In agricultural countries where peasants readily hoard money, an inflation, especially in its early stages, does not raise prices proportionately, because when, as a result of a certain rise in the price of agricultural products, more money flows into the pockets of the peasants, it tends to stick there;—deeming themselves that much richer, the peasants increase the proportion of their receipts that they hoard.
Thus in these and in other ways the terms of our equation tend in their movements to favour the stability of p, and there is a certain friction which prevents a moderate change in n from exercising its full proportionate effect on p.
On the other hand a large change in n, which rubs away the initial friction, and especially a change in n due to causes which set up a general expectation of a further change in the same direction, may produce a more than proportionate effect on p. After the general analysis of Chapter I. and the narratives of catastrophic inflations given in Chapter II., it is scarcely necessary to illustrate this further,—it is a matter more readily understood than it was ten years ago. A large change in p greatly affects individual fortunes. Hence a change after it has occurred, or sooner in so far as it is anticipated, may greatly affect the monetary habits of the public in their attempt to protect themselves from a similar loss in future, or to make gains and avoid loss during the passage from the equilibrium corresponding to the old value of n to the equilibrium corresponding to its new value. Thus after, during, and (so far as the change is anticipated) before a change in the value of n, there will be some reaction on the values of k, k´, and r, with the result that the change in the value of p, at least temporarily and perhaps permanently (since habits and practices, once changed, will not revert to exactly their old shape), will not be precisely in proportion to the change in n.
The terms inflation and deflation are used by different writers in varying senses. It would be convenient to speak of an increase or decrease in n as an inflation or deflation of cash; and of a decrease or increase in r as an inflation or deflation of credit. The characteristic of the “credit-cycle” (as the alternation of boom and depression is now described) consists in a tendency of k and k´ to diminish during the boom and increase during the depression, irrespective of changes in n and r, these movements representing respectively a diminution and an increase of “real” balances (i.e. balances, in hand or at the bank, measured in terms of purchasing power); so that we might call this phenomenon deflation and inflation of real balances.
It will illustrate the “Quantity Theory” equation in general and the phenomena of deflation and inflation of real balances in particular, if we endeavour to fill in actual values for our symbolic quantities. The following example does not claim to be exact and its object is to illustrate the idea rather than to convey statistically precise facts. October 1920 was about the end of the recent boom, and October 1922 was near the bottom of the depression. At these two dates the figures of price level (taking October 1922 as 100), cash circulation (note circulation plus private deposits at the Bank of England[23]), and bank deposits in Great Britain were roughly as follows:
[23] It would take me too far from the immediate matter in hand to discuss why I take this definition of “cash” in the case of Great Britain. It is discussed further in Chapter V. below.
| Price Level. | Cash Circulation. | Bank Deposits. | |
| October 1920 | 150 | £585,000,000 | £2,000,000,000 |
| October 1922 | 100 | £504,000,000 | £1,700,000,000 |
The value of r was not very different at the two dates—say about 12 per cent. Consequently our equation for the two dates works out as follows[24]:
| October 1920 | n = 585 | p = 1·5 | k = 230 | k´ = 1333 |
| October 1922 | n = 504 | p = 1 | k = 300 | k´ = 1700 |
[24] For 585 = 1·5(230 + 1333 × ·12), and 504 = 1(300 + 1700 × ·12).