A Note on Banking Policy and the Income-Velocity of Circulation of Money

Abstract

IT is the purpose of this note to consider the effects of an increase in the amount of saving made by the public through the mediation of the banking system. It is generally agreed that this change, which is a decrease in the income-velocity of circulation of money, will upset equilibrium. The quantitative importance of such a change as a cause of disequilibrium has, however, often been exaggerated due to the neglect of the distinction between autonomous and induced changes. An autonomous change may be defined as a change in the saving habits of the public which is not brought about by a condition of disequilibrium. An induced change may be defined as one which is itself the effect of disequilibrium. To a certain extent it is merely the monetary aspect of the conditions of disequilibrium, but it may itself become an aggravating cause. The more important quantitative changes in income-velocity take place during the downward swings of the trade cycle and are to be considered as induced changes. These changes would, of course, be avoided by the elimination of the inflationary boom. This note deals only with the effects of an autonomous change. The effects of an increase in the amount of saving which directly causes a reduction in income-velocity depend upon the policy of the banking system. The results of such a change can be analysed on the basis of three different assumptions regarding the reaction of the banking system. The banking system may take no action; it may maintain the quantity of money multiplied by its income-velocity of circulation constant; it may maintain the quantity of money constant. i. If the banking system takes no action it will, in effect, be maintaining the money rate of interest above the equilibrium rate.' This will cause a reduction in the quantity of money. The decrease in incomevelocity will mean a reduction in the amount of money spent on consumers' goods and a fall in the prices of these goods. If stocks are not increased the public will consume just as much as before with a lower money expenditure because prices will have fallen proportionately. Voluntary saving will thus be in excess of investment and the new savings