CH. I 5

207

INCENTIVES TO LIQUIDITY

Thus there are certain limitations on the ability ofthe monetary authority to establish any given complexof rates of interest for debts of different terms andrisks, which can be summed up as follows:

(1) There are those limitations which arise out ofthe monetary authority’s own practices in limiting itswillingness to deal to debts of a particular type.

(2) There is the possibility, for the reasons dis-cussed above, that, after the rate of interest has fallento a certain level, liquidity-preference may becomevirtually absolute in the sense that almost everyoneprefers cash to holding a debt which yields so low arate of interest. In this event the monetary authoritywould have lost effective control over the rate ofinterest. But whilst this limiting case might becomepractically important in future, I know of no exampleof it hitherto. Indeed, owing to the unwillingness ofmost monetary authorities to deal boldly in debts oflong term, there has not been much opportunity for atest. Moreover, if such a situation were to arise, itwould mean that the public authority itself could borrowthrough the banking system on an unlimited scale ata nominal rate of interest.

(3) The most striking examples of a completebreakdown of stability in the rate of interest, due to theliquidity function flattening out in one direction orthe other, have occurred in very abnormal circum-stances. In Russia and Central Europe after the war acurrency crisis or flight from the currency was experi-enced, when no one could be induced to retain hold-ings either of money or of debts on any terms what-ever, and even a high and rising rate of interest wasunable to keep pace with the marginal efficiency ofcapital (especially of stocks of liquid goods) under theinfluence of the expectation of an ever greater fall inthe value of money; whilst in the United States atcertain dates in 1932 there was a crisis of the oppositekind—a financial crisis or crisis of liquidation, when