200 THE GENERAL THEORY OF EMPLOYMENT BK. IV

an income Y, which determines M1, and L2 is theliquidity function of the rate of interest r, whichdetermines M2 . It follows that there are three mattersto investigate: (i) the relation of changes in M to Yand r, (ii) what determines the shape of L1, (iii) whatdetermines the shape of L2 .

(i) The relation of changes in M to Y and rdepends, in the first instance, on the way in whichchanges in M come about. Suppose that M consistsof gold coins and that changes in M can only resultfrom increased returns to the activities of gold-minerswho belong to the economic system under examination.In this case changes in M are, in the first instance,directly associated with changes in Y, since the new goldaccrues as someone’s income. Exactly the same con-ditions hold if changes in M are due to the Governmentprinting money wherewith to meet its current expendi-ture;—in this case also the new money accrues as some-one’s income. The new level of income, however, willnot continue sufficiently high for the requirements ofM1 to absorb the whole of the increase in M; andsome portion of the money will seek an outlet in buy-ing securities or other assets until r has fallen so as tobring about an increase in the magnitude of M2 andat the same time to stimulate a rise in Y to such anextent that the new money is absorbed either in M2or in the M1 which corresponds to the rise in Ycaused by the fall in r. Thus at one remove this casecomes to the same thing as the alternative case, wherethe new money can only be issued in the first instanceby a relaxation of the conditions of credit by thebanking system, so as to induce someone to sell thebanks a debt or a bond in exchange for the newcash.

It will, therefore, be safe for us to take the lattercase as typical. A change in M can be assumed tooperate by changing r, and a change in r will lead to anew equilibrium partly by changing M2 and partly