RELATION TO MONEY AND PRICES

cept as a matter of transition from one level or plateauto another.

The transition from one price level to another mayand does work havoc as we have seen, and the havoc fol-lows with a lag which is widely distributed. The resultis that during a period of inflation the interest rate israised cumulatively, so that at the end of this period whenthe price level is high, the interest rate is also high. Itwould doubtless in time revert to normal if the new highlevel were maintained, but this seldom happens. Usuallyprices reach a peak and then fall. During this fall theinterest rate is subject to a cumulative downward pres-sure so that it becomes subnormal at or near the end ofthe fall of prices. Thus, at the peak of prices, interest ishigh, not because the price level is high, but because ithas been rising and, at the valley of prices, interest islow, not because the price level is low, but because it hasbeen falling.

Another consideration seems to complete the explana-tion of the close association between high and low pricelevels with high and low interest respectively. This is thenecessity for banks to cope with maladjustments fol-lowing inflation and deflation. Mr. R. G. Hawtrey hasemphasized this point in a letter to me, and I have sum-marized his views almost in his own words:

When credit is expanding, the rising price level and high profitsbring about a high rate of interest. When the expansion has reached,the limit permitted by the stock of gold, the rate of interest is putstill higher in order to bring about a fall in the price level. Whenthe fall in prices takes effect, a low rate of interest becomes appro-priate, and when credit contraction has proceeded so far that aredundant supply of gold has accumulated, the rate of interest isdepressed still lower in order to bring about a renewed rise in theprice level. Thus a high rate of interest corresponds first with rising,

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