SOME COMMON PITFALLS

equally true, in another sense, that the purchasing powerof money is the price of money. Yet the rate of interestand the purchasing power of money are two very differentthings.

Nor is it very illuminating to say that the rate of in-terest is the price paid for the use of money, especially asthe money whose use is purchased is usually not moneyat all but credit—nor is either the money or credit liter-ally used continuously during the loan. It disappears atthe beginning and reappears at the end.

Enough has already been said to show that an increasein the quantity of money in circulation tends to raise theprice level and consequently to depreciate the value ofthe money unit. This depreciation in turn tends to in-crease the rate of interest. Yet, there is a very persistentbelief that an increase or decrease in the quantity ofmoney in circulation causes a decrease or increase in therate of interest. This fallacy seems to be based on a con-fused interpretation of the general observation that therate of interest generally rises or falls with a decrease orincrease in the reserve ratio of banks. While it is truethat if new money first finds its way from the mint intothe banks, it tends to lower the rate of interest, this ef-fect is temporary. The maladjustment between the moneyin banks and in circulation is soon corrected as the de-mand for loans overtakes the supply. As far as the totalsupply of money is concerned, if this is doubled in amountand prices are thereby, in the end, doubled too, there isdouble the money to lend, but borrowers will requiredouble the amount of money. At the doubled prices theywill need twice the money to make the same purchases.The demand is doubled along with the supply and theinterest rate remains as before.

[ 47 ]