THE THEORY OF INTEREST

market interest rate for prime 4-6 months commercialpaper and the average daily bills discounted for memberbanks by all Federal Reserve Banks .

The Federal Reserve Act requires the pooling of mem-ber banks’ reserves with the Federal Reserve Banks .These reserves must average the minimum legal require-ments and balancing periods are maintained once a weekin large cities and twice a month elsewhere. Surplus anddeficit reserves are, therefore, impossible for periods ofmore than two weeks at the very maximum under thissystem. But the influence of the banks on the moneymarket rates are now effected through borrowings at theFederal Reserve Banks . Thus a period of member banksborrowing corresponds in its relation to the money marketto a period of deficit reserves under the National BankingAct, and a period when member banks are paying offtheir loans at the Reserve Bank corresponds to a periodof excess reserves.

A similar correspondence between commercial paperrates and gold reserves is shown by a recent study byColonel Leonard Ayres, of the Cleveland Trust Com-pany. 26

Curiously enough, this well known and sound rela-tionship between bank reserves and interest rates is oftenconfused with the entirely different, generally incorrect,but commonly believed proposition that the rate of inter-est is high when money in general is scarce, and lowwhen money in general is abundant. The thought seemsto be if the rate of interest is called the price of moneyit is natural to conclude that abundance of money, likeabundance of wheat or anything else, makes its pricelow, while scarcity of money makes its price high.

" Cleveland Trust Company, Business Bulletin, June 15, 1928.

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