358

A TREATISE ON MONEY

BK. IV

tion of such goods, whether for home-investment orfor home-consumption. Thus a country increases itsforeign investment by increasing its surplus produc-tion of foreign-trade goods. Similarly we can call bythe name of home-trade goods all other goods producedat home. Now when the rate of foreign exchange isaltered, the prices of all foreign-trade goods arechanged forthwith in terms of the local money, whereasin the first instance nothing will have happened tochange the prices of home-trade goods. Let us supposethat the disequilibrium which we set out to cure is adeficiency of B relatively to L, and let us compare theworking in this case of exchange-rate policy with thatof bank-rate policy as a means of restoring equilibrium.

If the exchange-rate is altered so as to depreciatethe local money to an appropriate extent, equilibriumis restored by raising the price of foreign-trade goodswhilst leaving that of home-trade goods unchanged,thus attracting entrepreneurs towards an increasedproduction of the former with the consequence of in-creasing the surplus production of foreign-trade goods,i.e. of B. If, on the other hand, bank-rate is raisedto an appropriate extent, forces are set in motiontending to lower the price of home-trade goods whilstleaving the price of foreign-trade goods unchanged (Iam speaking broadly and without reference to niceties).That is what we meant above by saying that the twomethods work similarly but the other way round. Inthe case supposed the foreign-exchange method restoresequilibrium by an act of inflation, whereas the bank-rate method would produce a similar relative changeby an act of deflation. If, on the other hand, the dis-equilibrium had consisted in an excess of B relativelyto L, then it would be the foreign-exchange methodwhich would function by means of a deflation, whereasthe bank-rate method would employ inflation. Thus—so far as friction is a serious trouble—the line ofleast resistance will be to employ the foreign-exchange