RELATION TO MONEY AND PRICES

then has no choice, under the law, but to raise his ratesin self-defense. The result is a shrinkage of credit whenan expansion is needed, a fall of prices and high bankrates at the very time that low money rates of interestare needed. The real rates are then doubly high—highbecause the money rates are high and still higher becauseof the appreciation of money.

These maladjustments are largely responsible for theso-called business cycle. When they are serious, not onlyare the consequences disastrous but there is little thenleft in the market figures of interest to register the influ-ence of fundamental income conditions. 27 The interestrate then registers, rather, a choking or stalling of thebanking machinery. In an acute panic, scarcity of moneyitself has made interest high. Money of any kind broughtinto the market at such times will relieve the stringencyand lower the rate of interest. To relieve the money strin-gency, the United States has, in times past, pouredmoney into the channels of trade by prepaying intereston bonds, and clearing houses have accomplished it byissuing clearing house certificates.

The establishment of the Federal Reserve System hasstabilized prices and interest rates in the United States, although the cataclysm of war in 1914-1921 upset theprice level and the normal correspondence between realand money rates of interest as they had never been upsetbefore.

At present, the Federal Reserve System exerts a nor-malizing influence and seems to be groping to apply the

17 Conditions of this type emphasize the importance of thorough studyof the institutional factors influencing market interest rates such asthat made by Mr. A. W. Marget in his doctoral dissertation The LoanFund presented to the faculty of Harvard University in 1926-1927.

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