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those things whose marginal utility is lowest to them. If, however, the loan is created by an inflation of bank credit and does not represent real saving, there will be no transference of demand, and the lending country's imports will not be affected anyway · - at least so far as the short period is concerned. In any case, however, the quantity of goods relative to the quantity of money will be increased in the borrowing country and decreased in the lending country; general prices will fall in the one and rise in the other. Eventually, but only, as Professor Taussig points out,1 over a long period and not " automatically. . . at the very beginning of the borrowing period," gold will flow to the borrowing country and the relation between the price levels of the two countries be readjusted; in the intervening period, however, price levels will have been affected.

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To consider the application of this analysis to two practical cases the rise in the level of Indian prices during the period 1903-07 is attributed, among a number of other causes, to the large borrowings of foreign capital which were made during those years. It is evident that whether the influx of capital had the immediate effect of raising prices or not depends on whether the loans took the first or the second of the two forms described above. In the first case, an influx of capital would immediately produce a rise in general prices; in the second case it would produce an immediate fall (or a check to an existing rise) and a compensatory rise later. Again in the case of a loan raised in America by England during the war, the second case is probably the actual one. If this is so, we should expect a check to the rise of prices in England and an increased rise in America. Thus the absence of that fall in the American price level which Professor Wicksell expects theoretically to result from the borrowing transaction may be due to other causes besides the alleged world depreciation of gold.3

The second part of Professor Wicksell's note is concerned with the effect of borrowing on international trade through 1 Quarterly Journal of Economics, February, 1918, p. 411.

* J. H. Keynes, "Recent Economic Events in India," Economic Journal, 1909, p. 51. Cf. Quarterly Journal of Economics, February, 1918, p, 409.

its effect on costs of transport in the case of two countries separated from each other by sea. If America borrows from England, then, he says, freight rates to America will rise (because of the increased quantity of goods to be carried) while freight rates from America will fall. Then the prices of " both imported and exported goods will have a tendency to rise in America and to fall in England "and" consequently the general level of prices will have been raised in America and lowered in England."

In this statement it does not seem clear in what connection the words" rise and fall" are used. Prices will rise or fall relatively to what? - Relatively to prices of the same things in the other country at the same time, or relatively to prices of the same things in the same country at a previous time? Evidently what will actually happen is this. Suppose A is the borrowing and B the lending country. Prices of imports to A will rise relatively to the prices of the same things in B at that time and relatively to the prices of the same things in A before that time-i.e., before the borrowing process began; on the other hand, the prices of goods exported will rise in A relatively to their price in B at the same time but not relatively to their price in A before the process started. The general level of prices in A will not so far be affected because it can only be affected by a change in the quantity of money or in the quantity of goods exchanged. Similarly the price of B's imports will fall relatively to their price in A and to their price in B before but the price of exports will only fall relatively to their price in A. The general level of prices will not be affected. What is important in this is the rise in the price of A's imports relatively to what they were before and the fall in the price of B's imports relatively to what they were before. This rise and fall will affect demand in A and B. The exact result on the general level of prices in the two countries will depend on the elasticities of their respective demands. If, for instance, A's demand for B's goods has an elasticity greater than unity while B's demand for A's goods has an elasticity equal to or greater than unity, the aggregate value of A's exports will exceed the aggregate value of her imports,

gold will flow to A and the general level of prices there will rise. If, on the other hand, the elasticity of A's demand is less than one while the elasticity of B's demand is equal to or less than one, the aggregate value of A's imports will exceed the aggregate value of her exports, gold will flow to B and the general level of prices there will rise. This rise or fall in A's prices will be proximately the result of gold movements and there will not be first a rise in A's price level and then an influx of gold to support that rise. In fact, as Dr. Fisher says "so far from its being true that high prices cause increased supply of money, it is true that money avoids the place and time of high prices and seeks the place and time of low prices, thereby mitigating the inequality of price levels." 2

The effect of issuing more convertible bank notes in the borrowing country would be nil if the issue was completely covered by gold, since it would presumably be accompanied by the withdrawal of an equivalent amount of the precious metal. An issue of partially or wholly inconvertible notes would raise the price level and tend, by increasing the country's effective demand, to alter the effect of the rise in import prices, aggravating it if the elasticity of the borrowing country's demand for imports were less than unity, and counteracting it if the elasticity were greater than unity. The English price level has risen during the war owing, in part at any rate, to the overissue of treasury notes and the inflation of bank credit. It appears probable in view of the extreme urgency of the need for war material that the English demand for American goods is very highly inelastic, probably it has an elasticity less than unity. In this case the rise in the price level will aggravate the existing effect of a rise in import prices and the aggregate value of English imports will be larger than if either of these monetary phenomena did not exist.

The American demand for English goods must be much more elastic, probably it is greater than unity. If this is so, the short period effect of borrowing by England in America 1 Quarterly Journal of Economics, p. 408.

2 Fisher, Purchasing Power of Money, p. 173.

will be to make the aggregate value of both their imports greater than before. Which will be the greater of the two depends on the exact relation between these elasticities, a relation which could only be determined by detailed statistical study.

We have seen that the overissue of treasury notes and the inflation of bank credit would tend to increase the aggregate value of English imports. If we assume that the effect of borrowing operations has been such as to increase the aggregate value of American imports less, or only slightly more than the increase in English imports due to the same cause, then the inflation of English currency by aggravating the effect of the borrowing transaction on English imports would tend to make these much larger than American imports and so cause an outflow of gold and a fall in the English price level. But under the actual circumstances this inflation may also have a different and contradictory effect on the price level. Disregarding for the moment the complications resulting from borrowing transactions, suppose there had been no inflation. If the English price level had then been lower than the world level gold would have flowed in and pushed English prices up. But if local non-monetary causes of a high price level had been such as to make the English level higher than the world level, then gold would flow out of England. In this last case the existing restrictions on gold export, the incomplete convertibility of treasury notes and the continuous and rapid inflation of credit would be responsible for a very large part of the rise in English prices, for the continuous issue of fresh paper and bank money would counteract, or more than counteract the effect of any such outflow of gold as might occur in spite of the prohibition.




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