Need For Controlling Trade Cycle
Business cycles, especially the violent fluctuations in
economic activities, cause not only harm to business
community, but also misery to the normal people.
Violent fluctuations in economic activities leads to
unemployment, and poverty.
Till great depression in 1930s,there was an economic
belief that ‘invisible market forces’ would
automatically maintain the balance in the economy.
The major stabilization problem in the developing
countries is the problem of controlling prices and in
the developed countries , preventing growth rates
from sliding further down.
Stabilization broadly means preventing extreme ups
and downs in the economy.
Preventing excessive and prolonged economic
Creating conditions for efficient utilization of labour
and other productive resources.
Encouraging free competitive enterprise with
minimum interference with the functioning of the
Promotion of employment.
The two important widely used
economic policies are
Fiscal policy uses government taxation, spending
and borrowing to influence the economy.
Monetary policy consists of adjusting the money
supply (the amount of money in circulation) and
setting the prime rate (the interest rate that banks
pay to each other on loans).
Refers to the government policy of changing taxation
and public expenditure programs.
Basic instruments used
Taxation is a measure of transferring funds from
private to the public.
Taxation reduces private disposable
income, thereby, the private expenditure.
Public expenditure increases the flow of funds in the
The public expenditure ,increases the private income
and thereby , the private expenditure.
How it relates with GNP
Public expenditure and GNP
An increase in the Public expenditure raises the level
Public expenditure in the form of purchase of goods
and services increases income and business
profit, which in turn increases government’s tax
Taxation and GNP
Direct taxes without an equivalent public
expenditure have adverse effect on GNP.
Increase in taxation either due to increase in the
rates of existing taxes, or due to imposition of new
taxes, reduces GNP.
The size of decrease in GNP as a result of increase in
taxation depends on the tax multiplier.
Counter cycle business policy : automatic and
It require increase in public expenditure and
reduction in taxes to fight depression ,and
reduction in public expenditure and increase in
taxation to control inflation.
Fighting depression would require a deficit
budgeting and controlling inflation requires
A central bank creates monetary policy by controlling the
money supply and the interest rate . These policies aim to
stabilize an economy by encouraging borrowing and
investment, and controlling unemployment and inflation.
It is to regulate demand and supply of money with
Traditional monetary instruments
Open market operation
2. Changes in bank rate
3. Changes in the statutory reserve ratios
Open market operation
It is an activity by a central bank to buy or sell
government bonds on the open market.
A central bank uses them as the primary means of
implementing monetary policy.
During the period of expansion, the central bank
sells the government bonds and securities to the
During the period of depression, the central bank
buys the government securities.
The bank rate or rediscount rate
It is the rate at which the central bank rediscounts
the bills of exchange presented by the commercial
For controlling inflation the central bank will raises
the bank rate, which will discourages public
borrowing from commercial banks.
The bank rate will be lowered, which will leads to
monitory expansion and works against the forces of
Cash reserve ratio
It is the percentage of total deposits which the
commercial banks are required to maintain in the
form of cash reserve with the central bank.
When the central bank wants to reduce the credit
creation capacity of the commercial banks, it
increases the ratio of there demand and time
deposits to be held as reserve with the central bank.
The fiscal and monetary policies may be alternatively
or simultaneously used to control business cycles in
Monetary policy is considered to be more effective to
control inflation than to control depression .
An appropriate mix of fiscal and monetary policies
would always prove more effective than a single