CH. 15

INCENTIVES TO LIQUIDITY

205

hi

We can sum up the above in the proposition that inany given state of expectation there is in the minds ofthe public a certain potentiality towards holding cashbeyond what is required by the transactions-motive orthe precautionary-motive, which will realise itself inactual cash-holdings in a degree which depends on theterms on which the monetary authority is willing tocreate cash. It is this potentiality which is summed upin the liquidity function L 2 .

Corresponding to the quantity of money created bythe monetary authority, there will, therefore, be cet. par.a determinate rate of interest or, more strictly, a deter-minate complex of rates of interest for debts of differentmaturities. The same thing, however, would be trueof any other factor in the economic system taken separ-ately. Thus this particular analysis will only be usefuland significant in so far as there is some speciallydirect or purposive connection between changes in thequantity of money and changes in the rate of interest.Our reason for supposing that there is such a specialconnection arises from the fact that, broadly speaking,the banking system and the monetary authority aredealers in money and debts and not in assets or con-sumables.

If the monetary authority were prepared to dealboth ways on specified terms in debts of all maturities,and even more so if it were prepared to deal in debts ofvarying degrees of risk, the relationship between thecomplex of rates of interest and the quantity of moneywould be direct. The complex of rates of interestwould simply be an expression of the terms on whichthe banking system is prepared to acquire or part withdebts; and the quantity of money would be the amountwhich can find a home in the possession of individualswho—after taking account of all relevant circumstances—prefer the control of liquid cash to parting with it