The General Theory of Employment, Interest, and Money

reduction 
relatively to money-wages abroad
when both are reduced to a common unit, it is evident that the 
change will be favourable to investment, since it will tend to increase the balance of trade. This 
assumes, of course, that the advantage is not offset by a change in tariffs, quotas, etc. The greater 
strength of the traditional belief in the efficacy of a reduction in money-wages as a means of 
increasing employment in Great Britain, as compared with the United States, is probably 
attributable to the latter being, comparatively with ourselves, a closed system. 
(3) In the case of an unclosed system, a reduction of money-wages, though it increases the 
favourable balance of trade, is likely to worsen the terms of trade. Thus there will be a reduction in 
real incomes, except in the case of the newly employed, which may tend to increase the propensity 
to consume. 
(4) If the reduction of money-wages is expected to be a 
reduction relatively to money-wages in the 
future
, the change will be favourable to investment, because as we have seen above, it will increase 
the marginal efficiency of capital; whilst for the same reason it may be favourable to consumption. 
If, on the other hand, the reduction leads to the expectation, or even to the serious possibility, of a 
further wage-reduction in prospect, it will have precisely the opposite effect. For it will diminish the 
marginal efficiency of capital and will lead to the postponement both of investment and of 
consumption. 
(5) The reduction in the wages-bill, accompanied by some reduction in prices and in money-
incomes generally, will diminish the need for cash for income and business purposes; and it will 
therefore reduce 
pro tanto
the schedule of liquidity-preference for the community as a whole. 
Cet. 
par
. this will reduce the rate of interest and thus prove favourable to investment. In this case, 
however, the effect of expectation concerning the future will be of an opposite tendency to those 
just considered under (4). For, if wages and prices are expected to rise again later on, the favourable 
reaction will be much less pronounced in the case of long-term loans than in that of short-term 
loans. If, moreover, the reduction in wages disturbs political confidence by causing popular 
discontent, the increase in liquidity-preference due to this cause may more than offset the release of 
cash from the active circulation. 
(6) Since a special reduction of money-wages is always advantageous to an individual entrepreneur 
or industry, a general reduction (though its actual effects are different) may also produce an 
optimistic tone in the minds of entrepreneurs, which may break through a vicious circle of unduly 
pessimistic estimates of the marginal efficiency of capital and set things moving again on a more 

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normal basis of expectation. On the other hand, if the workers make the same mistake as their 
employers about the effects of a general reduction, labour troubles may offset this favourable factor; 
apart from which, since there is, as a rule, no means of securing a simultaneous and equal reduction 
of money-wages in all industries, it is in the interest of all workers to resist a reduction in their own 
particular case. In fact, a movement by employers to revise money-wage bargains downward will be 
much more strongly resisted than a gradual and automatic lowering of real wages as a result of 
rising prices. 
(7) On the other hand, the depressing influence on entrepreneurs of their greater burden of debt may 
partly offset any cheerful reactions from the reduction of wages. Indeed if the fall of wages and 
prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach 
the point of insolvency,—with severely adverse effects on investment. Moreover the effect of the 
lower price-level on the real burden of the national debt and hence on taxation is likely to prove 
very adverse to business confidence. 
This is not a complete catalogue of all the possible reactions of wage reductions in the complex real 
world. But the above cover, I think, those which are usually the most important. 
If, therefore, we restrict our argument to the case of a closed system, and assume that there is 
nothing to be hoped, but if anything the contrary, from the repercussions of the new distribution of 
real incomes on the community's propensity to spend, it follows that we must base any hopes of 
favourable results to employment from a reduction in money-wages mainly on an improvement in 
investment due either to an increased marginal efficiency of capital under (4) or a decreased rate of 
interest under (5). Let us consider these two possibilities in further detail. 
The contingency, which is favourable to an increase in the marginal efficiency of capital, is that in 
which money-wages are believed to have touched bottom, so that further changes are expected to be 
in the upward direction. The most unfavourable contingency is that in which money-wages are 
slowly sagging downwards and each reduction in wages serves to diminish confidence in the 
prospective maintenance of wages. When we enter on a period of weakening effective demand, a 
sudden large reduction of money-wages to a level so low that no one believes in its indefinite 
continuance would be the event most favourable to a strengthening of effective demand. But this 
could only be accomplished by administrative decree and is scarcely practical politics under a 
system of free wage-bargaining. On the other hand, it would be much better that wages should be 
rigidly fixed and deemed incapable of material changes, than that depressions should be 
accompanied by a gradual downward tendency of money-wages, a further moderate wage reduction 
being expected to signalise each increase of; say, 1 per cent in the amount of unemployment. For 
example, the effect of an expectation that wages are going to sag by, say, 2 per cent in the coming 
year will be roughly equivalent to the effect of a rise of 2 per cent in the amount of interest payable 
for the same period. The same observations apply