Prosperity and Depression.pdf

Chap. z The PurelY Monetary Theory 2.1greater convenience to compensate for its inferior security. Theamount of cash '\vhich passes into circulation depends largelyon the incomes, expenditures and hoards of working-men. Anexpansion leads sooner or later to a drain of cash out of the holdingsofthe banks while, as earnings and wage rates rise, an increasingamount will be retained in cash balances. This, however,is a slow process, because the rise in wages lags· considerablybehind the expansion of credit and the rise in prices and profits.Meanwhile, the central bank, in its anxiety to maintain exchangestability, declines to supply cash to the commercial banks indefinitely.The latter are therefore forced to put the brake on andto stop the expansion. When they start to do this, the cash holdingsof the working population still continue to increase-byreason of their lag behind the credit expansion-and go on risingafter the expansion has come to an end. This induces the banks,not merely to stop expanding, but actually to contract; and sothe depression is given its start.§ ,. THE DOWNSWINGThe process of contraction is cumulativeThe reverse no less than the process of expansion. "Whenofthe IIp.swing. credit has definitely turned the corner, and acontraction has succeeded to an expansion, thedownward tendency of prices is sufficient to maintain the processof contraction, even though the rate of interest is no longer,according to the ordinary standards, high." 1The process is cumulative for the following reason. Whenprices are falling, merchants expect them to fall further. Theytry accordingly to reduce stocks, and .give smaller orders, or no.orders at all, ~o producers. Consumers' income and outlaydecrease; demand flags; stocks accumulate in spite of endeavoursto reduce them; borrowing is reduced further-and so on in along and painful process. All the factors which tended to stimulatethe upswing conspire now to push contraction further andI CUl'1'ency and Cl'edit, 3rd ed., London, 1928, page 153.