Money

As productive activity approaches capacity, prices rise. In fact, unless productive resources are seriously under-employed at the outset, the expansion of credit will very quickly cause a rise of prices. The rise of prices will tend to be such that the consumers' outlay will just buy total output ; consumption and production will then keep pace. Equilibrium will be regained when con sumers' balances are in due proportion to the consumers' income and consumers' outlay. Their balances cease to increase, and consumers' income and consumers' outlay are equal. The in creased lending by the banks is then completely balanced by in creased repayments.

A similar analysis applies to a contraction of credit, the case of diminished lending by the banks. Productive activity declines, and the consumers' income decreases. The consumers' outlay also diminishes but to a less extent, because balances are drawn on. Sales fall off, and traders repay bank advances more slowly. With diminished sales and producers under-employed, prices fall. Equilibrium is reached when consumers' balances have been re duced in due proportion to the consumers' income and the con sumers' outlay. But in the case of a credit contraction a further period of adjustment may still be required, to bring productive power into full employment again.

Quantity Theory.

In all these cases, if, after the transition is completed, the economic activities of the community revert to what they were before it began, the mutual proportions among in comes, balances, prices and other quantities expressed in monetary units will be substantially unchanged. All will have risen or fallen, as the case may be, in proportion to the unspent margin. In practice this does not occur, for economic conditions are con stantly changing, and the process of transition itself would prob ably modify them. Nevertheless the principle that the price level will be proportional to the unspent margin, hypothetical though it be, is one of profound significance. Money is not wealth. It is composed of symbols or tokens, which are valued not in themselves but for what they will buy. All sums of money, incomes, balances, debts, may be regarded as entitling their pos sessors to so much wealth. The amount of wealth represented by any sum of money is proportional to the number of monetary units it contains and inversely proportional to the price level. A man's balances of money and credit money are determined with a view to his probable receipts and payments. Balances, receipts and payments may be regarded each as the equivalent of a certain amount of wealth. Essentially the process by which the balances are adapted to the receipts and payments takes account of their mutual proportions, and not of the absolute number of monetary units in each. That is to say, had the number of monetary units

in each been different, but the amount of wealth represented by each the same, no material difference would have been made in the economic structure of the community. The numbers of money units representing balances, receipts, payments, prices, debts are of the form only ; their mutual proportions are of the substance. This is the principle underlying what is called the quantity theory of money, which states that, other things being the same, the price level is proportional to the unspent margin.

The unspent margin is composed of money and bank credit. If among all the things assumed to be the same we include the proportion of bank credit to money, the quantity theory may be enunciated in another form, that the price level is proportional to the quantity of money in the community. This is the older form of the theory, but it has the disadvantage of making one further assumption. The quantity theory is abstract and almost sterile so long as it makes the assumption that "other things are the same." Our earlier analysis enables us to see what the effect of other things varying will be. The price level is proportional to the consumers' outlay, and inversely proportional to the output of wealth (subject to temporary discrepancies due to changes in stocks of commodities). The authorities, whether governments or banks, responsible for monetary and credit policy, have no means of promptly regulating or certainly measuring the consumers' in come, the consumers' outlay or the output of wealth; the factor which is ascertainable, and which they keep under observation is the unspent margin. This circumstance gives a special practical importance to the unspent margin and therefore to the quantity theory.

The consumers' outlay and the unspent margin are related together by what may be called the velocity of circulation. If people hold smaller balances in hand in proportion to their re ceipts and payments, they may be said to "spend money faster." Velocity of circulation is used in more than one sense in monetary theory. It is sometimes (indeed usually) taken to mean the number of times every unit of money or credit money is trans ferred from one owner to another in a unit of time. But for the purposes of the quantity theory it is more convenient to define velocity as the ratio of the consumers' outlay to the unspent margin. (This is called "circuit velocity" by Messrs. Foster and Catchings.) Velocity is no more ascertainable than consumers' outlay. Changes in velocity have to be inferred from changes in the unspent margin and in the price level. The price level itself has to be measured by index numbers which can never be anything but approximate.