A Tract on Monetary Reform

by John Maynard Keynes

To complete the argument, one further factor, not yet mentioned, must be introduced, namely (d) the proportion of the banks’ second-line reserve in the shape of their holdings of Treasury Bills, which can be regarded as cash at one remove. In determining what is a safe proportion of “cash,” they pay some regard to the amount of Treasury Bills which they hold, since by reducing this holding they can immediately increase their “cash” and compel the Treasury to borrow more either from the Currency Note Reserve or from the Bank of England. The ninefold proportion referred to above presumes a certain minimum holding of Treasury Bills, and might have to be modified if a sufficient volume of such Bills was not available. This factor (d) is, however, also important because the banks in their turn are open to pressure by the Treasury, whenever it draws to itself the resources of their depositors—whether by taxation or by offering them attractive longer-dated loans—and uses them to pay off, if not Ways and Means advances from the Bank of England (which reduces the banks’ first-line reserve of cash), then alternatively Treasury Bills held by the banks themselves (which reduces their second-line reserve of bills).

Items (a), (b), (c), and (d) together, therefore, more or less settle the matter. For the purpose of the present argument, however, we need not pay much separate attention to (a) and (b), since their effect is, for the most part, reflected over again in (c) and (d). (a) depends partly on the volume of trade but mainly on the price level itself; and in practice fluctuations in (a) do not directly affect the banks’ “cash,”—for if more notes are required under (a), more notes are issued, the Treasury borrowing a corresponding additional amount from the Currency Note Reserve, in which case the Treasury either repays the Bank of England, which diminishes the Bank’s assets and consequently the other banks’ “cash,” or withdraws an equivalent amount of Treasury Bills, which diminishes the other banks’ second-line reserve; i.e. a change in (a) operates on the banks’ resources through (c) and (d).[53] Whilst as for (b), a change in the amount of what the Treasury borrows from the Currency Note Reserve is reflected by a corresponding change in the opposite sense in what it borrows in Ways and Means Advances or in Treasury Bills.

[53] If the additional issue of notes is covered by transferring gold from the Bank of England, this is merely an alternative way of diminishing the Bank of England’s assets.

Thus we can concentrate our attention on (c) and (d) as the main determining factors of the price level.

Now (c), namely the assets of the Bank of England, consist (so far as their variable part is concerned) of

(i.)	Ways and Means advances to the Treasury.
(ii.)	Gilt-edged and other investments.
(iii.)	Advances to its customers and bills of exchange.
(iv.)	Gold.

An increase in any of these items tends, therefore, to increase the other banks’ “cash,” thereby to stimulate the creation of credit, and hence to raise the price level; and contrariwise.

And (d), namely the banks’ holdings of Treasury Bills, depend on the excess of the expenditure of the Treasury over and above what it secures (i.) from the public by taxation and loans, (ii.) from the Bank of England in Ways and Means advances, and (iii.) by borrowing from the Currency Note Reserve.

It follows that the capacity of the Joint Stock banks to create credit is mainly governed by the policies and actions of the Bank of England and of the Treasury. When these are settled, (a), (b), (c), and (d) are settled.

How far can these two authorities control their own actions and how far must they remain passive agents? In my opinion the control, if they choose to exercise it, is mainly in their own hands. As regards the Treasury, the extent to which they draw money from the public to discharge floating debt clearly depends on the rate of interest and the type of loan which they are prepared to offer. A point might be reached when they could not fund further on any reasonable terms; but within fairly wide limits the policy of the Treasury can be whatever the Chancellor of the Exchequer and the House of Commons may decide. The Bank of England also is, within sufficiently wide limits, mistress of the situation if she acts in conjunction with the Treasury. She can increase or decrease at will her investments and her gold by buying or selling the one or the other. In the case of advances and of bills, whilst their volume is not so immediately or directly controllable, here also adequate control can be obtained by varying the price charged, that is to say the bank rate.[54]