How to Control the Business Cycle? | Managerial Economics

The following article will guide you about how to control the business cycle.

The steps are: 1. Monetary Policy 2. Fiscal Policy 3. Automatic Stabilisers 4. Another Built-In-Stabiliser in the U.S.A is Unemployment Insurance 5. Direct Controls.

Controlling Business Cycle Step # 1. Monetary Policy:

Whatever may be the cause of the short-business cycle it is always aggravated by the monetary factors.

The monetary factors may not cause the business cycle, but once the cycle occurs, the monetary factors do aggravate it.

Monetary inflation:

By leading to higher prices, higher profits and an optimistic. Outlook, strengthens the upswings of the cycle.

Monetary deflation:

On the ‘contrary, by leading to lower prices, lower profits and pessimistic outlook re-in-forces the down swing of the cycle. Some steps should be taken to check and control the monetary factors which aggravate business fluctuations caused by the business cycle. For this, the government may evolve a suitable monetary policy to deal with the situation.

So far as money supply is concerned its under expansion could be checked by insisting upon a proper and adequate cover against note-issue. As regards bank credit, the Central Bank of the country could utilise the various weapons of control, such as bank rate, open market operations, reserve ratios, moral suasion etc., to control it.

Whatever, there is a tendency towards an over-expansion of business activity, the Central Bank should utilise its weapons to check and control expansion of credit. On the contrary whatever there is a tendency towards an undue slackening of business activity, the Central Bank should utilise its weapons to ensure an adequate expansion of credit.

The bank rate weapons is being increasingly used in recent years in countries like—Great Britain and the U.S.A. to combat inflationary trends in business activity. Monetary policy has thus an important part to play in curbing cyclical business fluctuations and contributing to economic stability.

Controlling Business Cycle Step # 2. Fiscal Policy:

Monetary policy taken alone may not suffice to check cyclical business fluctuations. It is therefore suggested that monetary policy should be properly integrated with a suitable fiscal policy to achieve the desired results. Keynes and the Keynesians such as Alvin Hansen and others have recommended compensatory finance or compensatory fiscal policy to bring about stabilisation of business activity.

Government activity of late, has expanded so much that the government is now in a position to exercise a very great influence on the total volume of output in a country.

It is therefore suggested that the government should regulate its activities in such a manner as to off-set the cyclical fluctuations in private business activity. The three main instruments of fiscal policy-taxation, spending and borrowing can be used by the Government to achieve this purpose.

If business activity shows signs of slackening down or there are symptoms of a down­swing, the Government should at once enforce its three instruments of fiscal policy to check the down trend and ensure stability in the economy. At such a time the Government should not levy and new taxes on the people. Even the existing taxes should be substantially reduced.

This would leave more money in the hands of the people who should be encouraged to spend in on buying additional goods and services to off-set the decline in demand and business activity.

At the same time, the government itself should embark on a vast spending programme to stimulate business activity in the economy. The Government, at the time of depression should initiate Public Works Projects of various kinds involving expenditure of money and additional employment of labour.

The Government is expected to keep ready a number of Public Works Schemes, such as construction of roads, canals, parks, schools, hospitals etc., and execute them at the first sign of the coming depression.

These public works projects by giving employment to the unemployed workers, provide them with purchasing power to buy consumer goods. This would help in off-setting the decline in effective demand and business activity. The funds to finance the public works projects should be obtained either by printing more paper money or by borrowing from the banks.

In either case, more money would be created and put into circulation, thus off-setting the deflationary effect of reduced business spending. The Government should at such a time follow the policy of Deficit budgeting, which alone will increase the flow of income stream into the economy.

When the economy recovers and a wave of prosperity sets in the Government should follow an exactly opposite policy. Now, it should raise the existing taxes and even levy new taxes to check private spending. It should reduce its expenditure on public works and similar projects.

It should retire paper money and pay off its debts to the banks and the public, thereby reducing the quantity of money in circulation. The idea is that the Government at the time of boom should follow a policy of surplus budgeting. It is thus, evident that a compensatory fiscal policy followed by the Government would help to maintain a constant circuit flow by bringing about stabilisation in the economy.

Controlling Business Cycle Step # 3. Automatic Stabilisers:

In this case the economists have suggested the introduction of a number of automatic stabilisers or (built in stabilisers) to deal with the business cycle. An automatic stabiliser or (built-in-stabiliser) is an economic stock-absorber that helps smooth the cyclical business fluctuations of its own accord, without requiring deliberate action on the part of the government.

For example:

Such device in U.S.A. is the federal progressive income-tax. This tax is so devised that people in higher income brackets are taxed at a progressively higher rate than those in the lower income brackets.

Such a progressive type of income-tax trends automatically to offset cyclical fluctuations because in an up saving when incomes are rising people would pay more taxes to the government and thus their expenditure would be checked and in a down swing when incomes are declining and tax percentage is low people would pay less taxes to the Government leaving more funds for them to spend.

Controlling Business Cycle Step # 4. Another Built-In-Stabiliser in the U.S.A is Unemployment Insurance:

During the period of prosperity the employers pay taxes to the government at enhanced rates but the Government does not pay unemployment allowances to the unemployment persons because there is hardly any unemployment worth the name at such a time. Money therefore accumulates with the Government.

On the other-hand during the period of depression the Government lowers the taxes but pays out unemployment allowances to the unemployed persons thereby making available more money to the people, which automatically tend to offset the reduction in the circuit flow.

Thus consumers buying power is strengthened and recessionary pressures are tempered. In combination, these built in stabilisers have played a key role in the prompt reversal of U.S. recessions since the Second World War.

The main limitation of automatic stabilisers is that they provide only a partial solution of the problem. Empirical research conducted in the U.K. and the U.S.A. suggests that automatic stabilisers can control not more than 50% of the economic fluctuations in the economy. Hence, it is essential to supplement the automatic stabilisers with discretionary policy to secure effective and lasting stability in the National Economy.

Controlling Business Cycle Step # 5. Direct Controls:

This method is to ensure proper allocation of resources for the purpose of price stability. They are in the form of rationing, price and wage controls, export duties, exchange control, monopoly control etc. They are more effective in overcoming shortages arising from inflationary pressures.

Their point of success mainly depends upon the existence of an efficient and honest administration. They are mostly used in emergencies like war, crop failures and in hyper inflation.

In the end it can be said that there is no single method which can control cyclical fluctuations. Therefore, it can be suggested that all methods be used simultaneously. Because monetary policy is easy to apply but it is less effective.

Next, the fiscal measures are effective and better than monetary method but it is difficult to control and operate. Therefore, it can be a point to study that the right remedy for the trade cycles has not been found as yet. Therefore, its permanent remedy cannot exist.