CH. 21

INTERNATIONAL DISEQUILIBRIUM

359

method in the former case and the bank-rate methodin the latter case (with the result, however, that if wewere always to follow what was in the circumstancesthe line of least resistance the long-period trend ofprices would always be upwards).

But this is not the only contrast between the twomethods. The foreign-exchange method has the char-acteristic that it operates directly (whether upwardsor downwards) on relative price-levels, whereas thebank-rate method only does so indirectly , and there-fore with a time-lag. On the other hand, the bank-rate method has the characteristic that it operatesdirectly on L. Which of these characteristics is themore advantageous depends on whether the disequi-librium between B and L is due to a change of in-terest rates in the outside world or to a change ofprice-levels in the outside world. In the former case,the new position of equilibrium cannot be reachedmerely by exchange-rate policy but must be accom-panied sooner or later by a change in bank-rate also.Indeed, assuming that the average level of money-incomes at home and abroad remains finally un-changed, the new equilibrium rate of foreign exchangewill only differ from the previous rate to an extentcorresponding to the change in the terms of trade,the amount of which will depend, as before, on thephysical facts of production and investment in the twocountries. But in the latter case bank-rate methodsets up a disturbance in the rate of investment, whichis unnecessary and injurious in itself and is onlyapplied in order to produce at long last an effect onthe money-cost of production, after which it willhaveto be reversed again. Nothing is required in orderto reach a new position of equilibrium with money-incomes at home at the same level as before, except anappropriate change in the rates of foreign-exchange.

We can now sum up the question of choice asfollows. If the disequilibrium is due to changing price-