THE TRADITIONAL DOCTRINE

Bank rate does not appear explicitly as a factor in the fundamental equation of price. It cannot, therefore, affect price levels directly but only indirectly through its influence on one or more of the factors which do appear in the fundamental equation. We must not be satisfied, therefore, with any statement to the effect (e.g.) that an increase in bank rate will cause price levels to fall, unless it is explained to us at the same time by what intermediate action on the factors in the fundamental equation the fall is brought about.

In chapter 11 I have anticipated very briefly the general character of the solution which I shall offer. Bank rate operates primarily on the second term of the fundamental equation. It is the instrument by which a disturbance is set up or equilibrium restored between the rates of saving and of investment; for to raise it stimulates the one and retards the other, and conversely if it is reduced. This does not preclude it from affecting sooner or later the first term of the fundamental equation, or from having secondary effects on other elements in the fundamental equation, in particular on the quantity of bank money, the velocities of circulation, and the proportion of savings deposits.

Before, however, we embark on a detailed development of these ideas, it may be useful to outline the accepted doctrine as it has been developed historically and as it exists today.