CHAPTER 13

THE “ MODUS OPERANDI ” OP BANK-RATE

(i) The Traditional Doctrine

Bank-rate does not appear explicitly as a factor inthe Fundamental Equation of Price. It cannot, there-fore, affect price-levels directly but only indirectlythrough its influence on one or more of the factorswhich do appear in the Fundamental Equation. Wemust not be satisfied, therefore, with any statementto the effect (e.g.) that an increase in bank-rate willcause price-levels to fall, unless it is explained to usat the same time by what intermediate action onthe factors in the Fundamental Equation the fall isbrought about.

In Chapter 11 I have anticipated very briefly thegeneral character of the solution which I shall offer.Bank-rate operates primarily on the second term ofthe Fundamental Equation. It is the instrument bywhich a disturbance is set up or equilibrium restoredbetween the rates of Saving and of Investment; forto raise it stimulates the one and retards the other,and conversely if it is reduced. This does not precludeit from affecting sooner or later the first term of theFundamental Equation, or from having secondaryeffects on other elements in the Fundamental Equa-tion, in particular on the quantity of bank-money,the velocities of circulation, and the proportion ofsavings-deposits.