PERSPECTIVES

Economic Fluctuations and Stabilization Policies
G S Gupta

presents emerging issues and ideas that call for action or rethinking by managers, administrators, and policy makers in organizations.

Executive Summary

KEY WORDS

Phillip's Curve Kuznet's Curve Okun’s Law Stagflation Hyperinflation

Economic fluctuations refer to ups and downs in the levels and/or rates of changes in the economic goal variables like real national income (GDP), inflation rate, and the rate of unemployment. Stabilization policies are the tools in the hands of the policy-makers to counter economic fluctuations and these include fiscal policy, monetary policy, and foreign exchange rate policy. This paper analyses the extent and depth of all major fluctuations (business cycles) across the G-7 countries, India, China, Malaysia, and the world as a whole during the Great Depression and the last 40 years, identifies the major cause behind each significant departure from the trend, and examines the theoretical limitations as well as the actual application of the various policies to tame those business cycles. This paper finds that: Ø Business cycles are universal. Each of the countries under analysis here has experienced an overall positive growth rate but also a negative growth rate, generally in more than one year, during the period of this study. .urther, the standard deviation of the growth rate as a percentage of the growth rate (called the coefficient of variation) is sizeable in all countries as it varies between a low of 41 per cent in Malaysia and a high of 96 per cent in the UK. Ø Business cycles are not always synchronized across countries. During the Great Depression and stagflation periods, most countries suffered from similar maladies but such a synchronization was rarely found in other times. .or example, Japan performed relatively better during the 1950s and 1960s, and China and the South-East Asian economies enjoyed that position during the 1980s and 1990s. .urther, while every country has experienced a negative growth rate, there is no year in the last 50 years in which the growth rate was negative in all countries. The world as a whole, of course, has always enjoyed a positive growth rate. Ø Business cycles have become milder over time. During the Great Depression, output fell by over two digit rates in many countries. Japan experienced a two-digit growth rate in most of the years during 1960s, 1980s, and 1990s, but lately, the growth rate in most countries is hovering around 2 to 5 per cent. Ø Business cycles are caused by varying events. While the adverse demand shock caused the Great Depression, the adverse supply shock triggered the stagflation and economic reforms have been responsible for hyperinflation, financial crises, and prosperity. Ø Stabilization policies, besides suffering from some inherent limitations, have not always been applied in the right perspective. During the Great Depression, the nominal money supply should have increased but it fell and the government expenditure rose but only marginally. The simple correlation and multiple regression analysis’ results for the three select countries suggest that while the monetary policy was conducted as an anti-cyclical tool in India, it was pro-cyclical in the US and China, and quite the opposite was the case with regard to the conduct of fiscal policy. The cycles are bad and it is unfortunate that the stabilization policies do not offer panacea to tame them fully. However, it is heartening to find that economic fluctuations have become milder over time and the credit for this goes to the innovative developments in the macroeconomic theory and to the improvements in the practice of stabilization policies. Though cycles are unlikely to be eradicated, there is now only little fear of severe crises in future like the Great Depression or stagflation.

VIKALPA • VOLUME 28 • NO 1 • JANUARY - MARCH 2003

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LUCTUATIONS AND STABILIZATION POLICIES 2 . and inflation rate) for select countries. while the average growth rate during the said period stood at 3. China. The unemployment rates were accordingly high and most countries had experienced fairly high rates of deflation.8 per cent in 1973 to 0. and in the inflation rate in India.4 per cent. stability. Brazil.. G FLUCTUATIONS ECONOMIC FLUCTUATIONS Economic fluctuations are a fact of life (Schumpeter. 6 per cent in the UK. For the world as a whole. though not equal. the maximum fluctuations in the growth rate were in China. among the countries. 2001.6 %. Hungary. including Germany. the G-7 countries. growth rate. Malaysia. Since economics deals with the material well-being alone. Bolivia. • The hyperinflation (inflation over 1000%/year) plagued several European countries. the standard deviation turned out to be 1. and a fair. and finance. This paper basically addresses the issue of economic fluctuations and their monitoring through the application of stabilization policies. unemployment rate. In India. including India. and distribution in terms of the income distribution across households.4 per cent in 1982. Nicaragua. and so on. with standard deviations of 2. 11 per cent in France and Hungary. in the unemployment rate in the UK. most economists believe that growth and price stability are incompatible goals in the shortrun (Phillip's curve) and thus an ideal mix of the two is a debatable issue. The world inflation rate stood at two digit levels in all these years. Peru. and distribution are the three principal concerns of economics. insurance. Fischer and Startz. the GDP fell by about 29 per cent in the US. The data on growth rates. stability (rather instability) in terms of the fluctuations in real national income or in the rate of unemployment (the two are linked through the Okun’s law) and in the (general) price level (inflation/ deflation). and Ukraine suffered from this disease during the 1980s and 1990s. For instance. real estate. and Poland during the 1920s and again Hungary during August 1945 to July 1946.rowth. We analyse time series data on economic fluctuations and the indicators of stabilizing policies in selected countries to examine the depth and spread of these fluctuations and the actual uses of the corresponding policies. 16 per cent in Germany. the growth rate in the world output fell monotonously from 5.4%) took the growth to its peak rate of around 10 per cent in 1988-89. Economists unanimously recommend every country to aim at a high growth rate. These indicate a fairly high degree of volatility both over space and time. distribution. giving a coefficient of variation of 38 per cent. growth is defined in terms of the growth in real national income. Austria. 18 per cent in Czechoslovakia. and the world. The average growth rate in these countries during the last 34 years (1964-1997) has fluctuated between 2. The famous Kuznet's curve suggests that growth and desired income distribution do not always move in tandem.1 per cent in 1978 to 0.3 per cent in UK and 9.7 per cent. 9 per cent in Sweden. Several countries including the US and the UK had experienced negative growth rates in most of these years. We also highlight inherent limitations of these policies to appreciate their less than perfect role in taming business cycles. The data also indicate that. 1939) All countries have suffered from these though the booms and busts have not always synchronized across countries and neither the length nor the amplitude have been uniform. 22 per cent in Australia. But.7 per cent in 1975 and from 4. • The stagflation during 1974-75 and 1979-82 was fairly widespread throughout the world. the drought of 1979-80 (when the agriculture output fell by 12%) led to the worst negative growth rate of 6 per cent and the mild reforms-induced prosperity of the second half of the 1980s (when industrial output went up by 9. Several Latin American countries including Argentina.2 per cent and 6. The Japanese economy is currently ECONOMIC . 18): • The Great Depression of 1929-33 was fairly widespread across all countries. During these four years. ch. unemployment rates. and inflation rates further highlight the presence and depth of business cycles. Table 1 provides data for selected years on the three most significant macroeconomic variables (viz. high stability.7 per cent. respectively. Most of the countries had suffered a two-digit inflation rate or a high one-digit rate. Some striking examples of extreme fluctuations in the globe are cited below (Dornbusch.2 per cent in China. and business services’ output was up by 11. • Japan witnessed fast growing prosperity during the 1950s and 1960s. and the rest had lower than their respective trend rates in all these years.

A.3 7.7 6.6 2.0.2 2.5 2.7 N. The growth rates in European countries were either negative or low during the periods of stagflation (1974-75.9 Panel A: Growth Rates (Real GDP) 1960 2.A.8 5. As per Arthur Okun’s law.9 2.A. The fluctuations in real GDP have not always synchronized across countries.5 10.6 5.3 1980 -0.9 4.3 N.1 1980 7. The average inflation rate during 19642000 fluctuated between 3.1 11.A.2 per cent in 1964 and the lowest of 0.A.3 N.MARCH 2003 3 .3 12.8. 3. and a maximum growth rate of about 10 per cent in 1988-89. 4.9 3. N.A. N.4 4.3 1. the standard deviation of inflation was fairly high as well.A.8 3.8 1. and the 1980s and 1990s. 3.3 7.A. Table 1) further demonstrate the recurrence of business cycles. 5. N.1 5.A.1 6.5 4. 2.3 4.4 5.3 2.4 5.4 -1.1 2.9 13. 6.2.7 1.A.5 1990 1.A.0 Germany 31.8 9.5 N.2 4.9 .2 5.1 1997 5.3 1.1 -0.5-5.8 6.0%).4 8. N. N. China had experienced a relatively high growth rate (twodigit level) during most of the 1960s (barring 1967.6 1.0 7.5 3.0 UK 4.7 5. N. ***For the period 1964-2000.8 2.2 3.0 9.4 16.4 per cent in 1982.9 12.0 N. when she had the worst recession).5 N.9 0.4 2.5 3. respectively.5 2.3 4.5 N.2 11. with a standard deviation of 1.A.4 1. 4.38 India 7.4 3. 2.8 per cent. However.4 -3.5 4.5 5.A. and better in most other years.5 23.A.60 Malaysia N.2 0. 9.5 N. 1970 5. In general. the 1980s and 1990s have been decades of relatively Table 1: Economic Fluctuations good performance in most countries.6 10.0 4. This recession.5 3. and the stagflation of the mid-70s and early 80s is well spread across countries. India has had a negative growth rate in 1956-57.1 SD** 1.0 3.0 7.0 7.5 0.4 2001 5. N.0 2.0 4.4 18.4 6. N.A.6 2.7 Panel C: Inflation Rates 1964 1.4 3.1 2.7 7.4 1970 -0. SD*** 3. most regions in the world are experiencing a recession which is in terms of a fall in the growth rate rather than a negative growth rate. ** For the period 1964-1997/85-86-98.5 4. N. like the Great Depression of the early 1930s.A.2 3.7 2.5 6. Most of the South East Asian nations had achieved high growth rates during 1986 through 1996 until they got caught up by the recent financial crisis.3 5.2 1.7 5.3 1. 3.7 N. In particular.2 2. N.8 N. 1972-73.7 1.8 3.7 1.7 1.6 3.A.9 1.3 3.8 7.2 per cent in Germany and 9.0 Mean* 2.7 7.1 2.A.5 8. 1990 5. 1997 2.69 3.6 2.5 5.A.A.6 5. VIKALPA • VOLUME 28 • NO 1 • JANUARY .5 5.A. 7.8 2.5 Panel B: Unemployment Rates 1964 5.A.9 7.9 13.2 3. 2. and 1979-80 (maximum at 6.9 2001 0.8 0. The world recorded the highest growth rate of 6. the unemployment figures are just the mirror image of the growth rate.0 N. N.4 6. 1979-82) as well as the early 1990s.4.A.5 2.2 6.2 1.A.2 2. N.2 6. The unemployment and inflation data (Panels B and C.4 6. the inflation rate has been quite modest lately in most countries.4 2.1 5.4 4.A. Thus. 2.7 N.4 5.2 6.3 1964 5.9 4.6 29.1 1.1 1.7 2. N.8 Italy 11.1 SD* 2.9 per cent. respectively.0 15.7 3.7 4. various issues.A.2 2. 13.5 N.8 3.5 3.2 2.7 11.0 1990 5. 1964-65.6 1.4 2.9 5.4 0.7 3.0 N.A.A.0 4. Mean*** 4. * For the period 1964-1997.7 5.1 2.7.25 6.1 per cent and 5.8 5.7 2.7 -0.4 1.1 1.5 6.A.9 12.3 3.1 per cent in India. Mean** 6. N.0 0.7 N.0 21.4 2.8 4.4 N. The US suffered the worst recession after the Great Depression during 1979-82 but has performed reasonably well during most of the 1990s. 2000 3.8 1997 3.0 7.0 6.2 2.3 4.A.A. N.A.A.A. N.4 9. while (Percentages) USA Canada Japan France 7.3 8. N. 7.1 2.2 7.0 N. African countries and Latin American countries have witnessed even worse cycles. 8.A.7 0 7.62 World 5.A.3 China -1.A.5 2.7 N.A.0 8.3 .5 10. • Since early 2001. N.9 3.8.4 3. N.8 8.56 5.5 6.9 4.5 Source: IMF: International Financial Statistics.0 1. 6.8 3.8 5.8 per cent and 2.1 -0. The said figures for the world turned out to be 11.5 3.2 6. 4.2 1.4 1.3 3. N.5 0.5 3.6 3.A. N.0 4.2 2.suffering from recession for over a decade.1 1970 4. 1980 13.6 2. 1.0 9.A.

industrial relations and riots. and even the US have done well during the 1980s and 1990s. economists used to distinguish between the real and monetary business cycles. though at very different rates. and firms. price elasticities of import and export. prices of inputs. and international trade effects. and vertical at the potential output in the long-run. and the recent recession? Though many factors would have contributed. technology. recognizing the role of both kinds of such factors. corporate tax. The policy variables that have a bearing on AD include money supply (or the high-powered money). we have the convergence of these two schools and a unified theory. currently it is very much within the desired range in most parts of the world. and the foreign exchange rate. called the eclectic or heterodox approach. Economists are unanimous with regard to the downward sloping of the AD curve which is caused by the Keynesian. government fiscal operations like government expenditure. Pigou. firms’ attitude towards risk and profit. both the real income as well as the price fell. Kydland and Prescott 1990).LUCTUATIONS AND STABILIZATION POLICIES 4 . postulating the wage-price flexibility and market clearing. the shifts in AD and AS could be caused by a variety of factors even in the short-run. These can be caused by changes in one or more of the exogenous variables (policy or non-policy ones) and the behavioural parameters of the decision-makers. relative prosperity of the 1980s and 1990s. While inflation was perhaps the number one economic malady during the stagflation and hyper. and quotas. The non-policy variables that impinge on AS include weather/monsoon. 2001. For example. different schools attach varying significance for the reasons behind this slope. ch. tariffs. business expectations about future prices. and the rebates on saving and investment) affect AS as well through incentives/ disincentives to supply more labour and save and invest more or less. Workers’ leisure-work preference. both domestic and foreign. the classists think that the short-run AS curve slopes upward primarily because of the misperceptions about the real wage and relative prices and the Keynesians think the shape is largely due to the nominal wage-price rigidity. However. 11. During the stagflation. interest sensitiveness of investment and money demands. investment. etc. During the Great Depression. Also. The non-policy variables that affect AD include autonomous components of consumption. 1950. which is upward sloping up to the potential (natural level of) output in the short-run. are guided by the confidence and expectations of consumers and firms. factor supplies. different schools attach varying emphasis on the main factors behind the cycles. consumers. the Keynesians consider the nominal wage-price rigidity as the main source of business cycles. and vertical thereafter. argue for technological changes. while the classists. However. Malaysia. stipulations about pollution and environment regulations. In particular. The fluctuations in the real income and inflation rate have not been uniform through the various cycles. which. In contrast. The classists (supply-siders) believe that direct taxes (personal income tax. intertemporal substitution of leisure. hyperinflation. During the last decade. the former caused by the supply factors (classists) and the latter by the demand factors (Keynesians). and any one or more of them could have triggered/reinforced a particular contraction or recovery. etc. today. we identify the major factor behind each of these big events. Hitherto. and misperfec. The fundamental factors behind these fluctuations are shocks in aggregate demand (AD) and/or aggregate supply (AS) (Gupta.tions about the real wage and relative prices as the principal factors behind fluctuations. even today. The behavioural parameters affecting AD include propensities to consume/save. taxation. India. prosperity was accompanied with mild inflation. The same trend was witnessed. during hyperinflation. China. it has suffered badly during the 1990s. What had caused the Great Depression. exports and imports. constitute the behavioural parameters that affect AS. raw-materials and intermediate goods.Japan had achieved a relatively high economic growth during the 1950s and 1960s. input supplier. Tinbergen and Polak. the former fell while the latter rose. Lack of effective demand has been identified as the single most important factor that caused the Great ECONOMIC . invest and import. discovery of new natural resources.inflation phases. and transfer payments. viz. the non-policy and policy variables do change even in the short-run. there is a near consensus even about the slope of the AS curve. Thus. Of course. in turn. etc. though these are partly offset by the income redistribution and price expectations’ effects. stagflation. While the behavioural parameters are fairly constant in the short-run.

Governments’ fiscal operations. affect AD both directly and indirectly and AS indirectly. Fiscal policy. The fiscal policy is more effective in a closed economy than in an open economy with floating forex rate and free movements of capital. those countries started financing the deficits through increasing the high-powered (base) money (and thereby money supply) more and more. Government expenditure is a component of AD and taxation reduces private income thereby reducing private consumption and investment. The countries which liberalized trade and international capital flows grew faster than the others. and thereby. The hyperinflation of Europe in the 1920s was triggered by war time damages and reconstruction. The telecommunication and computerization boom resulted into a structural shift from the traditional industries to the knowledge-based industries and services. The firms were forced to jack up their prices and hence the AS curve shifted upward. It affects the interest rate. The part shifting of the production base from the high cost North American. The South-East Asian countries and China provide enough evidence to this hypothesis. are never enough to counter business cycles. are considered to be among the main factors responsible for the current growth recession. Fischer and Startz. The collapse of VIKALPA • VOLUME 28 • NO 1 • JANUARY . government expenditure and taxation. Since the US happens to be an economic power. the world for the first time experienced the twin evils of unemployment and inflation at the same time. The stock market crashed on October 29. 2001. As a consequence. In addition. and the proper handling of stabilizing policies. thereby increasing aggregate supply. As it was demand caused. The increase in the energy cost led to increase in the production cost of all goods all over the world. The busting of this boom and the speculations in foreign exchange. and when debt became unsustainable. The stagflation was triggered by the formation of a cartel by oil exporters (OPEC) leading to restricted oil supply and significant increases in the crude oil price. cash reserves requirements. Unemployment grew and the vicious circle led to a deep recession. STABILIZA ABILIZATION STABILIZATION POLICIES The built-in (automatic) stabilizers. This being an adverse supply shock. open market operations. Dornbusch. Banks got into the problem of recovering their loans. tax cuts provide incentives to work longer and harder and to save and invest more.Depression. viz. progressive direct taxes and social security system. while the output fell. which. monetary policy. and statutory liquidity ratio. The fall in demand led to poor sales causing high level of inventories which prompted firms to cut production and lay off the workers. viz. When the debt became unsustainable. 1929 (Monday) with the Dow Jones Industrial Average (DJIA) falling by 12 per cent in a single day. causing the Asian financial crisis of the 1997-98. Chs 11-12. and the foreign exchange rate system provide the necessary tools in the hands of the policymakers to tame economic fluctuations (Gupta. The prosperity of the 1980s and 1990s could be credited to the spread of globalization. all these hyperinflations were accompanied by equally high growth in the high-powered money. Chs 11-12). as increased government expenditure leads to increase in interest rate. The growing terrorism. and environmental hazards have also contributed in aggravating the recession. both output and price fell simultaneously. The wealth of the households got eroded which affected consumption expenditure adversely. and European regions to the low cost Asian and Latin American regions has helped in bringing down inflation throughout the world. and through that the appreciation of the exchange rate (if the economy is on a floating rate system). Japanese. Needless to say. fluctuating monsoons. causing heavy debts. giving rise to hyperinflation. technical progress. The Latin America’s hyperinflation was caused by its attempts to grow through debts. in turn. their non-performing assets mounted and thus investment suffered. some of the countries got into external debt crisis and all of them resorted to excessive printing of currency causing hyperinflation. prices went up. Part of the effect of the expansionary fiscal policy is crowded out through reduction in private investment and net exports. exerts influence on 5 .MARCH 2003 the USSR and the poor experience of the African countries offer the added support. 2001. The monetary policy operates through regulating the supply of money via its control on the high-powered money and through other instruments like the bank rate. this phenomenon spread across to other countries and there was the Great Depression. The confidence of both the consumers and firms shattered.

• Changing structure causing the multipliers to be dynamic and not quite known. the fiscal policy suffers from the following: • Fiscal expansion leads to fiscal deficits which add to the public debt.5 per cent of GNP during the period under discussion. • Counter reactions from other countries. does not enjoy the power of regulating its money supply. and Panama and Equador. thus. • Open economies with the floating exchange rate have additional crowding out of fiscal expansion through contraction in net export via forex rate appreciation. • Ricardo-Barro equivalence theorem suggests that if people have bequest motive and no liquidity constraint. This happens when the central bank is required to monetize some part of fiscal deficit.LUCTUATIONS AND STABILIZATION POLICIES 6 . Taking up the specific policy-wise limitations first. which have “dollarized” (US) their medium of exchange. This limited use was due to the then prevailing classical belief in the ECONOMIC . and two. each of these policies is subject to some inherent limitations. the tools of monetary policy are not available to mitigate economic fluctuations. The forex rate policy suffers from limitations such as: • Low price elasticities of exports and imports. • If the interest sensitiveness of money demand is low. and this limits the operations of fiscal policy in restricting the unsustainable recovery/prosperity. tax-financed government expenditure is tantamount to debt-financed government expenditure and this is mostly crowded out through cuts in private expenditure. which are on the currency board. In addition to the above policy specific constraints. monetary tools subserve the fiscal instruments. all the stabilization policies suffer from the following limitations: • Policy lags. The US Federal Reserve Bank is independent in this regard and the Reserve Bank of India has become theoretically independent only lately. • The counter policy changes in the income velocity of money/liquidity preference could also frustrate the efforts of monetary authorities. why did these policies really fail to check the significant business cycles? Analysing first the Great Depression. we can safely say that the fiscal policy was not adequately applied. fiscal policy is of little use.2 per cent in 1933. The Euro region of Europe. The foreign exchange rate exerts its influence on the relative price in the country in relation to abroad and thereby affects net export which is a component of AD. This is what is called the international trilemma or impossible trinity. which are readily available. In other words. which are long and variable. and/ or there are significant restrictions on the movements of capital in or out. One. and the fiscal deficit increased from –1 per cent (surplus of 1%) to 2. If one examines the US data. and/or that of investment is high. The real balance (Pigou) effect provides yet another source for the effectiveness of monetary policy. monetary authorities then had only limited powers to regulate the money supply. If all these policies are there. how is it that these did not work to counter business cycles? Two reasons. the government expenditure as a proportion of GNP increased from 10 per cent in 1929 to 19. inside and outside. The monetary policy also suffers from some unique limitations: • In some countries. The moot question now is. • In countries where the exchange rate is fixed. leaving little impact on AD. • Considerations which suggest the adoption of the fixed exchange rate system/currency board/ currency union or the dollarization (US $) which prohibit the use of the exchange rate policy. fiscal policy is asymmetric. the respective governments may have failed to use them appropriately. • Political costs of hard policies. debt is sustainable only up to a limit. Obviously. • Errors in forecasting the exact magnitude of recession/recovery. • Public has little tolerance to cuts in government expenditure and increases in tax rates.investment (Keynes effect) and net export (via forex rate. if floating). and the flexibility in the forex rate was not available due to the presence of the gold standard. • The low interest sensitiveness of investment and/ or high interest elasticity of money demand acts as yet another constraint in the effectiveness of monetary policy. as devaluation and re-valuation are components of “beggar thy neighbour” tools. So are countries like Hong Kong and UAE.

81 0. N.17 0.85 0.40 21.90 12. Stabilizing policies have helped rescue the debt and foreign exchange crises faced by several countries including Mexico. A reduced form regression model results are given in Table 4. 26. the Federal Reserve Bank did not possess the flexibility in issuing the high-powered money.10 0.” which recognized the effect of these policies on aggregate supply. 24.55 1.78 16.11 Money Supply Growth China USA N.87 5.non-interventionist policy.A. their corresponding magnitudes would grow slower during prosperity and faster during recession. Thailand. government expenditure. which.50 -3.59 16.50 1.73 2. The results in the last two tables are based on annual data for the period 1969 to 2000 in case of India and the US and 1979 to 2000 in case of China.01 5.81 12. and fiscal deficit as a proportion of GDP in the three countries under analysis.79 4.49 18. for a policy to have been applied as (Percentages) Year India 1969 1970 1980 1990 1997 2000 Mean* SD* 9. Argentina. the low level of interest rate augmented the liquidity preference. if the stabilizing policies are applied to counter business fluctuations.15 6.A. and rational expectations hypothesis further limited the scope of Table 2: Changes in Policy Indicators all stabilizing policies in taming business cycles.87 Source: IMF: International Financial Statistics.52 3. * For the period 1969-2000.12 4.30 3. During the four-year period of the Great Depression. To some extent.28 2. and fiscal deficit as a proportion of GDP for these countries.A. reduced the effectiveness of monetary policy.11 2.23 17.09 18.80 5.34 19. Due to bank failures and non-availability of insurance against bank deposits.40 21. The beauty of the fiscal policy.MARCH 2003 7 . Currently.59 18. in Table 5.60 10. N. VIKALPA • VOLUME 28 • NO 1 • JANUARY . this hypothesis was modified by the “supply-side economics.59 2.24 2. Stabilizing policies suffered a setback during stagflation as they operate basically through aggregate demand. was then hardly known.11 4. Data in Table 2 indicate the broad workings of these policies in select countries. including the US and India to tame the growth of recession and to come out of the terrorist attacks.62 22. Is GDP growth rate related to money supply.70 1. Prompted by the latter possibility. However. growth rate in money supply. the nominal money supply in the US actually fell by over 25 per cent. These policies could attack unemployment through being used as “accommodating” or inflation through being “extinguishing.80 6.A.79 N.27 17. various issues. government expenditure as a proportion of GDP. countering unemployment leads to aggravate inflation and taming inflation worsens unemployment. and the policy-makers’ over-riding concern of ensuring balanced budget operations.98 14.60 1. India.80 10.80 3.97 -0.38 9.19 20. US.88 N.48 Fiscal Deficit (%of GDP) India China USA 2. these tools are being applied successfully in many countries. The recognition of the natural rate of output and unemployment.70 14. and fiscal deficit? In Table 3 we provide the simple correlation coefficients between GDP growth rate and each of the growth rates in money supply.47 4. particularly during the recession. we would find the pattern as shown in Table 5. viz.80 12. government expenditure as a proportion of GDP.86 1.90 3. The interest rate hardly moved up or down. and China for some selected years. A careful analysis of these results indicates the following: • There is no particular pattern among the growth rates in GDP.54 8.43 19.00 13.80 13. and Indonesia during the 1980s and 1990s. policy lags. 2. It may be noted that.50 21.A.35 5.” However. Further. though leaving the real money supply practically unchanged. The results were only partially successful and.30 18. there were ups and downs in unemployment and inflation during the said period. Being on the Gold Standard.82 Government Expenditure (%of GDP) India China USA 8. accordingly.99 19. Thus. N.A.40 19. many governments resorted to tax cuts and tax breaks on saving and investment.60 9. in turn. households and banks’ preferences for currency and reserves went up which adversely affected the deposit money (money multiplier).97 3. looking at the best and the worst years in terms of the GDP growth rate for each of the three countries.

Generally. ten as totally opposite.105 GM – (1. the US. the signs of the coefficients of Table 5 : Best and Worst Years of GDP Growth Country Year India China USA 1988 1985 1984 Money A AA AA Best Year Government Expenditure AA AA AA Fiscal Deficit AA BA AA USA GY = GY GY = GM = GEY = FDY = + – R 2=.26964 -0. In contrast.02) 0. The classists favour the monetary policy over the fiscal instruments as they believe that the demand for money and the other behavioural functions is relatively stable.621 GEY (2. Fiscal deficit as percentage of GDP. Both schools believe that for policies to be effective. out of a total of 18 entries in the table.43) 0.04185 Table 4: Multiple Regression Results India GY = GY = 9. the Keynesians favour the fiscal policy.86) 0.380 (3. The foreign exchange rate policy has not been used much in stabilizing the economy. This observation corroborates the one inferred above on the basis of the correlation results.380 (1. the fiscal policy was anti-cyclical in the US and China and pro-cyclical in India.378 FDY (1. • Though all the correlation coefficients are small. In contrast.84) – – 0. the opposite was true for the other two countries. The sign of the coefficients of GM (growth rate in money supply) is negative for India and in one equation for the US and is positive for China and the other equation for the US.521 FDY (3.070 R 2=.59) – 0.339 R 2=. particularly to check recession.939 (2. AA: Above average growth.37240 -0. it is positively correlated in the other two countries.07) 0. Year 1979 1990 1982 Money AA BA AA Worst Year Government Expenditure A BA AA Fiscal Deficit A BA AA A: Average growth. are poor. The other two have been applied with varied success. Economists differ with regard to the relative effectiveness of different stabilizing policies. BA: Below average growth.533 counter cyclical.331 GM – (3. they have to be credible.06 GM (.257 GEY (1.030 (3. In case of China alone.LUCTUATIONS AND STABILIZATION POLICIES .90) 3.97) 9.60) 0. Growth rate in money supply (broad). it was pro-cyclical in the other two countries. The data on the relevant policy variables in India.22940 China GY = GY = + + R 2=.064 = Growth rate in GDP. the fiscal policy was pro-cyclical there. • The regression results.72) 14. in general. we must have BA (below average) entry during the best year and AA (above average) entry during the worst year. These findings suggest that while the monetary policy was counter-cyclical in India.148 GM + (1.04) 5. In contrast.94) 2. it is interesting to note that while the growth rate in GDP negatively correlated with money supply in India.24200 -0. These suggest that while the monetary policy was conducted as an anti -cyclical policy in India. only five qualify as the correct ones.16104 0.152 GM + (1.277 GEY (1.061 -0.244 GM – (2. Of the five correct ones.14150 0.03) 0.25) 0. the regression coefficients and the R-square values are significant. and China are reported in Table 2.21) 4.19073 0.31110 USA 0. and the remaining three as neutral (A: average) cases.29 FDY (1. On this criterion. 8 ECONOMIC . GEY (government expenditure as proportion to GDP) and FDY (fiscal deficit as proportion to GDP) are positive for India and negative for the other two countries. three are for the US (all during the worst year) and one each for India (for money supply during the worst year) and China (for fiscal deficit during the best year). Quite the reverse is true for government expenditure and fiscal deficit proportions. This simple analysis thus suggests that the stabilizing policies were applied consistently only to tame recession in the US.38) R2=0. when the interest rate hardly responds to fiscal deficit.Table 3: Simple Correlation Coefficients Growth Rate in Money Government Expenditure Fiscal Deficit Growth Rate in GDP India China -0.45) 0. these policies were pro-cyclical thereby aggravating the fluctuations rather than countering them. In a majority of the cases. Government expenditure as percentage of GDP.775 (2.171 R 2=.093 (1.11) 0.

a proper mix of an expansionary fiscal and an expansionary monetary policy would tend to raise output without raising interest rate. Countries after countries have faced slow-down but they have all been short-lived and relatively shallow.The improvements in the knowledge base. CONCLUSION Economic fluctuations have occurred. etc. The policies do have side effects. some of which may be undesirable. but a judicious combination of the various tools can minimize the bad effects. technology. The credit for this goes squarely to the development in macroeconomics and its application by policy-makers across the globe. at least one of the three stabilizing policies analysed above is effective under any condition to at least partially counter fluctuations. Deep or/and long recessions and unsustainable prosperity are. It is because of this that the world has not seen any deep recession since 1929-33. in spite of vast developments in macroeconomic theory and policy and technological innovations. Also. are responsible for the inadequate effectiveness of policies in countering the current growth recession. The new Keynesians accepted the rational expectations’ theory and rationalized the wage-price rigidity hypothesis of the old Keynesian school. if an expansionary fiscal or monetary policy were accompanied with a devaluation of the foreign exchange rate. For example. There is nothing perfect in real life and so policies cannot guarantee full freedom from fluctuations. was not Milton Friedman encouraged to counter the inadequacy of the Keynesian theory to account for the stagflation through his hypotheses of price expectations. and policy lags? His ideas got the added support from Robert Lucas and others. and we can safely state that such a great depression would never be there in future. of course. The discoveries of new products. etc. Was not Keynes motivated to revolutionize macro-economic theory and policy on experiencing the Great Depression? Similarly. VIKALPA • VOLUME 28 • NO 1 • JANUARY . though the literature provides examples of their poor guidance/ force as well. cycles are bad and unfortunately. natural rate of unemployment. we can now simply state that policies exist to counter economic fluctuations but these policies even today are not good enough to do away with business cycles entirely. and are not entirely bad. These. Needless to say. relax. international organizations like the World Bank and IMF have helped the member nations to implement effective counter-cyclical policies. In summary. have persisted and are unlikely to ever disappear. through their advancement of the rational expectations’ hypothesis. The latter tends to raise the standard of living which no one likes to reverse. among other factors. The former brings undue hardship resulting into both economic and social/psychological loss. and trends towards mergers and globalization. have enriched our understanding of the economy and accordingly economic fluctuations are now better understood and managed than ever before. discover new techniques. Pump priming is desirable during recessions and thus easy fiscal-monetary policy mix is a good policy currently in operation in many countries. These policies have been applied in the real world with varying successes. Recessions provide opportunities to introspect. among others. and recognition of the significance of macro-economic (fiscal) balance in economic growth. though milder over time. Fortunately. learn the ways to improve performance. we would have higher output without endangering the trade balance. new technologies. and transparency in policies.MARCH 2003 9 . The lack of full success has been partly due to the inherent limitations of these policies and partly due to their poor applications. Nevertheless. There are ups and downs in all walks of life and economic performance cannot be an exception. have been inspired by the business cycles. not good. cycles. would continue to recur.

S and Startz. Fischer. USA. econometrics. Business Cycles. No 2. pp 3-18. Rabindranath Tagore Gitanjali 10 ECONOMIC . New Delhi: Tata McGraw-Hill. The author thanks Maya Swaminathan. 8th edition. A doctorate from Johns Hopkins University.” Federal Reserve Bank of Minnesota Quarterly Review. Schumpeter. Chicago: University of Chicago Press. and Swapan Chakrabarthy for their assistance in data collection and compilation. Triyakshana. and international finance. Where the knowledge is free. New York: McGrawHill. The Dynamics of Business Cycles.ather. G S (2001). Ahmedabad.ernet.LUCTUATIONS AND STABILIZATION POLICIES . New Delhi: Tata McGraw-Hill. EC (1990).in Where the mind is without fear and head is held high. Kydland. R. J A (1939). Where words come out of depths of truth. Where tireless striving stretches its arms towards perfection. Macroeconomics: Theory and Applications. Acknowledgement • This article is a revised version of the Sixth Dr D K Shukla memorial lecture delivered by the author at MS University. Where the clear stream of reason has not lost its way into the dreary desert sand of dead habit. let my country awake. 2002. R (2001). e-mail: gsgupta@iimahd. he has authored several books and published many articles in Indian and foreign journals.REFERENCES Dornbusch. Where the world has not been broken up into fragments by narrow domestic walls. F E and Prescott. Tinbergen. my . “Business Cycles: Real Facts and a Monetary Myth. Baroda on December 28. Macroeconomics. Vol 14. His areas of specialization include economic theory and policy. J J (1950). J and Polak. Where the mind is led forward by thee into ever-widening thought and actionInto that heaven of freedom. G S Gupta is Professor in the Economics Area of Indian Institute of Management. Gupta.

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