On the other hand, the community of banks is supposed to be somewhat insensitive to what is happening to the field of business, to the prospects, condition, etc., of the economic enterprises to which they are to intrust their funds. It is assumed that the factor which is quoted as the one which accounts for the peculiarities of banking policy, be it the economic reason of striving for greater gains, or the public pressure upon banks for low rates, or the influence upon a given bank of an expansion begun by another bank, exercises its full effect on banking policy without any complication by the circumstances in which the banks may find their prospective customers. It is obviously in a combination of this sensitivity of the business community with what might be called the single-track-mindedness of the banking community that the key to the banking theories of business cycles is to be found.

One might note that such a queer distinction between the two economic groups arises from the assumption of the equilibrium system, on the one hand, and the necessity of explaining cyclical fluctuations, on the other. All of the theoretical variants discussed in the foregoing assume that conditions of economic life correspond to the static equilibrium system. In such conditions there will be, of course, a highly sensitive reaction of economic individuals to such a change in costs as will be brought about by some misapplied action on the part of the banks. There is supposed to be a persistence of relations and of conditions, so that there is no possibility that any part of the system will fail to react to any change that is supposed to have occurred. If one doubts that such an exact picture is in the mind of the theorists whom we are discussing, one can hardly deny that this would be the assumption in the background if they attempted to formulate it definitely.

But the existence of cyclical fluctuations necessitates the introduction of a factor which would provide the disturbing element and explain this continual variability in the behavior of the business community. And if some peculiarity of the banking community's behavior is found to be a factor in the situation, it obviously would have been both a violation of the theo

retical assumption of the equilibrium economy and a detraction from the clear-cut working of this peculiarity, if it were suggested that the banking community does not act only or predominantly under the influence of the peculiarity singled out. It is in the type of approach to the problem that one must seek the reason for that peculiar combination of overemphasized fact and intellectual fancy which characterizes most of the variants of the banking theories of business cycles.

These general remarks serve as background to a list of critical reflections that suggest themselves in connection with the variants presented in the foregoing:

1. The whole question as to whether the business community is sensitive to changes in interest rates is still very much of a problem. The discussion which has taken place but recently between Carl Snyder and Waldo F. Mitchell26 has shown that, without deciding the argument one way or another, one may still be in doubt whether the variations in interest rate on loans, confined as they are to only a part of the large volume of loans outstanding in the economic system, are of decisive importance to the business community, even if we take into consideration the marginal operations. Recent cost-accounting studies show what a small part of the total cost of business interest charges play. The burden of proof is therefore on the banking theories of business cycles. They must provide a more specific explanation of the channels through which variations in the interest rate influence the volume of business activity undertaken. Some of them do it, e.g., Hawtrey, who claims that variations in interest rate are of utmost importance first of all to wholesalers, who, according to him, hold the key position as far as the inception or reversal of a cyclical movement is concerned. But unless we have this link between changes in interest rates and the fluctuations in the volume of business stated more fully, we can neither accept the assumption of this connection nor thoroughly evaluate the theory which is based upon it.

2. In the consideration of banking policy in regard to the

"See American Economic Review, December, 1925, June, 1926, September, 1926, December, 1926, Annual Supplement for 1926.

establishment of a charge for their credit services, all the variants in the foregoing omit completely the element of risk. Whether we say with Mises that banks can charge cheaply, because they can produce credit, and are urged to do so by public pressure; whether we say with Budge that they are prompted to charge cheaply by the prospect of larger gain; whether we say with Hayek that they are pressed to do so by competition; or whether we agree with Eucken that they consider mostly their liquidity; it is obvious that banks consider first of all the question of risk, and that their charge must provide for the coverage of possible losses. The consideration of this element has therefore two consequences: (a) the element of risk involved raises the costs of credit creation; (b) the consideration of the risk element introduces a whole range of factors which determine banking policy. If banks advance loans to business men, they are obviously called upon to exercise their judgment, not only as to the willingness of their customers to pay, but also to their prospective ability. And while they may consider themselves protected partly by the business man's capital, they will be called upon to exercise some discretion with an eye to the future of the loan, and the advisability of financing this or that undertaking for a given purpose. The risk element obviously makes the banking policy of advancing loans subject to some of the influences which guide the business community at large. And along the same lines, it can be said that central banks have in mind, not only profits to be made from a large volume of rediscounting business, but also the general state of the economic system in regard to some vaguely felt notion as to the normal course of events.

These two objections relate to all the variants which we have been discussing. In regard to each of them, some more specific critical reflections may be added; but they would involve going more deeply into the factual basis of the general objections already stated. But in regard to Hayek's thesis it may be suggested that:

3. If any increase in the volume of credits advanced by a single bank forms a permanent addition to the total volume of

bank credits outstanding (because of the spread of this change through the whole banking system) so does every contraction in the volume of credits advanced by a single bank form a permanent contraction. And if we have before us the picture of the banking system as a whole, we have to assume that the total volume of loans is undergoing a net increase through the fact that there are more loans advanced than loans withdrawn. The interconnection which characterizes the banks in the system works both ways, and therefore presents no independent factor in the situation. We still have to explain why in the banking system as a whole there is a net increase in the volume of loans, and why this is made without any change in the rate charged for credit. It has to be explained why the initial bank was either able to expand without impairing its usual liquidity ratio or why it expanded with the impairment of its liquidity ratio. If this single bank received additional cash, was not there a loss of cash in some other bank? If the bank augmented its loans outstanding without any corresponding increase of cash in its vaults, why should it not have charged more for its service in view of the impairment of its usual ratio of liquidity? It seems to me that the taking of a single bank as a starting-point, instead of speaking of the banking system as a whole, does not change essentially the argument within the limits imposed by the assumptions of a banking theory of business cycles.

While the general approach which characterizes the variants discussed prevents them from going deeply into the problem and thus detracts a great deal from their value to a serious student of the problem, their factual content is of considerable interest. It is valuable to know and to emphasize the peculiar conditions under which the functioning of the banking mechanism takes place in our economic system. It is of considerable interest to note the social pressure under which it functions. It is of importance to find out whether the pursuance of motives of gain leads the banking system into credit policies that are erroneous from the point of view of the economic system as a whole. It is interesting to find out whether the elasticity in the supply of credit, and the impossibility for the single banks to

act until it is too late, is of significance in the explanation of the cyclical fluctuations. It may be highly significant to observe that the banking system is in position and under inner compulsion to function in such a way as to account for the turns in the cyclical swing. But all these factors have to be studied further and evaluated in the light of inductive studies, since the theoretical approach which led to the singling out of these factors provides for them too narrow and too artificial a setting." SIMON KUZNETS

NATIONAL BUREAU OF ECONOMIC RESEARCH

27

* In the preceding survey, I have not included any discussions which, while emphasizing the monetary element, do not make it an exclusive cause of cyclical fluctuations. The following discussions are of this character:

Carl Rosch, Kreditinflation und Wirtschaftskrisen (Jena, 1927).

W. Röpke, "Kredit und Konjunktur," Jahrb. für Nationalökonomie und Statistik, LXIX (1926), 243–85.

J. Baracs, "Zins, Kredit und Konjunktur," Archiv für Sozialwissenschaft und Localpolitik, Vol. LIX (1928).

Neither have I discussed the theories of A. Hahn, since they do not seem to form an independent business-cycle hypothesis. A good summary of some of the theories discussed may be found not only in the article of Burchardt referred to in the text, but also in A. Michaelis, Die Quantitatstheorie als Grundlage der Konjunkturforschung (Jena, 1929).