Balik Rate

The hank rat I I e rate at which the central bank of a countrj i 111m,;It. discount first class. bills. It is, thus the rate of discount of the central banks, while the market rate I the rate of discount prevailing in the money mar et among the other lending institutions. Since the central bank is only the lender of the last resort, the ban rate is normally higher than the market rate. The tenn ‘rate of in te res I’ is the rate which the commercial banks pay to those who keep deposits with them. The hanks’ call rate is the rate at which money i. advanced by hanks for very short periods to bill brokers, etc. In a perfectly developed money market. all these rates bear a more or less constant relationship with each other. Before World War I, for instance, in England the banks usually fixed their deposit rate. t T per cent below the bank rate. The call rate was fixed usually ~ per cent above the deposit rate to enable the banks to have a margin of profit between what they charged and what they paid. The banks charged about I per cent above the bank rate on advances to their customers, subject to a minimum of 5 per cent. The relationship between the bank rate and the market rate ?f discount was determined by the conditions of the money mal kct. Under such conditions, therefore, if the bank ratc was changed all the other rates nom’ Illy moved in the ‘C same direction, though this did not always happen as we ~hall see, In countries, where the money market is not so wcll organised, the relationship between the bank ratc and thc other rates is not so close. To that extent, therefore. the central bank is unable to influence these other rates by changing its own rate of discount. Theory of Bank Rate Policy, According to the theory, changes in the bank rate of the central bank arc followed by corresponding changes in all the local money rates. If the bank is raised, the market rates and other lending rates of the money market also go up, Conversely, the market rate of discount and the other rates go down when the central bank lowers its ban” rate. These changes affect the supply and demand for money. Borrowing is discouraged when the rates go up and encouraged when they go UOWI!. In the former case a contraction of credit and in the latter its expansion, is the result. The now of foreign short-term capital is also affected. There is an inflow of foreign funds when the rates arc raised and .an outflow when they arc lowered. Internal price-level tends to fall with the contractionof credit and it tends to rise with its expansion.  Business activity, both commercial and industrial, is stimulated when thl rates of interest arc low, and discouraged when thcy arc high. An adverse balance of intemationaltrade can be corrected through lowering of domestic costs and prices by contraction of credit, since this stimulates exports ami discourages import.

Bank Rate I’nlicy under (;old Standard, The theory of this policy is specially adapted to gold standard. It operated most successfully, therefore, in Great Britain before 1914. Under gold standard, an adverse balance or trade is indicated by movement of the exchange rate to the gold export point and outnow of gold This may be duc to excessive export of capital or e cessivc import of merchandise. Converscly. When the balance of payments” is favourable, there is an inflow of gold. Under _uch conditions, raising of the bank rate led (0 contraction of credit. This was Followed hv greater sale of commodities and securities smcc their holding became more costly due to higher rates of intercst. fall in domestic demand due to fall in the incomes of various groups. decline in new investmcnt and speculation and fall in prices and wages. The ultimate result was encouragement of exports, inflow of foreign capital, discouragement in  the withdrawal of foreign capital, etc. In due course. equilibrium was restored and the outflow of gold stopped. If the policy was continued long enough, there would be inflow of gold, thus relieving credit stringency. lowering money rates and reviving business activity,