BUSINESS CYCLES AND ITS EFFECTS ON THE GOVERNMENT MONETARY POLICY

PRESENTED BY PRAJWALA MARTINA KESHAV RAJ SRINIVAS REDDY A.V.S.JATIN

CONTENTS OF BUSINESS CYCLES

1. 2. 3. 4. 5. Introduction. Features. Phases. Theories of Business Cycles. Effects of Business Cycles on Govt. Monetary Policy.

INTRODUCTION TO BUSINESS CYCLE

A business cycle refers to periods of expansion and contraction. A peak is the high point following a period of economic expansion. Although is the low point following a period of economic decline. Business Cycle refers to the cylindrical variation in an economic activity.

FEATURES OF BUSINESS CYCLE

Following are the features of the Business Cycles: A Trade cycle is a trade like movement. Cycling fluctuations are wave-like changes in economic activity. Expansion and Contraction in trade cycle are cumulative in effect. Trade cycles are all-pervading in their impact. A trade cycle is characterised by the presence of their crisis. Though cycles differ in timing and amplitude, they have pattern of phrases which are sequential in nature.

PHASES OF TRADE CYCLE

1. 2. 3. 4.

Phase of Prosperity. Phase of Recession. Phase of Depression. Phase of Revival or Recovery.

THEORIES OF BUSINESS CYCLES

1.THE MONETARY OVER-

INVESTMENT THEORY
The gist of monetary over investment theory is that working of monetary system brings about over investment in the economy.
Due to this it causes depressions.

This theory was explained by the Australian Economist F.A.Hayek.

According to Hayek cyclical fluctuations are the result of shortening and lengthening of the process of production.

Hayeks theory is based on the assumption that full utilization of investment in the capital goods,reduced the resources used in the production of consumer goods.

Keyness Theory
According to him trade cycles occurs due to the fluctuations in the rate of changes in the marginal effiency of capital.

A broad idea is visualised by Keynes: the expansion phase of the cycle is occasioned by a high value of marginal effiency of capital, a rapid increase in the rate of investment would take place.

Hickss Theory of Trade Cycles

The theory of acceleration and the theory of multiplier are the two sides of theory of fluctuations.

An expansionary phase starts in the economy when there is increase in the investment.

The process of interaction of multiplier and accelerator will continue to operate till the expansion of economic activity(measured in terms of income and employment).

EFFECTS OF BUSINESS CYCLES ON GOVT. MONETARY POLICY

WHAT IS MONETARY POLICY?

Monetary policy is the management of money supply and interest rates by central banks to influence prices and employment. Monetary policy works through expansion or contraction of investment and consumption expenditure. Monetary policy is the process by which the government, central bank (RBI in India), or monetary authority of a country controls.

Bank Rate Policy: The bank rate is the Official interest rate at which RBI rediscounts the approved bills held by commercial banks. For controlling the credit, inflation and money supply, RBI will increase the Bank Rate. Current Bank Rate is 6%. Open Market Operations: The Open market Operations refer to direct sales and purchase of securities and bills in the open market by RBI. The aim is to control volume of credit. Cash Reserve Ratio: Cash reserve ratio refers to that portion of total deposits in commercial Bank which has to be kept with RBI as cash reserves. Statutory Liquidity Ratio: It refers to that portion of deposits with the banks which it has to keep with itself as liquid assets(Gold, approved govt. securities etc.). the current SLR is 25%. If RBI wishes to control credit and discourage credit it would increase CRR & SLR.

Qualitative measures: Qualitative credit is used by the RBI for selective purposes. Margin requirements: This refers to difference between the securities offered and and amount borrowed by the banks. Consumer Credit Regulation: This refers to issuing rules regarding down payments and maximum maturities of installment credit for purchase of goods.

Rationing of credit: The RBI controls the Credit granted / allocated by commercial banks.

Moral Suasion: Psychological means and informal means of selective credit control.

Direct Action: This step is taken by the RBI against banks that dont fulfill conditions and requirements. RBI may refuse to rediscount their papers or may give excess credits or charge a penal rate of interest over and above the Bank rate, for credit demanded beyond the limit.