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A TREATISE ON MONEY

BK. Ill

of efficiency-earnings (or effort-earnings) to rise or fall,as the case may be, to a point which allows the bank-ing system to establish a new position of equilibriumcompatible with the criteria by which this system isgoverned.

(ii.) The Rate op Interest, or Bank-rate

It is now evident in what manner changes in theBank-rate, or—more strictly—changes in the rate ofinterest, are capable of influencing the purchasingpower of money.

The attractiveness of investment depends on theprospective income which the entrepreneur anticipatesfrom current investment relatively to the rate of in-terest which he has to pay in order to be able to financeits production;—or, putting it the other way round,the value of capital-goods depends on the rate of in-terest at which the prospective income from them iscapitalised. That is to say, the higher ( e.g.) the rateof interest, the lower, other things being equal, willbe the value of capital-goods. Therefore, if the rateof interest rises, P' will tend to fall, which will lowerthe rate of profit on the production of capital-goods,which will be deterrent to new investment. Thus ahigh rate of interest will tend to diminish both P' andC, which stand respectively for the price-level andthe volume of output of capital-goods. The rate ofsaving, on the other hand, is stimulated by a highrate of interest and discouraged by a low rate. Itfollows that an increase in the rate of interest tends—other things being equal—to make the rate of invest-ment (whether measured by its value or by its cost) todecline relatively to the rate of saving, i.e. to move thesecond term of both Fundamental Equations in thenegative direction, so that the price-levels tend to fall.

Following Wicksell, it will be convenient to callthe rate of interest which would cause the second