Thus,the raising of the bank rate has two effects:
(i) lunuedlate, and (ii) ultunatc.. lmmediatcly. borrowing is discouraged as the discounting of bills becomes a costly affair. Money. therefore. docs not leave the banks. Instead. funds flow in even from abroad as the raising of the bank rate is followed by the raising of the hankers’ deposit rate. liltimatcly. prices fall through contraction of credit and currcney. Exports arc stimulated and imports arc checked. The objective of raising the bank rate is thus achieved. I’i<.., drain of gold out of the country is checked and, instead, gold collies in.
Conversely, if there was a continued inflow of gold, the central bank would lower the bank rate. TIllS would cheapen money and encourage expansion of credit, trade, production. investment and speculation . It would raise domestic prices and costs. encourage imports and discourage exports Invesuncnt in foreign countries would be encouraged. If the policy is continued long enough, an adverse balance of payment would arise and gold inflow would be changed into outflow. Limiting Conditions or BanI- Rate Policy. For a successful working of such a policy. a little rctlcction will show (hat a number of conditions have to be satisfied: (i) All the other ra e . hould follow the hank rate in its movement 0 that creJit should expand and contract as the. may be. (ii)·.1C :unomic. tructurc of the country should be clastic utI t changes in credit conditions should lead t rrc ponding changes in wages, reut-. pro· duct m, radc. etc. . In cll-organiscd money ma: kct like that of Great Britain. the first condition is satisfied. In Great Britain, as we have seen, all other rates hare a more or I’ con: taut relationship with the bank rate as a matter of convention.
As regards the second condition. again. conditions in Great Britaiu were most favourable. especially before 1924. The economic structure was fairly clastic. Wages. rfnts and production responded within limits to changes in money rates and credit conditions . In subsequent years the British economic structure considerably lost its old elasticity. This w IS due to various reasons among which were the breakdown of the gold standard and coming in of the managed currency and regulation of wages and nrices As regards other countries, the hank rate policy was always much less successful due to the absence of the above two conditions. The decline 111its relative importance is due to changes in money market conditions and the greater rigidity of the economic system as already noted 32 4000 .!Y .S 3000 &! 2000 Several recent developments in the money markets have made the bank rate policy less efficacious. For instance, domestic trade is financed now more through bank overdrafts and less through hills of exchange which play an important pan in discounting operations. l-orcign bills have also lost a good deal of their importance due to the fact that London no longer enjoys the same financial status as it used io bcfoi e the war of 1’114-111. Moreover. short-term Treasury Bills have taken the place of bills of exchange for short-term investments. This has increased the influence of the Treasury over the money market. Moreover, the old sensitivity of business with regard to changes in the rate of interest has been greatly reduced by increased resort to self-financing of bus incss investment nut ofundistrib cd profits. Thc businessmen do not depend 011 borrowed funds as much as they did before with the result.that a change in the rate of interest. and interest is the price of borrowing. leaves them unmoved.