§11. Relations of Interest to Business and Prices

As implied by what has just been said regarding banking policy, the relationships of P' and i are mutual. A change in i undoubtedly has an effect upon P' as well as the reverse. Our analyses have demonstrated that, in a decisive majority of instances, price changes precede changes in i. This does not mean that changes in the interest rate can never be used to forecast changes in prices and in business activity.66 In fact, an arbitrary increase in i at any time does tend to pull down the level of general commodity prices, while a decrease in i tends to increase P. This is a fact which has been quite well established and is made use of by central banks in formulating their banking and credit policies.

The influence of changes in interest rates upon prices and business activity is made use of also by forecasting agencies in making their prognostications of business and price movements for the near future.67 The fact that i follows P', in most instances over secular and cyclical periods, is not inconsistent with the other fact that every increase or decrease in i exerts an influence upon P in the Edition: current; Page: [444] opposite direction. Within limits, a fall in the rate of interest may and often does produce a rise in prices and in business activity almost immediately. This effect may be continued for many months until increased prices again become dominant and pull the interest rate up again.

In so far as the rate of interest is cause and the price movements are effect, the correspondence is just the opposite of that which occurs in so far as the price movements are cause and the interest movements effect.

It is outside the scope of this treatise, which has to do only with things which affect the theory of the rate of interest, to attempt to explain fully all the very complicated relations connecting interest and business. The studies completed or in progress in my office show some interesting results which I hope to publish later.

It is unfortunate that many students in this field seem to take it for granted that there is one and only one definite cycle, or that the cycle is controlled by one and only one definite influence. I have been accused of inconsistency for presenting several seemingly incompatible theories concerning the business cycle. As a matter of fact, I have never as yet studied the so-called business cycle as a whole. I have only studied a few of its elements or aspects.68