chapter  XXV
4 Pages

Do. -THE MACHINERY OF REGULATION

The second, and much the most important, method by which the Bank controls the movement of gold has also been discussed: it lies in the practice of varying the Bank rate. Such action becomes effective, it was noticed, through its influence on the Market rate; for a rise in the Market rate has two consequences, the one immediate, the other more remote, but each operating in the same direction. Its immediate effect is to make it more profitable than before to have funds in London, so that an outflow of gold is checked and an inflow of gold encouraged. Its more remote effect, that is to say, the ultimate effect of a persistently high Market rate, is to contract the volume of bank loans and consequently of the currency, to raise the internal value of the sovereign and so to draw in gold from abroad. By the employment of this second method, therefore, the Bank is enabled to meet temporary changes of pressure

on its reserve, due to causes originating at home and more especially abroad, and by so doing to mitigate changes in the internal value of the sovereign which would result from any marked expansion or contraction of the home stock of gold. The point to notice at the moment is that the power of the Bank to take effective action of this kind depends on its ability to influence the rates of the great Joint-Stock banks by whom the greater part of the supply is controlled. Apart from collective action, a rise in the rates charged by the central bank works out its effects through several routes. By discouraging borrowing from the Bank itself, it tends to reduce the totals of Other Securities and Other Deposits, thereby initiating a rise in Market rates, directly through the contraction of loans, and indirectly through the contraction of the deposits which form the principal reserves of the Joint-Stock banks. It leads also to a partial rise in the rates at which capital is supplied throughout the whole country; for a large and perhaps a growing part of the loans of the Joint-Stock banks are made at rates of interest which vary automatically with changes in the Official rate. Finally, each change in the Official rate is customarily followed by a meeting of the Clearing House bankers, and leads usually, though not always, to a rise in the rates allowed by them to the public for money lodged on deposit account. It seems to be true that a rise in Bank rate will always become effective if time is given for these various influences to work out their full results. But the Bank controls only a relatively small part of the total supplies in the short loan market; and the fact that it has at times to reinforce the influence of a rise in its rate by borrowing from the market shows that the Bank rate is inadequate as an effective means of dealing immediately with temporary disturbances. The lack of any close connexion between Bank and Market rates marks, then, a definite weakness in the power of the Bank of England to carry out the duties with which it is entrusted.