business cycles and policies new (1)

7/31/2019 Business Cycles and Policies New (1)

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BUSINESS CYCLE ANDPOLICIES

Ankita Nigam (51)

Ruchi Sharma (52)

Ritika Chitnis (53)

Chandana Awasthi (54) Tushar Tiwari (55)

Rachna Chandrashekhar (56)

Nirmal Gulabani (57) Bindal Thakkar (58)

Sneha Kulkarni (59)

Ankit Srivastava (60)


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WHAT ARE BUSINESSCYCLES ?

Recurring and fluctuation level experienced inthe aggregate economic activity of nation overa period of time.

It varies from one year to ten or twelve years.

Involves phases of growth and decline in aneconomy.


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Business Cycles Contd

measured by real G.D.P

Average duration of expansion -45months.

average duration of recession -11 months


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THE STAGES

EXPANSION

Speed up in the pace of economic activity

high level of effective demand resulting in highproduction

Employment growth with rise in income.

G.D.P growth rate is positive.


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PEAK

Optimum production and rise in employment.

Inflationary pressure and rise in bank rates.

Rise in the prices of raw material and finishedgoods.

indicator of an upcoming contraction


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CONTRACTION

Slow down in economic activity.

slow down in production output andemployment rates.

decrease in bank rates to boost business


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RECOVERY

Expansions and rise in economic activities.

Steady rise in output, income, employment,price and profits.

Increase investments

Business expansion takes place, stocks areactivated.


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WHO DETERMINES THEBUSINESS CYCLE STAGES?

The National Bureau of Economic Research(NBER) analyzes economic indicators todetermine the phases of the business cycle.
http://useconomy.about.com/od/economicindicators/u/economic_indicators_trends.htmhttp://useconomy.about.com/od/economicindicators/u/economic_indicators_trends.htm


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WHAT CAUSES BUSINESSCYCLE?

The business cycle is affected by all theforces of supply and demand. Whenconsumers are confident, they buy now

knowing there will be income in the future frombetter jobs, higher homes values andincreasing stock prices.
http://useconomy.about.com/od/supply/Supply.htmhttp://useconomy.about.com/od/supply/Supply.htm


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Causes of Business CycleContd..

In addition to demand, the business cycle isalso heavily dependent on the availabilityofcapital. This is known as liquidity, and is itself

dependent upon interest rates. Too muchcapital will turn a healthy expansion into apeak, at which point greed will bid up the priceof assets, often causing inflation.
http://useconomy.about.com/od/supply/p/Capital_Supply.htmhttp://useconomy.about.com/od/interestrateindicators/p/interest_rate.htmhttp://useconomy.about.com/od/interestrateindicators/p/interest_rate.htmhttp://useconomy.about.com/od/supply/p/Capital_Supply.htm


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Causes of Business CycleContd..

At this point, a stock market correction mayindicate that assets are overvalued, creatingfear and a contraction. The Federal Reserve

lowers interest rates to spur the economy intoexpansion during a trough. It raises ratesduring an expansion to avoid too much of apeak.

A troughusually is accompanied by arecession and a bear market, while anexpansion is usually signaled by a bull

market and inflation.
http://useconomy.about.com/od/glossary/g/Market_Correcti.htmhttp://useconomy.about.com/od/glossary/g/Bear_market.htmhttp://useconomy.about.com/od/glossary/g/Bull_Market.htmhttp://useconomy.about.com/od/glossary/g/Bull_Market.htmhttp://useconomy.about.com/od/glossary/g/Bull_Market.htmhttp://useconomy.about.com/od/glossary/g/Bull_Market.htmhttp://useconomy.about.com/od/glossary/g/Bear_market.htmhttp://useconomy.about.com/od/glossary/g/Market_Correcti.htm


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Business Policies

Business policies refer to the actions that theGovernment takes in the economic field tocover the systems for setting interest rates and

Government budget.

Monetary

Policies

FiscalPolicies

Business Policies


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Monetary Policies

Harry Johnson defines it as a policy

employing central banks control of the supply

of money as an instrument of achieving the

objectives of general economic policy.

It is a programme of action undertaken by the

monetary authorities, generally the CentralBank, to control and regulate the supply ofmoney with the public & the flow of credit.


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Scope of monetary policy

The scope spans the entire area of economictransactions that the monetary authorities can influenceby making changes in monetary policy instruments. Thescope depends upon two factors:

The level of monetization of the economy

The level of development of capital market.

The monetary policy to have a widespread impact on theeconomy, other capital sub-markets must have a strongfinancial link with the commercial banks.


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Instruments of monetarypolicy

It refers to the economic variables that thecentral bank can change at its discretion with aview to controlling and regulating the supply anddemand for money and availability of credit.

Also called as weapons of monetary control &

the Nuts & Bolts of monetary policy.

Quantitative measures

Qualitativemeasures


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Quantitative Measures

It is a traditional measure of monetary control.

It is classified as follows:

Open market operations

Discount rate

Cash reserve ratio

Statutory liquidity Requirement(SLR)


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It is sale and purchase of government securities andtreasury bills by the central bank of the country.

The central bank carries out its open market operations

through the commercial banks & not directly with the public.

The sale of government bonds & securities affect the supplyof credit by affecting the credit creation capacity of the banks

& demand for credit by changing the rate of interest.

The buy-back of government bonds & securities increasesthe monetary flow from central bank to the public throughcommercial banks.

Open Market Operations


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Discount Rate

Also known as Bank rate, RBI Act 1935 defines it as-

Standard rate at which the bank is prepared to buy or

rediscount bills of exchange or other commercial paperseligible for purchase under this act.

When central bank wants to increase the credit creationcapacity of commercial banks it decreases the discountrate & when it decides to decrease the same, itincreases the discount rate.

When central bank changes their discount rate,commercial banks also change their own discount rategenerally with a difference of 1%.


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Cash Reserve ratio

It is the percentage of total deposits which commercialbanks are required to maintain in the form of cashreserve with the central bank.

It is expressed as a percent of depositors balances thebank must have on hand as cash.

CRR are non-interest bearing deposits & hence a handytool for central bank to control money supply.

When economic conditions demand a contractionarymonetary policy, the central banks raises the CRR &vice-versa.


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Statutory liquidityRequirement(SLR)

RBI has imposed another reserve requirement inaddition to CRR.

SLR in a way compels the commercial banks to invest ingovernment securities or bonds.

SLR is the proportion of the total deposits whichcommercial banks are statutorily required to maintain inthe form of liquid assets in addition to CRR.

SLR was imposed because commercial banks used tocovert their liquid asset into cash to replenish the fall intheir loanable funds due to rise in CRR.


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Qualitative Measures

They lead either to expansion or contraction of totalcredit and the impact on all the sectors of the economyis uniform.

Following are the common qualitative control measures:

Credit Rationing

Change in lending Margins

Moral Suasion

Direct Control


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Credit Rationing:In order to overcome the problem of shortage of institutional credit

available for business sector, the central bank adopted the followingtwo measures:a) Imposition of upper limits on the credit available to large

industries & firms.b) Charging a higher or progressive interest rate on bank loans

beyond a certain limit .

Moral Suasion: It is a method of persuading & convincing the commercial banks

to advance credit in accordance with the directives of the central

bank in overall economic interest of the country. Under this method, the central bank writes letter to hold meetings

with the banks on money & credit matters.


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Change in Lending Margins:The banks advance money more often than not against amortgage of property.

Banks provide loans only upto a certain percentage of the valueof the mortgaged property . The gap between the value ofmortgaged & amount advanced is called Lending Margin.

This method was used for the first time by RBI in 1949 with theobjective of controlling speculative activity in stock market.However this method is no more used widely in India.

Direct Control:When all other methods prove ineffective, the monetary authoritiesresort to direct control measures with clear directive to carry outtheir lending activity in a specified manner.


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Transmission mechanism ofMonetary policy

The basic approach of monetary policy is to change themoney supply. So the working mechanism of monetarypolicy has to be traced through the effects of change inmoney policy & its effect on real variables.

The central theme of the transmission mechanism isportfolio adjustment by the households & the firms.


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Portfolio Adjustment

It refers to reallocation of total investment betweendifferent forms of assets.

The need for adjustment in portfolio arises due tochange in money in the form of wealth, which causesdisequilibrium in portfolio.

Disequilibrium in portfolio makes asset holders adjusttheir portfolio to regain their equilibrium position. This iscalled portfolio adjustment process.

In this process of adjustment, the equilibrium levels ofincomes & prices change.


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TheMonetaristApproach

TheKeynesianApproach

Portfolio AdjustmentProcess


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Keynesian Approach vs MonetaristApproach

Keynesian Process:

Increase in money supply Increase in cash balanceIncrease in demand for financial assets Fall in interest

rate Increase in investment Increase in theaggregate demand

Monetarist Process:

Increase in Money supply Increase in cash balanceIncrease in demand for real assets Increase in aggregatedemand


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The Keynesian Approach

Under this process of portfolio adjustment process, thefirms & households tend to increase their financial assetsand not in the real assets.

According to Keynesian approach, increase in demandfor financial assets, pushes the price of financial assetsup. As a result, the interest rates go down; whichincreases investment and thus the level of income.

Increase in income causes a rise in aggregate demand,which further results in increase in equilibrium level ofincome and continues till new equilibrium point is

achieved.


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The Monetarist Approach

Under this process of portfolio adjustment process, thefirms & households tend to increase their demand forreal assets and not in the financial assets.

Monetarists treat cash balance and real assets as closesubstitutes.

In this Approach, the aggregate demand can changewithout change in the interest rate.

Li it ti f M t


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Limitations of MonetaryPolicy

1) Time Lag

a. Inside Lag :

- Identifying the nature of the problem

- Identifying the source of the problem- Assessing the magnitude of the problem

- Choice of appropriate policy action

- Implementation of policy actions

b. Outside Lag :Time taken by the household and firms to react to thepolicy action taken.


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2) Problems in Forecasting

Requires magnitude of problems like,

a. Recession

b. Inflation

to be correctly assessed

3) Non banking Financial intermediaries

The proliferation of non banking financial

intermediaries have reduced the share of thecommercial banks in the total credit control.

4) Underdeveloped Money and capital Markets

Effectiveness of monetary policy is less in less

developed countries

Eff ti f M k t


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Effectiveness of open MarketOperation

1) When commercial bank posses excess liquidity, theopen market does not work effectively

2) In buoyant market, effective control for credit through the

open market is doubtful

3) In period of depression, open market operations are noteffective for lack of demand for credit

4) In countries were banking system is not developed andsecurity capital markets are not interdependent, openmarket operations have a limited effectiveness


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Monetary Policy of India

- Policy Objective

Major Objective :

a. Economic Growth

b. Social Justice

c. Price stability

- Targets

To achieve the objective, RBI adopted a reconciliatory approachthat incorporates the various kinds of interactions between real

and monetary sectors.

- Monetary Measures

To control money supply, RBI is using traditional measures:

Open Market Operation, CRR and Bank Rate


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FISCAL POLICIES

Fisc means state treasury

Fiscal policy refers to policy concerning the use

of state treasury or Government finances toachieve the macroeconomic goals.

Fiscal policy is a means by which a governmentadjusts its levels of spending in order to monitorand influence a nations economy.


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SCOPE OF FISCAL POLICY

Scope of fiscal policy is the number of fiscalinstruments and target variables.

Fiscal instruments are the variables thatGovernment can change and make strategy atits own discretion.

The target variables are the macro variablesthat are intended to be changed to achieve theintended results.


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FISCAL INSTRUMENTS

1. Budgetary Balance Policy

2. Government Expenditure

3. Taxation

4. Public Borrowings


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TARGET VARIABLES

1. Intended change in the aggregate demand

2. Private disposable income

3. Private consumption expenditure

4. Private savings and investments

5. Exports and imports

6. Level and structure of prices


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Objectives of Fiscal Policy

To achieve desirable price level

To achieve desirable consumption level

To achieve desirable employment level

To achieve desirable income distribution

Increase in capital formation.


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KINDS OF FISCAL POLICY

DISCRETIONARY

NONDISCRETIONAR

Y


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DISCRETIONARY FISCAL POLICY

It is the deliberate change in the governmentexpenditure and taxes to influence the level ofnational output and prices.

It aims at managing the aggregate demand forgoods and services.

Expansionary fiscal policy is used when the

economy is in recession. Contractionary fiscal policy is used to

control the inflation in the economy.


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EXPANSIONARY FISCAL POLICYFISCAL POLICY TO CURE RECESSION

PRI

CE

LEVEL

AS

AD1

AD2

Y1Y20


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Recession occurs when the aggregate demanddecreases due to the fall in private investment.

When the government adopts expansionaryfiscal policy, it raises its expenditures withoutraising taxes or cuts down on taxes with no

change in expenditure of increases expenditureand cuts down on taxes as well.

This leads to the government having a deficitbudget policy.

TWO FISCAL METHODS TO GET THE ECONOMY OUT OF


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TWO FISCAL METHODS TO GET THE ECONOMY OUT OFRECESSION

Increase in government expenditure

To increase the aggregate demand the governmentincreases its spending and buys various types of goods andmaterials and employs workers. The effect of this increase in

expenditure is both direct and indirect.

Reduction in taxes

This is another measure to cure recession and achieve

expansion in output and employment. The reduction in taxesincreases the disposable income and leads to the increase inconsumption spending by the people.


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CONTRACTIONARY FISCAL POLICYFISCAL POLICY TO CONTROL INFLATION

PRI

CE

LEVEL

AS

AD2

AD1

Y2Y10

P1

P2


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Inflation in the economy occurs due to a situationof excess demand.

This could occur because of large increases inconsumption demand, investment expenditure ora bigger budget deficit caused by too large an

increase in government expenditure. When contractionary policy is adopted, the

government reduces its expenditure or increasesits taxes.

In this case, the government is planning for abudget surplus.


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FISCAL MEASURES TO CONTROL INFLATION

Reducing government expenditureTo decrease the aggregate demand in the economy the

government reduces its spending on goods and services.This creates a surplus in the budget and removes the

excess demand from the economy.

Increase in taxes

Taxes can be increased to reduce aggregate demand.

The hike in taxes reduces the disposable income leading toreduction in consumption demand.

NON DISCRETIONARY FISCAL POLICY


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NON DISCRETIONARY FISCAL POLICYAUTOMATIC STABALIZERS

The tax structure and expenditure pattern are sodesigned that taxes and government spendingvary automatically inappropriate direction with

changes in national income. They automatically raise aggregate demand in

times of recession and reduce it in times ofinflation and help in ensuring economic stability.


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AUTOMATIC FISCAL STABALISERS

Personal Income Taxes

Corporate Income Taxes

Transfer payments

Corporate dividend policy

Fiscal Policy and macro


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Fiscal Policy and macroEconomic growth

1. Fiscal Policy for economic growth

Progressive taxation of personal and

corporate incomes Widespread taxation of all kinds of consumer

goods

Taxation of luxury goods at a prohibitive rate

Imposition of exorbitantly high duty on importof consumer goods



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Fiscal Policy and macroEconomic growth Contd..

2. Public borrowings and economic growth

External debt

Internal debt



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3.Fiscal policy for employment

Heavy taxation of capital intensive goods

Subsidization of labour intensive groups

Heavy duty on imports of capital intensivetechnology

Concessions in customs for import of inputs for

labour intensive products



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4. Fiscal Policy for Stabilization:

Automatic stabilization policy is used for thedeveloped countries

Contra-cyclical fiscal policy should be used forleast developed economies.



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5.Fiscal policy for economic equality

Spending government money on projects thatenhance the earning capacity of the low

income people like free education. Reallocating capital expenditure so as to

enhance the employment opportunities forunemployed and underemployed people

Making provision for financial aid for theunemployed for their self-employment

Making provision for unemployment relief andunemployment insurance



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6. Fiscal policy and external balance:

Imposition of heavy import duty especially onthe import of consumer goods.

Subsidization of exports.


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Limitations of Fiscal Policy

Inaccuracy of forecasting

Dynamic multiplier

Decision and execution lags

Underdeveloped countries


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REFERENCES

Financial-education.com

Useconomy.about.com

business cycles and policies new (1)

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