Trade Cycles

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A trade cycle refers to fluctuations in economic activities
specially in employment, output and income, prices, profits
etc.
According to Keynes, “A trade cycle is composed of periods of
good trade characterised by rising prices and low
unemployment percentages altering with periods of bad trade
characterised by falling prices and high unemployment
percentages”.
Features of a Trade Cycle:
1. A business cycle is synchronic. When cyclical fluctuations
start in one sector it spreads to other sectors.
2. In a trade cycle, a period of prosperity is followed by a
period of depression. Hence trade cycle is a wave like
movement.
3. Business cycle is recurrent and rhythmic; prosperity is
followed by depression and vice versa.
4. A trade cycle is cumulative and self-reinforcing. Each phase
feeds on itself and creates further movement in the same
direction.
5. A trade cycle is asymmetrical. The prosperity phase is slow
and gradual and the phase of depression is rapid.
6. The business cycle is not periodical. Some trade cycles last for three
or four years, while others last for six or eight or even more years.
7. The impact of a trade cycle is differential. It affects different
industries in different ways.
8. A trade cycle is international in character. Through international
trade, booms and depressions in one country are passed to other
countries.
Phases of a Trade Cycle:
Generally, a trade cycle is composed of four phases – depression,
recovery, prosperity and recession.
Depression:
During depression, the level of economic activity is extremely
low. Real income production, employment, prices, profit etc.
are falling. There are idle resources. Price is low leading to a
fall in profit, interest and wages. All the sections of the people
suffer. During this phase, there will be pessimism leading to
closing down of business firms.
Recovery:
Recovery denotes the turning point of business cycle form
depression to prosperity. In this phase, there is a slow rise in
output, employment, income and price. Demand for
commodities go up. There is increase in investment, bank
loans and advances. Pessimism gives way to optimism. The
process of revival and recovery becomes cumulative and leads
to prosperity.
Prosperity: It is a state of affairs in which real income and
employment are high. There are no idle resources. There is no
wastage of materials. There is rise in wages, prices, profits and
interest. Demand for bank loans increases. There is optimism
everywhere. There is a general uptrend in business
community.
However, these boom conditions cannot last long because the
forces of expansion are very weak. There are bottlenecks and
shortages. There may be scarcity of labour, raw material and
other factors of production. Banks may stop their loans. These
conditions lead to recession.
Recession: When the entrepreneurs realize their mistakes,
they reduce investment, employment and production. Then
fall in employment leads to fall in income, expenditure, prices
and profits. Optimism gives way to pessimism. Banks reduce
their loans and advances. Business expansion stops. This state
of recession ends in depression.
Control of Trade Cycles
In modern times, a programme of economic stabilization is
usually directed towards the attainment of three objectives:
• Controlling or moderating cyclical fluctuations,
• Encouraging and sustaining economic growth at full
employment level, and
• Maintaining the value of money through price stabilization.
Thus, the goal of economic stability can be easily resolved into
the twin objectives of sustained full employment and the
achievement of a degree of price stability.
A trade cycle cannot be controlled by a single operation.
Following instruments are used to attain the objectives of
economic stabilization, particularly for the control of trade
cycles, relative price stability and attainment of economic
growth:
• Monetary policy,
• Fiscal policy,
• Anti-cyclical budgeting, and
• Automatic stabilizer (or) Built-in stabilizer.
1. Monetary policy to control trade cycle
Monetary factors aggravate the operation of trade cycle.
Monetary inflation, leading to higher income and profits,
strengthens the boom conditions. Similarly, monetary
deflation reinforces the downswing in the economic activities
leading to depression. So, the monetary policy should be
adopted in an anti-cyclical way. During the period of upswing
and boom, supply of money and credit should be controlled
and regulated.
The central bank of the country should adopt all or
chosen methods of credit control. The weapons of credit
control, such as bank rate, open market operations, reserve ratio, etc.
should be utilized and to control inflationary tendencies and over-
expansion of business activity. In times of depression or signs of
recession, expansionary, credit policy should be adopted to mitigate the
severity of recession and depression.
Monetary policy alone may not be sufficient to check the instability
created by business cycle. It should be reinforced with suitable fiscal
policy.
2. Fiscal policy. Keynes and others have recommended compensatory
finance or compensatory fiscal policy to bring about stabilization of
business activity. The three main instruments of fiscal policy are:
• taxation,
• spending, and
• borrowing..
These three instruments have to be effectively utilized to
control the severity of boom or the difficulties of depression.
During the periods of recession and depression, the
government should reduce substantially the taxes and leave
more money in the pockets of individuals for spending and
investment.
The government should stimulate economic activity by
initiating public works project. In time of boom, the
government should try to mop up extra or the surplus money
through attractive borrowing schemes.
3. Anti-cyclical budgeting
The budgetary policy of the government should be in tune
with the measures already indicated to combat the instability
created by business cycle. During times of depression, a policy
of deficit budgeting should be adopted. This will increase the
flow of income in the economy. During upswing, surplus
budgeting should be adopted. Thus, the budgeting should be
done in anti-cyclical method.
4. Automatic stabilizer or Built-in-stabiliser
When fluctuations take place in the economy, the available
monetary and fiscal tools cannot be geared quickly to set right
the imbalance. Further it is also too much to expect the
government officials to act quickly to the tempo of change in
economic activity; So the policy makers make provisions for
automatic adjustments in the fiscal structure. These built-in-
stabilisers or automatic stabilizers will automatically come into
play in proportion to the rise and fall of economic activity.
By this method, the tax rates are so fixed that in the upward
phase of the trade cycle, with increase in national income, the
tax yield will go up automatically at a faster rate without any
change in the tax structure. The progressive rate of taxation is
one of the important built-in-stabiliser in the tax structure.
Another important built-in-stabiliser is the unemployment
insurance scheme. During periods of prosperity or upswing,
the employers pay taxes and the employees pay some amount
towards unemployment insurance scheme. This money gets
accumulated.
During times of depression and the consequent
unemployment, the public spending is automatically effected
by doling out money to the unemployed people. Thus, the
flow of money is regulated automatically from the people to the
government in times of prosperity, and from government to the people
in times of adversity. The built-in-stabilisers play a strategic role in
fighting recessions.