A Tale of Two Faulty Circulations

PART A – Examples and Comments

Our contention is that a large discretionary injection of “free money” into the channels of Demand – whether by the Fed or the Treasury – rather than as “money justified” through the channels into productive supply, (S’-s’O’) and (S”-s”O”), is intrinsically inflationary.  New money channeled into either the market for secondary financial assets or into the market for basic products, without the money being  “justified” by productive output, is dangerously inflationary.

… positive or negative transfers to basic demand (D’-s”I’) and consequent similar transfers to surplus demand (D”-s”I”) belong to the theory of booms and slumps.  They involve changes in (aggregate basic or aggregate surplus) demand, with entrepreneurs receiving back more (or less) than they paid out in outlay (which includes profits of all kinds).  The immediate effect (of these aberrational monetary transfers) is on the price levels at the final markets, and to these changes (in price), enterprise as a whole responds to release an upward (or downward)  movement of the whole economy.  But the initial increased transfers to demand [that is, excess transfers along (D’-s’I’)  and (D”-s”I”) ] are not simply to be supposed.  For that would be postulating without explaining the boom or slump. [CWL 15, 64]

Our intention is to demonstrate selected principles of inflation by two purposely-oversimplified examples of types of monetary circulations. Analysts can then apply these principles to explain and critique any actual circulations of money.  The fundamental questions herein are How does the money circulate?  Into what channels does the incremental money first and eventually go?  Is there always an exit from the channels or can there sometimes be no exit?  The ultimate problems caused by repeated disequilibrated flows become “more and more significant, if not intractable, as a rate of deficit spending is maintained over a long period.” (CWL 15, 176)

Let’s assume initially that, prior to an increase in the money supply by the Fed or Treasury, the economic process has been stable.  An economic four-phase expansion, characterized by a rise and tapering onto a level of greater bounty, has been completed.  The surplus and basic phases of the expansion have been successfully implemented.  The process has been reproducing itself at the same level interval after interval. This process consisting of productive and correlated monetary flows is characterized by continuity from interval to interval and by equilibrium between the solidary basic and surplus circuits; production operations are being conducted efficiently at the optimal percent of productive capacity; there is currently a conveniently assumed, absence of innovation and there exists no opportunity for monetary gain on widening-investment; all incomes are being spent for consumption and maintenance; surplus income for expansionary investment is zero;  full employment reigns and compensations in the incomes strata are fair and acceptable to all; the population is stable; reserves for retirement and insurance needs equal withdrawals for these needs; stocks, bonds, and real estate are properly priced relative to their correspondent production vis a vis consumer goods and services; there is just the right amount of money circulating in the system to support expeditious transacting; prices are stable because products/services and their correlated payments are flowing proportionately interval after interval; the banking system has nothing to do except renew working-capital loans at interest rates just covering the banks’ expenses; in current foreign trade and in international payments there is neither a surplus nor a deficit; the foreign-exchange rate is stable; the federal,  state, and local governments are efficient, not at all wasteful, and comfortably executing a balanced budget, i.e. tax inflows equal payments outflows.  Everything seems to be working and managed well.  But, suddenly, participants get restless and want more; there is much complaining about “stagnation;” and politicians and bureaucrats earnestly desire, and will do just about anything the citizenry demands, in return for the power and glory of election, appointment, and confirmation by the voting public.

We display now three Figures from CWL 15: Figure 14-1, the familiar Diagram of Rates of Flow; Figure 29-1, Diagram of Superposed Circuits; and Figure 31-1, Diagram of Government Spending and Taxes:

The rates of interdependent, mutually-defining monetary flows represented in the Diagram of Rates of Flow are rates of functionings implicitly-defined by their functional relations to one anotherAbstract, explanatory meanings are assigned to conventional descriptive terms.  The system is purely dynamic, purely relational, and field-theoretic.  Certain pairs of monetary flows are concomitant, with brief circulatory gaps in time covered by credit.  The analysis seeks the complete explanation of a unitary, solidary system consisting of functional flows within and between two interdependent circuits.

Example 1: Restricted Circulation A:  In brief:  Purportedly to stimulate the economy, the Federal Reserve Bank conducts open-market purchases which increase the money supply available in the Redistributive function supposedly for lending into the operative circuits.  The new money is created by a mere accounting entry on the Fed’s books; the new money in the Redistributive Function is expected to be loaned out with no debt-obligation strings attached.  But the admittedly-stark Restrictive assumption to indicate a principle of inflation is: The injected money stays and circulates only in the Redistributive Function.  It “gets stuck” in the center of the Diagram.

We-the-people in the person of the Federal Reserve Bank have decided to stimulate the process big-time and, to do so, execute open-market purchase of corporate bonds (not government bonds).  Entries to the Fed’s balance sheet: debit Liquid Corporate Bonds (but at historical prices); credit Money in Circulation.  In the Redistributive Function the supply of financial assets is reduced, and on the other hand, the money in the public’s investment accounts available to buy that reduced supply is increased.  More money chases fewer goods.  The open-market actions will, by assumption, amount to nothing more than exchanges of title between Smith and Jones without productive motive.  The exchange of one million shares of GM will not produce a single automobile.

In the first instance, under our rigid temporary assumption that the money stays and is circulated only in the non-operative exchange-of-title Redistributive Function, the investors who were bought out by the Fed simply dedicate their new-found money to further purchases of financial assets (stocks and bonds or other debt instruments).  That money – stuck in the secondary market – keeps being exchanged as its value is being continuously absorbed by the higher and higher prices of the existing, and recently-diminished, supply of stocks and bonds. Back and forth between stockholders and bondholders the speculative money goes and where inflating valuations stop nobody knows.  Speculative optimism feeds on itself.  Thus, purchasing power in the secondary markets is decreased; one has to pay more for a given quantity of property rights.  The phenomenon is called “inflation.” In addition, the citizenry not benefiting from the higher asset values protest.  Some complain about “increasing inequality” between the haves and the have-nots.

Note re reserves at the Fed: At the end of each day of exchange-of-title, inoperative trading, Smith has given money to Jones and received a financial asset from Jones.  Nothing has been produced.  The name associated with the money has changed, but the amount of money in the system has not changed.  Presumably this money is briefly in a bank account ready to be used again and ultimately qualifies as reserves at the Federal Reserve Bank.  Thus, while financial assets have changed hands, the money supply available for lending remains the same. But under our assumptions, the ever-optimistic Smiths and Jones’s can and will continue speculative inflationary trading – rather than lending – until they no longer deem it wise to do so.  Though the banking system is flush with the new money to lend, it does not lend; it notes that a productive expansion was fully and successfully completed, opportunities for investment are lacking, and it abides by strict lending standards, noting that the economic process is “stagnant,” (rather than explained properly as dynamically stable) and opportunities for returns in excess of the interest rate do not exist.

 Now, let us relax our assumptions about money being stuck in the Redistributive Function.   Note in the Diagram below that there are four channels “out of” and four channels “into” the Redistributive Function.  New money is no longer “stuck.”  The valves are open and money can flow through the interconnections of the Diagram according to its set of purely-relational field equations. (CWL 15, 53-55)

Still, in the new freedom problems lurk.  Though the new aggregate flows may be on average continuous and equilibrated, some participants in the surplus circuit will have fared better and some will have fared worse than others.  Also, individuals will react differently; feel differently, think differently, save differently, and spend differently.  They do so in different-sized population groups and, thus to different aggregate extents having different differentials of velocities and accelerations.  Also, and despite the previously described achievement of halcyon equilibria, no one understands – because academics cannot discern and communicate – the objective laws of the economic process to which participants must adapt their psychology and conduct.

In this second instance of the existence of new money, not all individual and corporate investors will use all their money to buy stocks and bonds continuously at inflated prices; some will channel their money into the basic circuit to upgrade their standard of living by purchasing more and better stuff from that basic circuit.  Some will invent and invest in new enterprise.  Some will wax philanthropic and donate to operative charities, thus effecting a type of direct transfer payment outside the government’s tax-and-transfer system.  Others will donate to college endowments, though, as the endowment reinvests, such may only substitute the individual Smith for the endowment Jones in the secondary market.

So, under the relaxed assumption, the Fed’s intention is not totally frustrated.  Under this relaxed assumption, a small amount of money could slightly stimulate the basic circuit, a lot of money could inflate the basic circuit, and some of the remaining money might go into socially-beneficial investment if it is determined that investment opportunity abounds.  The Fed, the Treasury, and the Private Sector will have to measure and relate flows and determine whether the altered flows in the unitary process are normatively balanced or dangerously disequilibrated.

Example 2: Restricted Circulation B: In brief:  The executive branch distributes money directly to lower-income consumers.  The Restrictive assumption to illustrate starkly a principle of inflation: The money will stay and circulate only to purchase consumer (point-to-point) goods in the basic operative circuit.  By this assumption, it cannot escape from the basic circuit and will continually circulate only in the basic operative circuit interval after interval.

The injection may be by one of two courses: the Treasury either prints money straight out and distributes it or it runs a deficit fueled by issuing temporary bonds, then distributes the money through its transfer systems and the money keeps circulating in basic circuit operations. No debt-obligation strings are attached to the recipients of the new money.

In the first instance, recipients of the money classify all their additional money as monetary demand for consumption items.  Production operations – already operating at optimal levels of capacity – can’t meet the increased demand and backlogs swell; so entrepreneurs concomitantly raise prices.  And, under our restrictive assumption that the money stays and circulates in the basic scheme of recurrence, in order to sell out their capacity entrepreneurs simultaneously raise wages and salaries and adjust prices such that purchasing power of a unit of currency is reduced, yet the same quantities continue to be produced and exchanged, but at inflated prices.  Thus, in this first instance of this example, entrepreneurs do not pocket the difference and send it to the Redistributive Function.  The difference remains in the basic circuit.

Now, let us relax our assumptions about money being stuck in the operative basic circuit.  In the Diagram of Rates of Flow all valves are now open.

In the second instance of this Circulation B, some workers in the basic circuit will have benefitd from the infusion more than others.  They become able to save and invest, and they decide to channel their money into the surplus circuit for a) greater reserves for retirement, or b) socially-beneficial investment enlarging the stock of widening or deepening capital, or c) inflationary purchase of previously-issued stocks and bonds.

Pause: A brief review of “relatively greater vulnerability”; some participants fare better than others: Lonergan applies the idea of relative invulnerability in his analysis of a slumping economy which is in the process of correcting a previously-excessive, booming economy.  Some people are less vulnerable and some are more vulnerable to the slump.  Some are able to retain their incomes in a slump; some are not. (See CWL 15, 153-55)  In this present analysis, in Circulation A, current owners of financial assets benefit while new buyers must pay higher prices.  In Circulation B, some consumers benefit from incomes which are relatively greater and legally protected, while relatively vulnerable recipients suffer a reduction or loss of income.  The vulnerable become angry and demand higher wages and salaries to maintain their purchasing power and standard of living.

We again display the three Diagrams of Rates of Flow: Figure 14-1, the familiar Diagram of Rates of Flow; Figure 29-1, Diagram of Superposed Circuits; and Figure 31-1, Diagram of Government Spending and Taxes:

The rates of interdependent, mutually-defining monetary flows represented in the Diagram of Rates of Flow are rates of functionings implicitly-defined by their functional relations to one anotherAbstract, explanatory meanings are assigned to conventional descriptive terms.  The system is purely dynamic, purely-relational, and field-theoretic.  Certain monetary flows are concomitant, with brief circulatory gaps in time covered by credit.  The analysis seeks the complete explanation of a system consisting of functional flows within and between two interdependent circuits.

The fundamental economic problem: Borrowed money must be “justified” by its being used as the monetary correlate of valuable production contribution.

Artificial stimulus by the government – whether acting as We-the-People in the person of the Fed, the Treasury, or the Congressional taxing authority – is not the solution to  an imagined or real problem of stagnation.  The path to greater abundance requires and is constituted by

  • Invention, innovation, and implementation of new and better producer goods, methods and skills
  • Justification of a greater money supply by correlation with a greater rate of production
  • A balance of money flows between two solidary circuits during both dynamic stability and dynamic expansion
  • Proper restraint re increasing the money supply grounded in understanding that failing monetary stimuli cannot be repeated over and over again without exacerbating debt problems until the ultimate accumulation is intractable
  • Proper distribution of income in the two circuits according to the phases of expansion
  • Discovery, appreciation, communication, and implementation by university professors and bureaucratic leaders of explanatory Macroeconomic Field Theory
  • Enlightened self-interest in the conduct of their lives by all participants (See Practical Precepts For Plain People)

PART B – Substantiation and backup

We enter excerpts relative to, and in substantiation of, the tendencies and actualities of restricted and unrestricted circulations of Part A.

Money should enter the system as credit money to the supply function, not to the demand function. (See Modern Monetary is Backward; It Creates “Illegal” Superposed Circuits)

 the supposition that circuit acceleration to some extent postulates increments in the quantity of money in the circuits … points to excess transfers to supply, to (S’-s’O’) and (S”-s”O”), as the mode in which increments in quantities of money enter the circuits. [CWL 15,  61]

Further, the normal entry and exit of quantities of money to the circuits or from them is by the transfers from the redistributive to the supply functions.  [CWL 15, 64]

 Equations (4a) and (3a) are mathematically similar.  They then give us a simple model of how all exchange money enters and leaves the system as credit money … .  Burley, Evolutionary von Neumann Models, p. 272

 One cannot identify a reduction of basic income (by savings) with an increase in the supply of money (for investment), – (such a reduction is normally a misdirective drain of the basic circuit, not an increase) – for a reduction of basic income is only one source of such supply; moreover, it is neither the normal nor the principal source of such supply; … principally the increase in the supply of money is due to the expansion of bank credit, which is necessary to provide the positive (S’-s’O’) and (S”-s”O”) needed interval after interval to enable the circuits to keep pace with the expanding productive process. [CWL 15, 142]

Finally, provided (D’-s’I’), (D”-s”I”), G vary only slightly from zero, so that their action is absorbed by stocks of goods at the final markets, they exercise a stimulating effect in favor of positive or negative circuit acceleration; otherwise their action pertains either to superimposed circuits of favorable balances of foreign trade and deficit government spending, or else to the cyclic phenomena of booms and slumps.  (CWL 15, 64-65)

 Inflation should be avoided.

the dummy must be constant in exchange value, so that equal quantities continue to exchange, in the general case, for equal quantities of goods and services.  The alternative to constant value in the dummy is the alternative of inflation and deflation.  Of these famous twins, inflation swindles those with cash to enrich those with property or debts, while deflation swindles those with property or debts to enrich those with cash; in addition to the swindle each of these twins has his own way of torturing the dynamic flows; deflation gives producers a steady stream of losses; inflation yields a steady stream of gains to give production a drug-like stimulus. [CWL 21, 37-38]

A slump is explained primarily in terms of relative rates of production: dQ”/Q”  vs.  dQ’/Q’.

 until the position of the strong1 is undermined by the general and prolonged contracting, the requirement2 for the rate of losses continues, and with it the depression. … On the other hand, increasing contraction and liquidation tends to reduce the requirement for a rate of losses: with the surplus stage3 already operating at a minimum3b, any further reduction of the basic stage means that a zero dQ”/Q” is greater than a negative dQ’/Q’; this postulates4 an increasing rate of savings, and under the circumstances, this increase of required savings (since actual savings already are too great) is a reduction of losses.5  Thus the greater the contraction, the less the rate of losses required; again, the greater the contraction, the weaker the position of the initially invulnerable6; in the limit the rate of losses will disappear, and a distorted equilibrium7 give place to a true equilibrium.8  Meanwhile, obsolescence will have mounted, and so as orders for replacements begin to increase they will be accompanied by surplus purchases that are new fixed investment; v9 begins to increase, and the proportionate expansion of the revival is underway. [CWL 15, 155-56]

The enlightened self-interest of entrepreneurs would include an understanding by these entrepreneurs of the shift in incomes required throughout a phased expansion.  Incomes are what enables purchases.  In the aggregate, failure to provide sufficient incomes is to shoot oneself in the foot.  Labor unions must also be enlightened.

During the long-term surplus expansion there is a systematic necessity to let the rich get richer by, initially credit, and then savings.  The savings may be achieved in the form of freely-performed savings or in the form of forced savings through the higher prices and reduced purchasing power effected by surplus flows through the basic circuit.  Similarly, the systematic necessity to let the poor get richer during the basic expansion may work itself out through higher wages and salaries or reduced selling prices. Thus, the human drivers of the system can themselves effect the normative adjustments through higher or lower incomes or higher or lower selling prices.

The purpose of this section is to inquire into the manner in which the rate of saving W is adjusted to the phases of the pure cycle of the productive process.  Traditional theory looked to shifting interest rates to provide suitable adjustment.  In the main we shall be concerned with factors that are prior to changing interest rates and more effective.  [CWL 15, 133]

… …  Evidently, then, suitable migrations (among strata of incomes) are a means of providing adjustments in the community’s rate of saving.  To increase the rate of saving, increase the income of the rich; while they may be too distant from the current operations of the economic process to judge, at least they can put their money into the bank or bonds or stocks, and perhaps others there will see how it can best be used.  To decrease the rate of saving, increase the income of the poor. … The foregoing is the fundamental mode of adjusting the rate of saving to the phases of the productive cycle. [CWL 15, 133-134]

when profit shifts from being a motive to being a criterion, however, then the inevitable and reasonable tapering off to zero of profits as pure surplus income goes against mistaken expectations.  This may induce measures akin to panic on the part of capitalists, who drain the basic circuit in order to keep surplus profits and incomes accelerating – which is one of the ways the pure cycle is transformed into the booms and slumps that economies usually experience.  Something like the same mistaken reasoning based on profit as a criterion and not only a motive underpins the reaction of labor unions to the tremendous increases in profits and income in the earlier phases of the surplus expansion (CWL 15, 138)  Insofar as their demands for higher wages are out of season, they represent one group’s misguided attempt to claim for itself what is actually the social dividend of a society-wide aggregate.  This would be another way of misreading the demands of the pure cycle (CWL 15, 128-129) [CWL15, Editors’ Introduction lxvi]

Something like the same mistaken reasoning based on profit as a criterion and not only a motive underpins the reaction of labor unions to the tremendous increases in profits and income in the earlier phases of the surplus expansion (MD:ECA 138) [CWL15, Editors’ Introduction, lxvi]

 Lonergan’s Summary of the Argument:

The present inquiry is concerned with relations between the productive process and the monetary circulation.  It will be shown 1) that the acceleration of the process postulates modifications in the circulation, 2) that there exist ‘systematic,’ as opposed to, windfall profits, 3) that systematic profits increase in the earlier stages of long-term accelerations but revert to zero in later stages – a phenomenon underlying the variations in marginal efficiency of capital of Keynesian General Theory, 4) that the increase and decrease of systematic profits necessitate corresponding changes in subordinate rates of spending –  a correlation underlying the significance of the Keynesian propensity to consume, 5) that either or both a favorable balance of trade and domestic deficit spending create another type of systematic profits, 6) that while they last they mitigate the necessity of complete adjustment of the propensity to consume to the accelerations of the process, 7) that they cannot last indefinitely, 8) that the longer they last, the greater the intractability of ultimate problems.  From the premises and conclusions of this analysis it will the be argued 9) that prices can not be regarded (by the stewards of the economy) as ultimate norms guiding strategic economic decisions, 10) that the function of prices is merely to provide a mechanism for overcoming the divergence of strategically indifferent decisions or preferences, and 11) that, since not all decisions and preferences possess this indifference, the exchange economy is confronted with the dilemma either of eliminating itself by suppressing the freedom of exchange or of certain classes of exchanges, or else of effectively augmenting the enlightenment of the enlightened self-interest that guides exchanges.   [CWL 15, 5-6]

 Manipulation of the interest rate is ineffective.

Similarly a lowering of interest rates may encourage the expansion of basic industry; but it also will encourage the expansion of well-intentioned but not well-thought-out innovations, the number of bankruptcies, etc.  What is needed is the egalitarian shift in incomes, that will compensate for the previous and shorter anti-egalitarian shift, and will produce the things that people really need and can learn to purchase without the help of self-seeking advertisers.   [CWL 15, 141 ftnt 198]

Rates of interest, when increasing, encourage saving (but discourage borrowing).  This double edge is not the per se means of effecting the enormous shift in saving to bring about the transition from a slump or a basic expansion to a surplus expansion. [CWL 15, 141 ftnt 198]

Money circulates in circuits to match up with the rhythms of the productive process.  There can be several circuits in a hierarchy; however, for simplicity Lonergan subsumed all but the lowest, point-to-point circuit, into a single point-to-line circuit.  Thus we usually speak of two circuits.

The point-to-line and higher correspondences are based upon the indeterminacy of the relation between certain (surplus) products and the (later ultimate basic) products that (exit the process and eventually) enter into the standard of living. … The analysis that insists on the indeterminacy is the analysis that insists on the present fact: estimates and expectations are proofs of the present indeterminacy and attempts to get round it; and, to come to the main point, an analysis based on such estimates and expectations can never arrive at a criticism of them; it would move in a vicious circle.  It is to avoid that circle that we have divided the process in terms of indeterminate point-to-line and point-to-surface and higher correspondences. [CWL 15, 27-28]

… the productive process was defined as a purely dynamic entity, a movement taking place between the potentialities of nature and products.  In the present section, there has been attempted a dynamic division of that entity..  Elements in the process are in a point-to-point, or point-to-line, or point-to-surface, or even some higher correspondence with elements in the standard of living. … The division is not based upon proprietary differences, … for the same firm may be engaged at once in different correspondences with the standard of living.  Again, it is not a division based upon the properties of things; the same raw materials may be made into consumer goods or capital goods; and the capital goods may be point-to-line or point-to-surface or a higher correspondence; they may have one correspondence at one time and another at another. … the division is, then neither proprietary nor technical.  It is a functional division of the structure of the productive process: it reveals the possibilities of the process as a dynamic system, though to bring out the full implications of such a system will require not only the next two sections, on the stages of the process, but also later sections on cycles. [CWL 15, 26-7]

Two, Three or More Circuits; Point-to-Line, Point to Surface, Point to Volume etc.  On page 22 of CWL 15 there are two lists to demonstrate the (“horizontal”) sequence of operations over time from the potentialities of nature to finished cotton dresses and to finished machine tools. In these two lists, one can sort out – rather than the (“horizontal”) sequence of contributions to a finished consumer product – the several (“vertical”) levels of capital goods and the one level of consumer goods within the economic process.  There may be, for example, 4 levels of production in a “stack” of levels: 3 levels of capital-goods production and one level of consumer-goods production.  Level 4 supplies to level 3 tools to make machine tools; level 3 supplies machine tools to sewing machine manufacturers on level 2; the sewing machine manufacturers on level 2 supply sewing machines to level 1. Finally level 1 supplies clothing which exits the process and is consumed in a standard of living.

In most places, for a simple yet an adequate demonstration of economic principles, we have combined all capital goods circuits (levels 4 through 2) into a single “surplus” level.  Thus, instead of a 4 circuits of outlays-incomes-expenditures-receipts with 4 crossovers up one level for repair-and-maintenance and expansionary capital and 4 crossovers merging down to the consumer-goods level, we have 2 circuits connected by crossovers.  So, instead of point-to-surface, point-to-volume, or higher correspondences, we need deal simply only with the correspondence of current-determinate-pointflow-to-current-determinate-pointflow and current-determinate-point-to-future-indeterminate-lines-of-flows.[1]

Need the moral be repeated?  There exist two circuits, each with its own final market.  The equilibrium of the economic process is conditioned by the balance of the two circuits: each must be allowed the possibility of continuity, of basic outlay yielding an equal basic income and surplus outlay yielding an equal surplus income, of basic and surplus income yielding equal basic and surplus expenditure, and of these grounding equivalent basic and surplus outlay.  But what cannot be tolerated, much less sustained, is for one circuit to be drained by the other. That is the essence of dynamic disequilibrium. [CWL 15, 175]

The prime cause of economic problems is ignorance.

In equity (the basic expansion following the surplus expansion) should be directed to raising the standard of living of the whole society.  It does not.  And the reason why it does not is not the reason on which simple-minded moralists insist.  They blame greed.  But the prime cause is ignorance.  The dynamics of surplus and basic expansion, surplus and basic incomes are not understood, not formulated, not taught….. [CWL 15, 82]

When intelligence is a blank, the first law of nature takes over: self-preservation.  It is not primarily greed but frantic efforts at self-preservation that turn the recession into a depression, and the depression into a crash. [CWL 15, 82]

Booms and slumps must be explained, not merely postulated.

… positive or negative transfers to basic demand (D’-s”I’) and consequent similar transfers to surplus demand (D”-s”I”) belong to the theory of booms and slumps.  They involve changes in (aggregate basic or aggregate surplus) demand, with entrepreneurs receiving back more (or less) than they paid out in outlay (which includes profits of all kinds).  The immediate effect (of these aberrational monetary transfers) is on the price levels at the final markets, and to these changes (in price), enterprise as a whole responds to release an upward (or downward)  movement of the whole economy.  But the initial increased transfers to demand [that is, excess transfers along (D’-s’I’)  and (D”-s”I”) ] are not simply to be supposed.  For that would be postulating without explaining the boom or slump. [CWL 15, 64]

… prices tend to move in the same direction as quantities.  Prices rise in a boom, when quantities increase, to fall in  a slump, when quantities decrease.  However, the causes of such price variations are of two kinds.  There is the normal causation of increasing or decreasing scarcity.  As rates of production increase, competitive demands for labor and for materials, as well as for general services such as power, transportation, credit, and so on, increase. Inversely, as rates of production decline, demand falls off.  On this head, onw would expect price levels to mound increasingly as the expansion developed, that is, imperceptibly in the early period, in more marked fashion once expansion becomes generalized, and in a purely inflationary manner if the maximum if the maximum rates of production possible were attained yet credit continued to be expanded.  Thus, so far from canceling the requirement that E’ vary with Q’ and E” with ŒÆ one may expect price levels to reinforce and augment such variation, though in different degrees as the pressure on general markets is slight, notable, or fatuous. (CWL 15, 130-31)

(In the basic expansion) … There is the same automatic mechanism as before.  Prices fall.  This has the double effect of increasing the purchasing power of income and bringing about an egalitarian shift in the distribution of monetary income. The increase in purchasing power is obvious.  On the other hand, the egalitarian shift in the distribution of income is, in the main, a merely theoretical possibility.  The fall of prices, unless quantities increase proportionately and with equal rapidity, brings about a great reduction in total rates of payment.  Receipts fall, outlay falls, income falls.  The incidence of the fall of income, in the first instance, upon the entrepreneurial class, and so in the main it is a reduction of surplus income.  Thus we have the same scissors action as before: purchasing power of income increases, and the proportion of basic to surplus income increases; the rate of saving is adjusted to the rates of production as soon as the price level falls sufficiently.  But just as there is an upwardprice spiral to blunt the edge of the mechanism when the rate of saving is increasing, so there is a downward spiral to have the same effect when the rate of saving should be decreasing.  Falling prices tend to be regarded as a signal that expansion has proceeded too far, that contraction must be the order of the day.  Output is reduced; the income of the lower brackets is reduced; the adjustment of the rate of saving fails to take place; prices fall further; the same misinterpretation arises, and prices fall again.  Eventually, however, the downward spiral achieves the desired effect; surplus income is reduced to the required proportion of total income; and the prices cease to fall. [CWL 15, 138-39]


[1] See CWL15, 22-25