Hansen on the problem of the business cycle.

In December 1938, in Detroit, Hansen delivered his presidential address to the American Economic Association, titled “Economic Progress and Declining Population Growth.”¹¹ Its central point was that population growth was declining and that this would lead to a large fall in investment unless there was a rise in technical progress. “We are,” he argued, “rapidly entering a world in which we must fall back upon a more rapid advance of technology than in the past if we are to find private investment opportuni­ties adequate to maintain full employment.”¹² He also laid great stress on the accelerator, for what mattered was not the level of economic activity but its growth rate. It would be possible to compensate for a decline in private investment by increasing public investment “in human and natural resources and in consumers’ capital goods of a collective character,” but such compen­sation could be no more than partial. If government spending were taken too far, it might alter the cost structure so as to prevent the achievement of full employment.¹³ There were thus difficult choices, with which economists would have to grapple for a long time.

One option was to refrain from expanding the level of demand so that “the recuperative forces to which we have long been accustomed will, in the absence of political interference, re-assert themselves.”¹⁴ The alternative was to use increases in government expenditure to achieve full employment.

Two days later, Samuelson presented his paper, “The Theory of Pump­Priming Reexamined,” which formed part of a round-table discussion on “The Workability of Compensatory Devices.”¹⁵ This was not one of the ses­sions that Hansen had organized to complement his presidential address, though given the similarity of the topics, it could easily have been. Paul Ellsworth, from the University of Cincinnati, spoke on the use of monetary policy to counteract depressions. He recommended an easy money policy on the grounds that even if it did not work, it was unlikely to be harmful. The final speaker was Emile Despres. Like Samuelson, he came from the Midwest, born in Chicago and having graduated from Harvard in 1930. However, rather than stay on for graduate work, he went straight to the Federal Reserve Bank of New York, where he worked on short-term capital flows and U.S. monetary policy. Through the 1930s he had argued that expansionary policy would have helped mitigate the Depression; and in 1937, he had resumed his connection with Harvard as a consultant to the Littauer Center. Despres asked whether measures to tax hoards of money would be effective in stabiliz­ing demand or in countering long-term stagnation. After reviewing many of the technical issues, he concluded that, while it was an interesting theoretical idea, it would probably not be very effective.

Samuelson’s paper, sandwiched between the papers by Ellsworth and Despres, tackled the problem of fiscal policy. Some types of water pump work only when they are full of water, which means that they need to be primed—filled with water—before they can be used. “Pump priming” there­fore refers to the idea that, in a depression, it is sufficient for the government to have a burst of spending to get the economy going and then, once recovery has begun, leave further expansion to private initiative. It is possible to dis­cern Keynesian ideas in Samuelson’s paper, as when he spoke about invest­ment as being volatile and insensitive to changes in the rate of interest, and when he argued that the rate of interest could not equilibrate the demand for employment with the supply. However, at the point where he cited Keynes explicitly, Samuelson was critical: the instantaneous multiplier used in the General Theory “represented] a backward step from the more general analysis of the lagged effects through time.”¹⁶ Though conceding the usefulness of the Keynesian multiplier, he emphasized complications that Keynes had not taken into account, including the accelerator. This critical use of selected Keynesian ideas was entirely consistent with what Hansen was doing.

Samuelson made it clear that he rejected the quantity theory of money, for he described as “completely fruitless” the attempt to analyze the effects of a rise in government spending through the velocity of circulation. The multiplier was more useful. However, this should not be read as a pro­Keynesian position, because opposition to the quantity theory was not an exclusively Keynesian stance. Hansen, like many other American business cycle theorists, had been just as dismissive as Keynes of the quantity theory. Samuelson’s remark that “an insufficiency of [private net investment] would make long-term deficit spending mandatory” was Hansen’s position. The published abstract does not make Samuelson’s conclusions clear, and the con­ference proceedings contain no record of any discussion of his paper; perhaps the reason is that he was providing a technical review of the issues without offering any conclusions sufficiently controversial to provoke a response from the audience.