Business Cycles and Policies New (1)
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Transcript of 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
Fiscal Policy and macro
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Fiscal Policy and macroEconomic growth Contd..
2. Public borrowings and economic growth
External debt
Internal debt
Fiscal Policy and macro
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Fiscal Policy and macroEconomic growth Contd..
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
Fiscal Policy and macro
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Fiscal Policy and macroEconomic growth Contd..
4. Fiscal Policy for Stabilization:
Automatic stabilization policy is used for thedeveloped countries
Contra-cyclical fiscal policy should be used forleast developed economies.
Fiscal Policy and macro
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Fiscal Policy and macroEconomic growth Contd..
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
Fiscal Policy and macro
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Fiscal Policy and macroEconomic growth Contd..
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