It is outside the scope of this book to deal thoroughly with the theory of international values. But there are certain brief prolegomena to such a theory, which are necessarily in place in a treatise on money.

RELATIVE PRICE LEVELS AND RELATIVE INTEREST RATES AS CAUSES OF MONETARY DISEQUILIBRIUM

We have seen that equilibrium in an international currency system requires that for each country its rate of foreign lending should be equal to its foreign balance. Now this involves two sets of conditions. For the rate of foreign lending depends on relative interest rates at home and abroad; whilst the foreign balance depends on relative price levels at home and abroad.

There is, however, a radical difference between a disequilibrium which is set up by the relative price levels falling out of gear and a disequilibrium which is set up by the relative interest rates falling out of gear. In the first case, the disequilibrium can be cured by a change in price levels (or, rather, of income levels) without any permanent change in interest rates, though a temporary change in interest rates will be necessary as a means of bringing about the change in income levels. In the second case, on the other hand, the restoration of equilibrium may require not only a change in interest rates, but also a lasting change in income levels (and probably in price levels).