ABSTRACT
Hitherto we have hardly even mentioned the banking system, although experience shows that, at least in the short run, it can exert a dominating influence on the level of interest rates. We must now make up for this sin of omission. The influence of the banking system stems above all from its capacity to create money; but before we discuss this, we must say a word about the interrelation between the long-term rate of interest and the rate on short-term bank loans. In our previous analysis of the interdependence of the short and long interest rates, we have assumed that entrepreneurs in need of short-term funds issue marketable bills. The most important form of short-term financing, however, consists in borrowing from the banks.
