Prosperity and Depression.pdf

Nature and Causes of the CyclePart IIto adopt a slightly different approach to the problem, more inaccordance with the modern method of marginal analysis.We may conceive a market·for investible funds which is dividedinto a demand side and a supply side. This is not quite the samething as those sections of the demand and supply which actuallyappear in the market for loans or credit, because abstraction ismade ofthe contractual element in the debtor-creditor relationship.Entrepreneurs or corporations, for example, who invest their ownmoney appear both on the demand and on the supply side of themarket : they advance investible funds to thems':!ves. 1would obtain in a barter economy where capital is lent out in natura.This definition raises a hostofdifficulties which need not be discussed here.By others the "natural" rate is defined as the equilibrium rate. Butwhat are we to understand by "equilibrium"? Four or five differentpossible interpretations at once suggest themselves. Which one is bestcalculated to preserve stability of output and employment? The ratewhich, in given circumstances, tends to keep the price level-in one orthe other sense of this ambiguous term-stable? The rate which tendsto stabilise aggregate income, income per head, the price level of thefactors of production, MV, etc.? Everyone of these alternatives hasbeen, at one time or another, proposed as the right criterion. Ourdiscussion has, however, already made-and will make it abundantlyclear that it is very doubtful whether-is possible at all, by mere manipulationof the interest rate, to iron out short-term fluctuations in anyone of these .magnitudes. In any case, it would require drastic andrapid changes of the rate which in themselves would probably becomea de-stabilising factor.These difficulties need not-fortunately-be discussed here. It 'willbe sufficient to say that it is premature and inadvisable at the beginningof the analysis to come to a decision as to what interest rate is bestcalculated to preserve the economic equilibrium. It is not proposed,therefore, in the present study to make any use of the terms Unatural"or "equilibrium" rate; and it is hoped that the theoretical terminologywhich is developed in the text will make it possible to express clearlyand correctly all that is indicated by these terms in trade-cycle literature.1 Since we assume as a first approximation a perfectly smoothlyworking market for investible funds with only a single rate of interest,the problem of self-financing does not present special difficulties. It isassumed that·it makes no difference whether the money invested isborrowed or not. The opportunity cost is in all cases the market rate ofinterest. In other words, the entrepreneur who invests his own moneymust put on the debit side of his account the interest which he couldearnit he lent out the money in the market for investible funds.This 3$sumption is of course regarded by many writers as incorrect.It is alleged that Self-financing leads easily to Ie over-investment tt,because people are not so careful when investing their own money in