Business Cycle and Stabilization Policies

By : Gaurang Badheka MEBE, Sem-4

Business cycle
The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (expansion or boom), and periods of relative stagnation or decline (contraction or recession).

Business cycle

Business cycle
Contraction - When the economy starts slowing down. Trough - When the economy hits bottom, usually in a recession. Expansion - When the economy starts growing again. Peak - When the economy is in a state of "irrational exuberance."

Business cycle
Annual % change in real GDP 15

First World War boom

Second World War boom Change in real GDP

10
5

0
-5 - 10 1920-21 Recession 1937-38 Recession Great Depression

- 15 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 1915 1925 1935 1945 1955 1965 1975 1985 1995 2005

Business cycle
Reasons behind business cycle
Trend Seasonal Cyclical Irregular / random

Features of business cycle

It occurs periodically. It is synchronic. Fluctuations in many variables. Investment & consumptions of various goods. Effects on inventories. Profit fluctuate more than any other income. It is international in character.

Theories of business cycle

Sun-spot theory Hawtreys monetary theory Under consumption theory Over investment theory
Hayeks monetary version Wiksells over-investment theory

Stabilisation policies
A stabilization policy is a package or set of measures introduced to stabilize a financial system or economy. The term can refer to policies in two distinct sets of circumstances: business cycle stabilization and crisis stabilization. Stabilization can refer to correcting the normal behavior of the business cycle. In this case the term generally refers to demand management by monetary and fiscal policy to reduce normal fluctuations and output, sometimes referred to as "keeping the economy on an even keel."

Stabilisation policies
Goals of stabilisation policies :
A stable growth of real GDP A relatively stable level of price A high level of employment (low level of unemployment)

Stabilisation policies
Tools:
Fiscal policies
Government expenditure Taxation Subsidies and transfer payments

Monetary policies
Open market operations CRR, SLR, Bank Rate, repo Selective credit control Moral persuasions

Stabilisation policies
Two kind of policy stance
Easy, liberal or expansionary Dear, tight or contractionary

Stabilisation policies
about two policy debates: 1. Should policy be active or passive?
2. Should policy be by rule or discretion?

Stabilisation policies
Should policy be active or passive?
Argument for active policies Arguments against active policies

Stabilisation policies
Should policy be conducted by rule or discretion?
Policy conducted by rule: Policymakers announce in advance how policy will respond in various situations,and commit themselves to following through. Policy conducted by discretion: As events occur and circumstances change, policymakers use their judgment and apply whatever policies seem appropriate at the time.

Fiscal policy
Fiscal policy methods
Increase in government expenditure Reduction of taxes

Financing government expenditure

Borrowing Creation of new money

Govt. expenditure vs. taxes Non-discretionary fiscal policy

Monetary policy
Tools of monetary policy
Open market operation Changing the bank rate Changing CRR and SLR Selective credit control

Expansionary monetary policy Tight monetary policy

Some questions ?????

Which policy is more effective? What are the problems in implementing the policies? Fiscal deficit? Is fiscal deficit really bad? Can fiscal deficit create a problem for the country? OR at what level the fiscal deficit is sustainable? Policies to control inflation and deflation.