LESSON – 5
INFLATION AND TRADE CYCLES
OBJECTIVES
After going through this chapter, you should be able to
- Understand the meaning causes and effects of inflation
- Know the methods of controlling inflation
- Understand the definition, features and phases of trade cycle
- Know the measures to control trade cyclical fluctuations.
Structure
5.1 Inflation – Introduction
5.2 Definition
5.3 Causes of Inflation
5.4 Effects of Inflation
5.4.1 Effects on Production
5.4.2 Effects on Distribution
5.5 Anti – inflationary policy
5.6 Trade cycle – Definition
5.6.1 Features of Trade Cycle
5.6.2. Phases of Trade Cycle
5.6.3 Control of Trade Cycle
Unit Question
5.1 INFLATION INTRODUCTION
Inflation is a global phenomenon in present-day times. There is hardly any country in the capitalist world today which is not affected by inflation. It is on account of this that the phenomenon of inflation has widely attracted the attention of the economists all the world over, but despite that there is no generally accepted definition of the term inflation’. Different economists have offered different definition of inflation.
5.2 DEFINITION
Prof. Crowther has defined inflation ‘as a state in which the value of money is falling, i.e., prices are rising”.
Prof. Hawtrey defines inflation as the “issue of too much currency”.
Prof. Coulbourn says, “Inflation is too much money chasing too few goods”.
5.3 CAUSES OF INFLATION
Inflation can be attributed to two main factors: 1. Increase in the demand for goods and services, and 2. Decrease in the supply of goods.
Factors Causing an Increase in Demand
1. Increase in Public Expenditure: An increase in public expenditure consequent upon the outbreak of war or developmental planning invariably causes an increase in the demand for goods and services in the economy In fact, this is an important cause giving rise to the emergence of excess demand in the country.
2. Increase in Private Expenditure: An increase in private expenditure, both consumption expenditure as well as investment expenditure, is an important cause of the emergence of excess demand in the economy. When business conditions are good, private entrepreneurs start investing more and more funds in new business enterprises, giving rise to an increase in the demand for the services of factors of production. This results in an increase in factor-prices. When factor incomes increase, there is more and more of expenditure on consumption goods. The ultimate effect of an increase in private expenditure is to push up the demand for commodities as well as factors of production.
3. Increase in Exports: An increase in the foreign demand for the country’s exports reduces the stock of commodities available for home consumption. It is evident that when more and more of commodities are exported to foreign countries. It naturally creates a situation of shortages in the economy, giving rise to inflationary pressures.
4. Reduction in Taxation: The reduction in taxation offered by the government can also be an important cause for the emergence of excess demand in the economy. When the government reduces taxes, it results in an increase in purchasing power in the hands of the public. With increased purchasing power, the people are in a position to buy more and more of goods and services for private consumption.
5. Repayment of Past Internal Debt: When the Government repays its past debts to the public it results in an increase of purchasing power which the latter uses for buying goods and services for consumption purposes. This naturally leads to an increase in aggregate demand in the economy.
FACTORS CAUSING A DECREASE IN SUPPLY
1. Shortage of Supplies of Factors of Production: The economy of a country may be confronted with shortages of factors vinz., labour, capital equipment, raw materials, etc. These shortages are bound to reduce the production of goods and services for consumption purposes. In fact, the shortage of productive factors is a serious obstacle to any effort to increase production in the country.
2. Hoarding by Traders: At a time of shortages and rising prices, there is a tendency on the part of traders and merchants to hoard essential commodities for profiteering purposes. The stocks of essential goods during a period of inflation and rising prices, causes further scarcity of these goods in the market.
3. Hoarding by Consumers: It is not only the traders and the merchants who resort to hoarding at a time for inflation. The individual consumers also hoard essential commodities to avoid payment of higher prices in future. They also hoard essential commodities to ensure their uninterrupted availability for private consumption.
5.4 EFFECTS OF INFLATION
A period of prolonged, persistent and continuous inflation results in the economic, political, social and moral disruption of society. The effects of inflation can be discussed under two sub-heads (i) effects on production, and (ii) Effects on distribution.
5.4.1 EFFECT ON PRODUCTION
1. Hyper-infiation discourages savings on the part of the public. With reduced savings, the process of capital accumulation suffers a serious set-back.
2. If the value of money undergoes considerable depreciation, this may even drive out the foreign capital already invested in the country.
3. With reduced capital accumulation, the investment will suffer a serious set-back which may have an adverse effect on the volume of production in the country.
4. Inflation may result in the diversion of productive resources from the essential goods industries to the luxury goods industries, creating further shortages of consumer goods for the common man.
5. It may lead to a serious deterioration in the quality of goods produced in the economy.
6. Inflation also leads to a serious hoarding of essential goods both by the traders as well as the consumers. The traders hoard stocks of essential commodities with a view to making higher profits. The consumers also resort to hoarding of essential goods for fear of paying higher prices in the future.
7. It gives stimulus to speculative activities on account of the uncertainty generated by a continually rising price-level.
8. It disrupts the smooth working of the price mechanism, thereby creating an all-round confusion in the economy.
5.4.2 EFFECTS ON DISTRIBUTION
Inflation has bad effects on distribution too. It produces deep impact on the distribution of income and wealth in society. Inflation results in redistribution of income and wealth in favour of businessmen, merchants, and traders. The fixed income-groups such as workers, salaried employees, teachers, pensioners, etc., are always the losers on account of the inflationary rise in prices. Since the price rise and rise may not be uniform in all sections of the economy, there will be distortions and imbalances causing bottlenecks in distribution. For instance, the price of industrial goods go up rapidly during inflation and prices of farm products are not so flexible. The returns for farmers dwindle and their economic conditions worsen due to mounting cost of industrial and consumer products which they have to buy. Again there is always a time-lag between the rise in production costs as the rise in the price-level. This time-. lag brings rich profits to the business classes. The resources get diverted to the production of those commodities which rise up, as the entrepreneurs will be lured by windfall profits. The net result will be that while some classes of people enjoy the benefits of inflation, some other section of the society suffer. The concrete effects of inflation on various sections of the society are as follows:
On Debtors and Creditors
During inflation, debtors are the gainers while the creditors are the losers. Debtors while repaying their debts return less purchasing power to the creditors than what they had actually borrowed. Since creditors receive less in real terms, they are the losers during this period.
On Wage and Salary Earners
This group consists of workers, clerks, government servants, and teachers. The wages and salaries of this group generally do not rise in the same proportion in which the cost of living rises. Even if the wages and salaries are linked up with the cost of living index, still the wage and salary earners are adversely affected because there is often a lag between the rise in prices and the rise in wages and salaries. It is said that prices go up by lift, while wages go up by steps. Hence if workers and salary earners are organised into powerful trade unions, they may not suffer much during inflation.
On Fixed Income Groups
The fixed groups are the worst hit during inflation because their incomes being fixed do not bear any relationship with the rising cost of living. Persons who live in past savings, pensioners, interest and rent receivers suffer most during inflation as their incomes remain fixed and there is non existence of unions among them to react quickly to the changes in the cost of living.
On Investors
Investors are of two types 1. Investors in equities and 2. Investors in fixed interest-yielding bonds and debentures. The equity holders stand to gain because the return on equities varies with the rising prices. More and more dividends become available to them with a rise in the price level. Income from bonds and debentures, however, remain fixed and as much investors in fixed interest bonds and debentures have much to lose during inflation. They find their saving largely wiped out as a result of the depreciation in the value of money. Keynes points out that “inflation has not only diminished the capacity of the investing class to save but has destroyed the atmosphere of confidence which is a condition of willingness to save”.
On Farmers
Farmers are divided into three broad categories:
1. non-cultivating landlords
2. peasant properties and
3. farm labourers.
So far as landlords are concerned, they are the losers during inflation since the rents are fixed by contracts over a long period of time. The peasant proprietors gain substantially because they bring considerable surplus to the market when prices move in the upward direction. The farm labourers are very badly affected by the rise in prices since these people receive very low fixed income and there is absence of trade unions among them. These small farmers may gain to some extent when wage- payments are made in terms of farm products. The debtors in farming community are generally benefited by inflation.
Social, Moral and Political Effects : Inflation is socially unjust and inequitable for society because it redistributes income and wealth in favour of the affluent and well-off. This naturally leads to social conflict in society. The general morality of the people in the country also suffers a serious decline with the resulting all-round corruption in the country. The evils of gambling, hoarding, black market earning, smuggling, speculation, tax evasion, thefts and violence raise their ugly heads. This leads to general discontentment in the public which may result in loss of faith in the government. The political agitations and protests are launched by the public. Many governments fail altogether to withstand the public resentment and collapse down. Thus inflation prepares the ground for social, moral and political up-heavels.
5.5 Anti-inflation are Policy
There are three lines of action to check and control an inflationary boom, namely, 1. Monetary measures, 2. Fiscal measures and 3. Other measures.
1. Monetary Measures: These measures are adopted by the central bank of the country and include such steps as an increase in re discount rates, sale of government securities in the open market, an increase in reserve ratios and adjustments in selective controls to arrest an inflation.
(a) Increased Re-discount Rates: To curb inflation, the central bank generally increases the re-discount rates. An increase in re-discount rates leads to an increase in bank rates tends to discourage borrowings by businessmen and consumers from banks resulting in a fall in the intensity of inflationary pressures in the economy. But the increase in re-discount rates as a weapon to check and inflationary boom has its limitation too. Firstly, if the bank rates do not rise pari passu with the re discount rates, there will be no decline in the business and consumer borrowing, and hence, the inflationary pressures will continue even though the re-discount rates have been raised. Secondly, the effectiveness of higher re-discount rates as an anti-inflationary weapon shall be considerably undermined if the commercial banks have an easy access to additional reserves. Thirdly, an increase of re-discount rates will fail to check inflation if nonbank holders of government securities were to convert their holdings into cash.
(b) Sale of Government Securities in the Open Market: Another method to check the inflationary boom is to resort to sales of government securities to the public by the central bank. As the buying public purchases and pays for those government securities the commercial banks’ reserves with the central bank are correspondingly reduced and they are obliged to adopt a restrictionist credit policy in relation to business requirements. This process helps in creating tight money conditions in the market, and thus arresting the further growth of the inflationary boom. But the sale of the government securities as an anti- inflationary weapon is also subject to limitations. Firstly, this policy may be rendered ineffective if the commercial banks are able to increase their reserves by selling their stocks of government securities to the central bank. Further, the non- bank holders of government securities may also, in the absence of other buyers, sell them to the central bank and deposit the proceeds with the commercial banks. The deposits and the reserves of the commercial banks are thus increased, neutralizing the effect of sale of government securities by the central bank. Secondly, this policy may also be offset by increased borrowings or by increased sales of treasury bills to the central bank by the commercial banks. Thirdly, the import of gold may also offset the anti-inflationary effect of this policy to a certain extent.
(c) Higher Reserve Requirements: An increase in reserve requirements of the member-banks also serves as an anti- inflationary weapon during inflation. Higher reserve requirements as an anti-inflationary weapon is also subject to limitations. Firstly, if the commercial banks have very large excess reserves, even the raising of reserve requirements may not significantly curtail their power to create credit. Secondly, the ability of commercial banks to increase or replenish their reserves through sales of government securities may render higher requirements ineffective to check credit expansion. Thirdly, a large inflow of gold on account of the existence of an export surplus will also, offset the anti-inflationary effect of higher reserve requirement.
(d) Consumer Credit Control: This is a device which is generally introduced during inflation to curb excessive spending on the part of consumers. Most of the durable consumer goods, such as. radios, television sets, washing machines, etc., are purchased by the consumers on instalment credit. During an inflationary boom, facilities for instalment buying are reduced to the minimum to curtail excessive spending on the part of consumers. This is done, (i) by raising the minimum initial payment on specified goods. (ii) by extending the application of consumer credit control to a large number of goods, and (iii) By decreasing the length of the payment period.
(e) Higher Margin Requirements: The central bank may raise the margin requirements to higher levels. Every commercial bank before granting a loan to a businessman against collateral security keeps a certain specified margin, say, 20 per cent or 30 per cent. For example, if the value of security offered by the businessman is Rs.10,000 and the bank keeps a margin of 20 per cent, then it means that it will advance not more than Rs.8,000 to the businessman. Now, in order to discourage excessive credit on the part of member-banks, the central bank may direct them to keep higher margins, say 50 per cent instead of 20 per cent. In that case, the member-bank shall not be able to lend more than Rs. 5,000 against a security of the value of Rs. 10,000. The higher the margin requirement, the lower the amount of the loan that the borrower can obtain from the bank.
2. Fiscal Measures: Fiscal policy is now recognized as an important instrument to tackle an inflationary fiscal measure are the following:
(a) Government Expenditure: During inflation, effective demand increases. To counteract increased private spending, the government should, at such a time, reduce its own expenditure to the minimum extent possible to help limit the aggregate demand. It is not so easy to reduce government expenditure particularly in the war period when any decrease in military expenditure is simply unthinkable. Secondly, any drastic cut in government expenditure to cure inflation may actually land the economy in a slump. Thirdly, this policy of a cut in government spending may actually come into clash with a long-range public investment programme. So a policy of reduced government spending, howsoever important, has its limitations in actual practice. And yet this policy appears to be indispensable to curb inflationary boom.
(b) Taxation: The problem during inflation is to reduce the size of disposable income in the hands of the general public in view of the limited supply of goods and services in the market. It is, therefore, necessary to take away the excess purchasing power from the public in the form of taxes. The rates of existing taxes should be steeply increased while new taxes should be imposed on commodities and services.
(c) Public Borrowing: Public borrowing is another anti-inflation ary weapon. The object of public borrowing is to take away from the public excess purchasing power. Public borrowing may be voluntary or compulsory. Ordinarily, public borrowing is voluntary. But voluntary borrowing has one disadvantage, and that is, it does not bring to the government sufficient amounts. It, thus, becomes essential in due course of time to resort to compulsory saving or compulsory borrowing from the public. According to this plan, a certain percentage of the wages or salaries is compulsorily deducted in exchange for savings bonds which become redeemable after a few years. Compulsory borrowing suffers from two limitations. Firstly, it involves the use of compulsion and it results in discontent.
(d) Debt Management: The existing public debt should be managed in such a manner as to reduce the existing money supply and prevent further credit expansion.
(e) Overvaluation: An overvaluation of domestic currency in terms of foreign currencies will also serve as an anti-inflationary measure in three ways. Firstly, it will discourage exports and thereby result in an increased availability of goods and services in the domestic market. Secondly, by encouraging imports from abroad, it will add to the domestic stock of goods and services and, thus, absorb the excessive purchasing power in the economy. Thirdly, by cheapening the prices of those foreign material which enter domestic production, it will help in checking an upward cost-price spiral. Overvaluation as an anti-inflationary weapon also suffers from limitations. For example, if other countries are also suffering from inflation, then the country concerned shall have to overvalue its currency considerably to neutralize the inflationary effect of the rising cost of imports.
3. Other Measures: Among the other anti-inflationary measures may be included such things as (a) An expansion of output, (b) wage policy and (c) price-control and rationing. They can be used to supplement the monetary-fiscal measures undertaken to contain inflationary pressures.
(a) Expansion of Output: Increased production is the best anti dote to inflation. If it is not possible to increase output as a whole, steps should be taken to increase the output of those goods which seem to be extremely sensitive to inflationary pressures by shifting productive resources from the less inflation- sensitive goods. A more feasible suggestion would be to increase the output through encouraging technical innovations in industry. It is also essential at a time of inflation to maintain industrial peace in the country by reducing strikes and lockouts to the minimum.
(b) Wage Policy: During an inflationary boom, wage cannot be left free to chase prices upward. They have to be controlled so as to contain inflationary pressures in the economy. Wage increases may be allowed to workers only if their productivity increases.
(c) Price-control and Rationing: The object of price control is to lay down the upper limit beyond which the price of a particular commodity would not be allowed to rise. To ensure the successful functioning of price-control, two conditions shall have to be satisfied. Firstly, the government should have under its control adequate stock of the commodity concerned. Secondly, the demand for the concerned commodity should be controlled through rationing.
5.6. TRADE CYCLE – DEFINITION
An important feature of the working of a capitalist economy is the existence of alternating periods of property and depression generally referred to as “business cycle”. In the words of W.C. Mitchell, “Business cycles are spices of fluctuations in the economic activities of organized communities”. According to Keynes, “A trade cycle is composed of period of good trade characterized by rising prices and low unemployment percentages, alternating with periods of bad trade characterized by falling prices and high unemployment percentages”. In the words of Frederic Benham, “A trade cycle may be defined as a period of prosperity followed by period of depression. It is not surprising economic process should be irregular, trade being good at some time and bad at others”.
5.6.1 Feature of Business Cycle
1. A trade cycle is a wave like movement. It is characterized by alternation of expansion and contraction.
2. A trade cycle is rhythmic and recurrent in nature. It means that it is repetitive. Prosperity is followed by depression and depression is again followed by prosperity.
3. A trade cycle is synchronic which means that the cyclical fluctuations start in one sector and it spreads to other sectors.
4. A trade cycle is cumulative and self-reinforcing in nature. It feeds on itself and creates further movement in the same direction.
5. A trade cycle affects virtuaily every segment of the economy. When one part of the economy suffers depression this is transmitted to the other parts.
6. The periodicity of trade cycle is different. Some trade cycles last for three or four years, while others last for six or seven or even more years.
7. In a trade cycle the change from the upward to the downward movement is more sudden and violent than the change from downward to the upward movement. Hence the peak of the trade cycle is pointed while the trough is gently sloping.
8. Through international trade booms and depressions in one country are transmitted to other country; hence its effects may be felt throughout the world.
5.6.2. Phases of Business Cycle
A typical or standard business cycle is characterized by five different phases or stages — depression, recovery (or revival), prosperity (or full employment), boom (or, overfull employment) and recession.
Depression
This constitutes the first stage of a business cycle. It is characterized by a sharp reduction of production, mass unemployment, low employment, falling prices, falling profits, low wages, contraction of credit, a high rate of business failures and an atmosphere of all-round pessimism and despair. A decline in output or production is accompanied by a reduction in the volume of employment. All construction activities come to a more or less complete standstill during a depression. The consumer-goods industries, such as, food, clothing, etc., are not so much affected by unemployment as the basic capital goods industries. The prices of manufactured goods fall to low levels. Since the costs are “Sticky” and do not fall as rapidly as prices, the manufacturers suffer huge financial tosses. Many of these firms have to close down on an account of accumulated losses. The fall in prices distorts the relative price structure, The prices of agricultural commodities and raw materials fall to greater extent than the prices of finished manufactured goods. The agriculturists are hit more than the manufacturing class.
Recovery
It implies an increase in business activity after the lowest point of the depression has been reached. During this phase, there is a slight improvement in economic activity, to start with. The entrepreneurs begin to feel that the economic situation was, after all, not bad as it was in the preceding stage, This leads to further improvement in business activity. The industrial production picks up slowly and gradually. The volume of production steadily increases. There is a slow, but sure rise in prices, accompanied by a small rise in profits. Wages also rise, though they do not rise in the same proportion in which the prices rise. Attracted by rising profits, new investments take place in capital good industries. The banks expand credit. The business inventories also start rising slowly. The pessimism and despair of the preceeding period is replaced by an atmosphere of all- round hope.
Prosperity
This stage is characterised by increased production, high capital investment in basic industries, expansion of bank credit, high prices, high profits, a high rate formation of new business enterprises and full employment. There is a general feeling of optimism among businessman and industrialists
Boom
It is the stage of rapid expansion in business activity to new high marks, resulting in high stock and commodity prices, high profits and over full employment.
The prosperity phase of the business cycle does not end up with a stable state of full employment; it leads to the emergence of boom. The continuance of Investment even after the stage of full employment result in a sharp inflationary rise of prices. This causes undue optimism among businessmen and industrialists who make additional investments in the various branches of the economy. This puts additional pressure on the factors of production which is already fully employed, causing a sharp rise in their prices. Soon a situation develops in which the number of jobs oxceeds the number workers available in the market. Such a situation is known as overfull employment. Profits touch a new height Attracted by the rising profits, the businessmen and industrialists further increase their capital investments. This adds fuel to the fire. Runaway inflation raises its head in its head in all its ugliness. Prices rise sky-high. The tempo of the boom reaches new heights. There is an atmosphere of over- optimism all around.
But the developing boom carries with it the seeds of self-destruction. Bottlenecks begin to appear in various sectors of the economy. Factors of production become scarce, causing further spurt in their prices. The cost calculations of the businessmen and the industrialists are completely upset. Some new hastily set-up firms collapse. This makes the businessmen overcautious. They now being to stay away from new projects and even stop the expansion of the existing units. This prepares the ground for the succeeding stage.
Recession
The feeling of over-optimism of the earlier period is replaced now by pessimism. It is characterized by fear and hesitation on the part of the businessmen. The failure of some businesses creates panic among businessmen. The banks also get panicky and begin to withdraw loans from business enterprises. More business enterprises fail. Price collapse and confidence is rudely shaken. Building construction slows down and unemployment appears in basic, capital goods industries. This initial unemployment then spreads to other industries. Unemployment leads to fall in income, expenditure, prices and profits. Once a recession starts, it goes on gathering momentum and finally assumes the shape of depression — the first phase of the business cycle is complete.
The various phases of the business cycle can be illustrated by the Figure.
In the above diagram, PM is the full employment line. Above this line, we have two stages of the business cycle - a boom in the upswing and a recession in the downswing. Below this line, again, we have two stages of the business cycle-recovery in the upswing and depression in the downswing. The business cycle as shown in the diagram, passes through five stages. It starts with depression to be followed by recovery, prosperity, boom, recession and ultimately ends up again with depression.
The main features of the four phase of the trade cycle are shown in the cHart
S.No | Variables | Recovery | Prosperity | Recession | Depression |
1. | Industry output | Gradual increase | Rapid increase | Decreases | Fall rapidly |
2. | Commodity prices | Gradual increase | Increases rapidly | Decreases | Fall rapidly |
3. | Cost of production | Gradual increase | Increases rapidly but slower than the rise in commodity prices | Gradual decline | Falls rapidly but slower than commodity prices |
4. | Profits | Satisfactory level | High | Gradual decline | Negligible profits or losses |
5. | Investment | Replacement of existing capital equipment | High | Falls slowly | - |
6. | Employment | Gradual increase | Increases rapidly | Starts falling | Falls rapidly |
7. | Wage rate | Improvement | Increases rapidly | Starts falling | Falls rapidly |
8. | Bank advances | Liberal loans | Liberal loans | Starts falling | Falls rapidly |
9. | Speculative activity | Increases slowly | At a high level | Minimum | Nil |
10. | Stocks | Gradual decline | Little | Gradual increase | High |
11. | Business failure | Small in number | Nil | Small in number | Large |
12. | Business psychology | Optimism with caution | Highly optimistic | Pessimistic | Highly pessimistic |
5.6.3 Control of Trade Cycle
Since cyclical fluctuations affect the smooth functioning of the economy steps should be taken to control it. There are three ways by which a trade cycle can be controlled.
1. Monetary Policy.
2. Fiscal policy and
3. Automatic stabilisers.
1. Monetary Policy
Monetary factors can cause permanent cyclical fluctuations. An increase in money supply lowers the rate of interest, which in its turn increases investment, and profits, thus creating an optimistic outlook. This leads to prosperity. On the contrary a decrease in money supply leads to pessimistic outlook and depression. Therefore, to avoid cyclical fluctuations, suitable monetary policy should be adopted. Central bank should use all its credit control weapons like bank rate, open market operations, reserve ratios, moralsuasion etc., to control trade cycles. For example, during a period of prosperity, bank rate should be increased; open market sale of securities should be undertaken reserve ratios should be increased. An increase in money supply should be controlled by adequate cover against note issue. On the contrary, during depression, these weapons should be used to ensure adequate expansion of credit. Thus, monetary policy has an important part to play in controlling cyclical fluctuations.
2. Fiscal Policy
Monetary policy alone cannot check cyclical fluctuations. Therefore, economists like Keynes and Alvin Hansen suggested compensatory fiscal policy to stabilise business activity. The three main instruments of fiscal policy are, taxation, spending and borrowing. During a period of depression, government should reduce the existing taxes; it should not levy new taxes; it should increase its spending to stimulate business activity. At the time of depression it should undertake public works programmes like construction of roads, canals, parks, hospitals etc. which will provide employment to unemployed workers. The government should follow deficit budgeting and deficit financing. It should also follow public borrowing. When the economy recovers, it should follow opposite policy. The government should raise the tax rates, levy new taxes, reduce spending on public works and follow surplus budgeting.
3. Automatic Stabilisers
Automatic stabilisers are also called as built in stabilisers. It refers to a shock absorber which helps to smooth the cyclical fluctuations without government interference. An important built-in-stabiliser is progressive income tax. It helps in compensating cyclical fluctuations as it makes the people to pay more tax during upswing and pay less tax during depression. Unemployment insurance is also another built-in-stabiliser. During periods of prosperity, the government does not pay unemployment allowance. During depression the government lowers the taxes and pays unemployment allowance. During depression the government lowers the taxes and pays unemployment allowance.
Since fiscal and monetary policies involve delay, automatic stabilisers are superior as they go into action immediately. But the provide only a partial solution to the problem. Therefore automatic stabilisers should be supplemented with fiscal and monetary policies.
Unit questions
1. Define inflation and explain the causes of inflation.
2. Describe the methods of controlling inflation
3. Define business cycles and examine its phases and features
4. What are the ways by which trade cycles can be controlled.
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