RELATION TO MONEY AND PRICES

§11. Relations of Interest to Business and Prices

As implied by what has just been said regarding bank-ing policy, the relationships of P' and i are mutual. Achange in i undoubtedly has an effect upon P' as wellas the reverse. Our analyses have demonstrated that, ina decisive majority of instances, price changes precedechanges in i. This does not mean that changes in theinterest rate can never be used to forecast changes inprices and in business activity. 21 In fact, an arbitraryincrease in i at any time does tend to pull down the levelof general commodity prices, while a decrease in i tendsto increase P. This is a fact which has been quite wellestablished and is made use of by central banks in formu-lating their banking and credit policies.

The influence of changes in interest rates upon pricesand business activity is made use of also by forecastingagencies in making their prognostications of business andprice movements for the near future. 22 The fact that ifollows P', in most instances over secular and cyclicalperiods, is not inconsistent with the other fact that everyincrease or decrease in i exerts an influence upon P in the

“Prof. Knut Wicksell was one of the first to recognize the influenceof interest rates upon prices. See his book, Geldzins und Giiterpreise;Prof. Alfred Marshall, Prof. Gustav Cassel, Rt. Hon. Reginald Mc-Kenna, Chairman of the Midland Bank of London, Mr. R. G. Hawtrey ,of the Treasury of Great Britain, and many other well known econom-ists, bankers, and business men have emphasized that business activityis influenced and may be largely controlled by manipulation of the dis-count rate.

” Mr. and Mrs. K. G. Karsten, for example, in their forecasts, makeuse of commercial paper rates in computing their forecasts of wholesaleprices and business activity. They find an r of —0.98 between (1) thelogarithms of P' and (2) the logarithms of the deviations of commercialinterest rates from bond yields.

[443 ]