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A TREATISE ON MONEY

BK. IV

change in the relative attractions of lending at homeand abroad.

The neglect to allow for the effect of changes in theterms of trade is, perhaps, the most unsatisfactorycharacteristic of Prof. Cassel’s Purchasing Power Parity Theory of the Foreign Exchanges. For this not onlyupsets the validity of his conclusions over the longperiod, but renders them even more deceptive overthe short period, whenever the short period is char-acterised by a sharp change in the attractions offoreign lending.

2. Second, the Characteristics of the Transition .—We have seen that the international-rate cannot returnto equality with the natural-rate in both countriesuntil an appropriate change has taken place in therelative rates of money-earnings in the two countries.But this relative change could come about either byone country bearing the whole brunt of change bymodifying its own absolute rate, leaving the absoluterate of the other country unchanged, or by the twosharing the burden of change.

If each of the countries is determined to keep aquantity of gold reserves, which bears a constant pro-portion to the level of its money-income, the share ofchange to be borne by each is predetermined, the majorpart of the change being borne by the smaller of thetwo countries. But if the countries are prepared toallow some variation in this proportion (and thechanges which actually occur as the result of increasedforeign investment would generally involve only asmall change in the proportion of gold reserves tototal income, even if no gold at all moves from onecountry to the other), then the proportionate sharingbetween the two countries of the burden of the changein absolute rates of earnings is indeterminate, and de-pends on the course of events and on the policies of thetwo central banks during the period of transition.

To illustrate this let us take the extreme cases.