The Theory of Money and Credit
2. Money and Interest
Variations in the ratio between the stock of money and the demand for money must ultimately exert an influence on the rate of interest also; but this occurs in a different way from that popularly imagined. There is no direct connection between the rate of interest and the amount of money held by the individuals who participate in the transactions of the market; there is only an indirect connection operating in a roundabout way through the displacements in the social distribution of income and wealth which occur as a consequence of variations in the objective exchange value of money.
A change in the ratio between the stock of money and the demand for money, and the consequent variations in the exchange ratio between money and other economic goods, can exert a direct influence on the rate of interest only when metallic money is employed and variations arise in the quantity of metal available for industrial purposes. The augmentation or diminution of the quantity of metal available for nonmonetary uses signifies an augmentation or diminution of the national subsistence fund and thus it influences the level of the rate of interest. It is hardly necessary to state that the practical significance of this phenomenon is quite trifling. We may, for example, imagine how small in comparison with the daily accumulation of capital was the increase in the subsistence fund caused by the discoveries of gold in South Africa, or even the increase in the subsistence fund that would have occurred if the whole of the newly mined precious metal had been used exclusively for industrial purposes. But however that may be, all that is important for us is to show that this is a phenomenon that is only connected with nonmonetary avenues of employment of the metal.
Now as far as the monetary function is concerned, a long discussion is not necessary to show that everything here depends on whether or not the additional quantity of money is employed uniformly for procuring production goods and consumption goods. If an additional quantity of money were to increase the demand both for consumption goods and for the corresponding goods of higher order in exactly the same proportion or if the withdrawal from circulation of a quantity of money were to diminish these demands in exactly the same proportion, then there could be no question of such variations having a permanent effect on the level of the rate of interest.
We have seen that displacements in the distribution of income and property constitute an essential consequence of fluctuations in the objective exchange value of money. But every variation in the distribution of income and property entails variations in the rate of interest also. It is not a matter of indifference whether a total income of a million kronen is distributed among a thousand persons in such a way that a hundred persons get 2,800 kronen each and nine hundred persons 800 kronen each or in such a way that each of the thousand persons gets 1,000 kronen. Generally speaking, individuals with large incomes make better provision for the future than individuals with small incomes. The smaller an individual’s income is, the greater is the premium which he sets on present goods in comparison with future goods. Conversely increased prosperity means increased provision for the future and higher valuation of future goods.11
Variations in the ratio between the stock of money and the demand for money can permanently influence the rate of interest only through the displacements in the distribution of property and income that they evoke. If the distribution of income and property is modified in such a way as to increase capacity for saving, then eventually the ratio between the value of present goods and future goods must be modified in favor of the latter. In fact, one of the elements that help to determine the rate of interest, the level of the national subsistence fund, is necessarily altered by the increase of savings. The greater the fund of means of subsistence in a community, the lower the rate of interest.12 It follows immediately from this that particular variations in the ratio between the stock of money and the demand for money cannot be always accredited with the same effects on the level of the rate of interest; for example, it cannot be asserted that an increase in the stock of money causes the rate of interest to fall and a diminution of the stock of money causes it to rise. Whether the one or the other consequence occurs always depends on whether the new distribution of property is more or less favorable to the accumulation of capital. But this circumstance may be different in each individual case, according to the relative quantitative weight of the particular factors composing it. Without knowledge of the actual data it is impossible to say anything definite about it.
These are the long-run effects on the rate of interest caused by variations in the ratio between the total demand for money and the total stock of it. They come about in consequence of displacements in the distribution of income and property evoked by fluctuations in the objective exchange value of money, and are as permanent as these fluctuations. But during the period of transition there occur other variations in the rate of interest that are only of a transitory nature. Reference has already been made to the fact that the general economic consequences of variations in the exchange value of money arise in part from the fact that the variations do not appear everywhere simultaneously and uniformly, but start from a particular point and only spread gradually throughout the market. So long as this process is going on, differential profits or differential losses occur, which are in fact the source from which the variations in the distribution of income and property arise. As a rule, it is the entrepreneurs who are first affected. If the objective exchange value of money falls, the entrepreneur gains; for he will still be able to meet part of his expenses of production at prices that do not correspond to the higher price level, while, on the other hand, he will be able to dispose of his product at a price that is in accordance with the variation that has meanwhile occurred. If the objective exchange value of money rises, the entrepreneur loses; for he will only be able to secure for his products a price in accordance with the fall in the price level, while his expenses of production must still be met at the higher prices. In the first case, the incomes of entrepreneurs will rise during the transition period; in the second case, they will fall. This cannot fail to have an influence on the rate of interest. An entrepreneur who is making bigger profits will be prepared if necessary to pay a higher rate of interest, and the competition of other would-be borrowers, who are attracted by the same prospect of increased profits, will make payment of the higher rate necessary. The entrepreneur with whom business is bad will only be able to pay a lower rate of interest and the pressure of competition will oblige lenders to be content with the lower rate. Thus a falling value of money goes hand in hand with a rising rate of interest, and a rising value of money with a falling rate of interest. This lasts as long as the movement of the objective exchange value of money continues. When this ceases, then the rate of interest is reestablished at the level dictated by the general economic situation.13
Thus, variations in the rate of interest do not occur as immediate consequences of variations in the ratio between the demand for money and the stock of it; they are only produced by the displacements in the social distribution of property that accompany the fluctuations in the objective exchange value of money that the variations in the ratio between the stock of money and the demand for it evoke. Moreover, the oft-repeated question of the precise connection between variations in the objective exchange value of money and variations in the rate of interest betrays an unfortunate confusion of ideas. The variations in the relative valuations of present goods and future goods are not different phenomena from the variations in the objective exchange value of money. Both are part of a single transformation of existing economic conditions, determined in the last resort by the same factors. In now devoting to it the consideration it deserves, we atone for a negligence and fill a gap in the argument contained in our second part.
