Prosperity and Depression.pdf

Chap. 2.The PurelY Monetary Theoryproductive activity, in consumers' income and outlay, and indemand, and a further depletion of stocks. Increased activitymeans increased demand, and increased demand means increasedactivity. A vicious circle is set up, a cumulative expansion ofproductive activity") 1 which is fed and propelled by a continu~usexpansion of credit."Productive activity cannot grow withoutEffects of limit. As the cumulative process carries onerising prices. industry after another to the limit of productivecapacity, producers begin to quote higher andhigher prices ." 1 When prices rise, dealers have a further inducementto borrow. Rising prices operate in the same way as fallinginterest charges : profits are increased and traders stimulated tohold larger stocks in order to gain from a further rise in prices.In the same way, the producer is stimulated to expand productionand to borrow more freely in order to finance the increased pro...duction. The cumulative process of expansion is acceleratedby a cumulative rise in prices.There is yet another accelerating element.Instability In addition to the expansion of the circulatingof the velocity mediu,m~ there is an increase in its velocity ofof circulation. circulation. When prices fise and trade isbrisk, merchants and producers not only harrowmore : they use up any idle balances which may be at theirdisposal. Idle balances are the inheritance of the previousdepression. If they exist to a large extent, "it may be thatan enlargement of the consumers' income ·and outlay isbrought about with little or no expansion of the outstandingbank credit"." Thus there is a principle of the instability of velocity of circulation,which is quite distinct from the principle of the instabilityof credit, but is very apt to aggravate its effect."·To sum up, expansion is a cumulative process-that is to say,once started, it proceeds by its own momentum. No furtherencouragement from the banks is required. On the contrary,1 The Art 01 Central Banking. page 167.I o.p. cit., page 17I.