“kit > frees. — atempted .g more the i public than that is beeen F ity of opinion amon f Business Cycles N other problem in the capitalist countries their own. theoreticians, statesmen and a F Dail Scie cycles. There This definition brings out the following points : ig the economists () Business"eycles-oceursin the jail i f oP this complex phenomenon. , 7 cas Fe Ci) Cyclical factuation i a characteristic of those is10 Bing te explana ces to the tions range widel not only ab tusiess CY ~ sfbusiness cyeles- ho stimulated muc fuctuations after | nni-presence of busin - ssuciated with business cycle stu the definition given by P.Burts. According to them, fi 96. Meaning of Business Cycle fas perhaps the h theorizin{ he established stat ess cycles in the latter half ince then extensive research hem but academicians have ‘ded in steering clear of ,, Keynes has di mreerin agethis soomposed of Pere definition, there DY rising Fee Framong the altering with periods of bad tra TeBureautof. falling prices an (A. which has been a business cycl Clement Juglar w: ofthe 19th century. Si hasbeen conducted on tt pot yet completely succes imltitude of complexities su - phenomenon. In respect of its very “fas been much difference of opinio ational tconomists. However, the Ni - Tconomic Research in the U.S. ‘ Sequence of change is recurret in drat ‘ {duration business cycles vary from m _ Sevsarto ten or twelve years; they are _ lo shorter cycles with amplitudes appr t N.C, Mitchell and A-F. Burns (1946), P. 3. Oe technological and intvenee’ Mine present chapter, out the nature and ly from the natural other exogenou a study will be < fai ‘ phases of totalitarian economies. igs but also about the principal theories first economist g on cyclical istically the economies in whicl Little information is available, if these are found in Ss efined a business cycle as ‘ds of good trade characterised riges and low unemployment percentages de characterised by ‘d high unemployment percentages.” S has stated in a similar tone, “The Myron Ros "le refers to’ the inexorable succession dies has adopted oF good and bad times.” an “Feasuring Busines Alexi, Robert Aaron Gordon has provided a definition of business cycles which is not only comparable to that accepted by the United States National Bureau bf Economic Research but goes even a step ahead of that. In the words of Gordon, “Business cycles ‘oycle ; this tiepar not periodic’; consist of recurring alternations of expansion and ore than wot divisible ‘oximating contraction in aggregate economic activity, the alternating movements in each direction being self- reinforcing and pervading virtually all parts of the 3 Cyeles, National Bureau of Economie Research, New York 425426 economy,”? This definition has a distinet feature in that it lays emphasis on the fact that business Muctuations are self-reinforeing or cumulative in character, Jan Tinbergen considers the eyelical fluctuations as the “interplay between erratic shocks and an economic system's ability to perform cyclical adjustment movement to such shocks."” Ragnar Frisch has echoed the same express following words, “Impulses from outside op: upon the economy causing it to move in a wave-li manner, just as an extemal shock will set a pendulum swinging.” The length of the wave movement is, however, determined by the “inner structure of the swinging, system.” Frisch recognises that, ‘the variation of the system may have a high degree of regularity, even though the impulses which sct it going are quite irregular in their behaviour.” A.H. Hansen has defined the business cycle as a “manifestation of the industrial segment of the economy from which prosperity or depression is redistributed to other groups in the highly interrelated modern society.” Through this definition, Hansen has pointed out that the cyclical variations get transmitted from one sector or group of industries to the others in a system. Similarly, the prosperity or depression in one economy may be transmitted to the other until business cycle becomes a global phenomenon in a world system where every economy is related to all the other economies. 26.2. Characteristics of a Business Cycle The definitions of the business cycle given above display the following important characteristics of this economic phenomenon = (@ A business cycle is synchronic : Whenever the process of fluctuations gets initiated in any sector or group of industries, it is not possible to restrict " the fluctuations exclusively to that sector or group ‘of industries. The rest of economic activities in a country are bound to be affected by the cyclical phenomenon and thus all the sectors or industries fa the system do experience almost, simultaucous expansions or contractions. (i A business cycle exhibits a wave-like : The system moves Tram one extreme to another like a:pendulum. The Business Fluctuations (1952), P. 214. -RA; Gordon ee ‘eview of Burns and Mitchell, Measuring 3. Tinbergen 4. AHL Hansen : Bus! Business Cyeles in Erasnius (1947), Pt jiness Cycles and National Income (1964), P. 21. MACRO-ECONO MIG A expansion or prosp. WY and vice-versa, (Ui) The business fluctuations sree, nature Ifa period of good trade | trade period of bad trade, it does not mean te bya Will thereafter suffer continuously from he of low sales, low prices and incomes, 4st change is recurrent. ‘There will altemal {9 i expansions and contractions in the activities, () Although business cycles are ree they are not periodic : Some trade cycles 7 only two or three years, while others may lary longer period of say, six or cight or even int number of years. ‘The actual experience of fo business world has clearly shown that no fae periodicity ean be contemplated for a complete get @) The £Conomg ‘Once the cyclical movement starts in one direction, it continues ts feed on itself and as a result the rate of change becomes more and more accelerated. Over te contraction phase, the initial decline in sales or production may be very small but as the time passes, it assumes more and more catastrophic proportions. ‘A similar pattern is exhibited by the expansion phase also. The cyclical movements are generally The movement from trough (minimum point) to peak may be slow and halting, but the downward movement may occur with a sudden and catastrophic. pace. "Thus expansion may last longe than. contraction, But the reverse cannot also be denied. It is always a matter of empirical circumstans that will determine whether prosperity or depression will last longer in the economic system. (vit) The true that economi impact of fluctuations upon sectors in a country is usu industries are more sensitive : others and they may be affected disproportion more than many others, For instance, the £2 goods industries or construction indus y relatively much more sensitive ham industries, cycles are all-pervasive, different industries a ally differential. to fluctuations a ther 1p. 627-630.og BUSINESS CYCLES es ess eycles may be international ze busin’ ical changes in the advanced jer? Te eer transmitted to the other gqnerll) Since most of the countries gg of the Nr yd economy are mutually inter- etreett YN iers of intemational trade and ie inthe eons of prosperity or depression ats Te “tect, by a larger or smaller degree, He could) gies in the rest of the countries. Eoomil 80 psmission of cyclical fluctuations Seiten pia particular economic system Fro Nom the effects of the forces of ey i pall, yments. a, ee Se characteristics tend to impress that i les is ir pattern of the business cyc! jeteheviout Pe But we must remember that no vthe same. mbe pes my jst in respect of their periodicity, cass and intensity. \d Minor Cycles ready studied that business cycles smretend vera fixed period. The length of the Ealwave hes found so profound an expression Sate eyele literature that Myron Ross had to ‘entk, “We should no more speak of the business frethan we should speak of the woman's hat since tke are about as many varieties of business cycle ster re women’s hats.” The academicians have studied the cyclical futons varying between a wide range of 2 years lst years Alypes of fluctuations in economic activities ‘a been placed into two broad categories—major ‘thin cycles, Hansen has defined major cycles te which, “from trough to trough vary in length minimum of six years to a maximum of thirteen Nisa Minor eyeles can be termed as those im ted fom trough fo trough range over a wou 280 Years to a maximum of five years. on tek in their case can be three years. Seopa (oes oF a study extending over 73 See: yny(t855—1938), concluded that the United in ae th Nore tdduting this period 18 cycles in all. Mt, eet could be regarded as minor E censor as the major cycles, Ja much ee StU4y concerning this problem ete liver, in 1860, by Joseph Clement asad States ated the cyclical movements in ts ‘lap tnee and England on the basis tS ‘© discounts and advances of. Tia ness Cycles, Third Edition (1962), P. 14: 344 Major am We have al 427 the banks, notes in circulation, gold reserves and bank deposits. Juglar suggested that the average length of a'cycle was about 10 years. ‘The Swedish economist Cassel believed that the period between two points of recognised crises in Germany during the last quarter of the 19th century varied between eight to'tenyears. Mitchall in his work Business Cycles and Unemployment states, “Fifteen times within the past hundred and. ten years, American business has passed through a crisis.” The periods between two successive points of crises varied between 3 years to 16 years. The statistical records clearly reveal that the Major cycles are interrupted by a number of minor upswings or downswings. J.A. Estey has pointed out that the expansion of 1920’s was twice interrupted by: minor downswings, first in 1924 and again’ in 1927. Similarly the expansion since the Second World War was interrupted by minor downswings in 1949 and 1954.5 Hansen has found 23 minor cycles with an average duration of 3-48 years as compared to ten major cycles of an average length of 8 years in the United States during the period 1857-1937. Joseph Kitchin, on the basis of the statistical data pertaining to bank clearings, wholesale prices and interest rate during the years 1890-1922 found that there had been a strong tendency towards a minor cycle averaging 34 years, or 40 months in Britain and the United States. This finding has been confirmed by an investigation conducted by W.S. Crum who also found that the average duration ofa cycle was 40 months. In contrast with it, ‘Russian’ ‘economist Nikolai D. Kondratieff has attached much importance to the long waves and has advanced the hypothesis that they are an. inherent constituents of the capitalistic process rather than the result of random factors. For his study, he relied upon the statistical data concerning wages, interest rates, wholesale prices, exports, imports and production in Britain, France and the United States. The data that covered the period 1780-1920, seemed to sr dg les, each full cycle having a periodicity in. an of 50 years, Chambers has, howe eicsed the position taken by Kondratieff in the ellos words, apart from the price and long a ae a Tate series, his data are inconclusive ané Sot, his data are so fragmentary-in time Yea he make highly questionable any inference 700" aggregate nature of long. waves.428 {successful in finding long waves in his production _The cyclical variations according to their Periodicity, can now be sub-divided possibly into three categories—Juglar’s cycle of nine to ten years, "s 40 months cycle and Kondratieff's long waves extending over 50 years. Schumpeter maintains that these three cycles should not be studied in exclusion of one another. The business cycles of different durations, in his opinion, occur side by side, and the course of economic activity can be described by a pattern of these three different cycles super-imposed upon each other. From the standpoint of scientific classification and for purposes of systematic analysis of the essential patterns of cyclical behaviour, there is no fundamental difference in the behaviour of major or minor cycles. Both contain in them a characteristic pattern of the cycle. In both occurs the normal sequence of prosperity, recession, depression and revival. So. we phenomenon d that business cycle is a following each other in succession. It implies that there are two broad phases of a cyclical phenomenon. Burns and Mitchell, however, intervene to suggest that the points of peak and trough are the two critical mark- Off points between them. The point of peak marks the termination of prosperity while the Burns and Mitchell, in order to elaborate further, have divided a complete Standard cycle from trough to trough into nine distinct stages as shown in Fig. 26.1. The points of trough have been designated by stages 1 and IX, while the peak has been designated by stage V. The ‘expansion phase extends from II to IV and contraction ~ extends from VI to VIII stages. Z é Z : é Fig. 26.1 6. EJ. Chambers ¢ Economic Pluctuations and Forecasting (1961), P. $4. MACRO-ECONOMIG gy, ay J.A. Schumpeter has, however, diss, the above demarcation of the different. the cycle. In this opinion, the expan * of contraction should not be marked off fre peak or from trough to trough, rather hen Pn be marked off from equilibrium to equilibria. Slt into consideration the equilibrium levet aye, Ae activity, Schumpeter visualises a cycle a: ‘conone phase cycle and (if) a four-phase cycle. ?™% (o Two-phase eyele : tn a vx entire period during which the eee Oe above the equilibrium position is treated ae." of good trade depicted by part A of Fig. 26, 2 og this period, the system intially experiences camer? expansion which leads it to the point of peak. 1, is the prosperity phase. From the point of peak. 4, economy starts sliding down towards. depression The GNP, however, is still above the equiliia, position. The period of good trade comes to an ns as soon as the GNP approximates to the equiltram level at E. GNP (in roe Re.) Fig. 26.2 26.2, CDE represents he quilibrium position. 1d recession Part B of this figure shows In part A of Fig. movement of GNP above the e includes the prosperity (from C to D) an (from D to E) phases. ihe period of bad trade. path EFG remains throug! position, The movement fro phase of depression while from state of recovery, (i) Four-phase eyel of Schumpeter involves (a) the jement aong the mov eal bias hout below the equil 1m Eto. F represents FwG represeats® le Je: ‘The four-phase © he prosperity (2) _—wot quainess CYCLES depression, and (d) the recovery. ) ges can be shown through Fig. 26.3. if SETOW EQUILIBRTUyECULIORIUM ‘ ' “gg the forces of expansion exert, GNP moves ‘slong the path ABC above the equilibrium. The movement from A to B represents prosperity (Phase ‘and from B to C represents recession (Phase II). From the point C, the pressure of depressing forces mes so strong that GNP moves along the path CDE below the equilibrium position. The movement fom C to D represents depression (Phase II) and - from D to E, the recovery (Phase IV). The salient features of these four, phases of @ typical trade cycle may be described as follows : @ Prosper: The prosperity has been defined , ty Haberler as “a state of affairs in which the real iacome consumed, real income produced and the level of employment are high or rising, and there are 10 idle resources or unemployed workers or very few of either.”? Thus the prosperity represents a Thi precisely is the state which most.of the economi policies strive to achieve. During, the prosperity phase, apart from high magnitudes of real consumption, production and employment, the level of wages and prices too rules high. But the former: generally has a tendency to lag behind the latter, Consequently, as prosperity proceeds there is.a gradual erosion of real wages. The increase in prices tends to gather more and more momentum, The cost of production naturally rises due to the impact of high wages, prices and profits. ‘There is a state of general exhiliration in the business community. The optimism pervades the FTaberler, G.: Prosperity and Depression, (1958), P. 259. 7 a 429 eatin and the ec mercial and industrial ivities, both of speculative and non-speculative types are on the expansion, There is a cumulative growth of the construction activity in the country. The confidence in future is so greatly strengthened that the business inventories become very large and heavy investment is undertaken in the durable capital goods. The security prices rise yielding handsome gains to their holders and the investment in new issues of securities is greatly stimulated. The discount rates and other interest rates have an upward trend because of an excessive pressure of demand for loans from banks and other financial institutions. These boom conditions cannot sustain themselves infinitely because the forces of expansion, after a point, get progressively weakened. The economic activity is debilitated by the shortages and bottlenecks. The excessive demand for labour and materials pushes up both the factor and product prices in a rather disproportionate way. The distortion Of the relative prices causes grave consequence for the economic system. Since a very large part of investment is financed by banking and other institutions, and during the process of ‘expansion, these institutions extend credits sometimes to such an. extent that their reserves get dangerously low. The further extension of loans is discouraged through increased interest and discount rates. As the financial institutions start recovery operations, serious financial bottlenecks force the business firms to liquidate their stocks of inventories, which all of them, obviously, cannot do at the same. prices. The disposal of inventories causes 2 decline in:prices and. consequent losses to business firms. ‘The optimism gives way/to pessimism. The production schedules are curtailed ; workers are laid off ; and the outstanding orders for the purchases of inventories are cancelled out. The decline in sales causes a further fall in prices and thus the economic system gets envelo| is. © It is evident from the above study that the seeds of destruction of prosperity are implicit within the prosperity itself.» The prosperity, after some time, relapses into crisis or Pecession,, As the ent-epreneurs start realising that their earlier anticipations of profits could not materialize, over-pessimism, nervousness, uncertainty and fear overtake the! business world. In. this psychological state, not only. the new projects arethose in hand are also abandoned, den rise in business failures, Ay the » the fear of losses co entrepreneurs ty en and come ce production and contract is a visible tend ¢ remarks, “A nce started, tends to bui Much as forest fj its own drafts and gives internal impetus to its destructive ability,"*8 The state of recession generates such a complex forces as lead the entire system to era h headlong against the trou; © : The most fearsome phase of a busine: le is that of depression; defines depression as “a State of affairs in’ which real income consumed or volume of production per head and the rate of employment are falling or are subnormal in the sense that there are idle resources and unused capacity, especially unused labour.? The most notable feature of depression js that production and employment undergo a very substantial decline, There is no doubt that the decline is generally throughout the entire economy, it is by no means uniform. While the contraction is quite substantial the fields of manufacture, particularly of capital ds, buildings, machinery and equipment, mining, i i transport, the ‘sectors like retail are little affected, The others like agriculture ‘hich are exposed to inclemencies of weather, and "are relatively non-commercial in character, experience erratic variations, Not only production and employment go down in depression but there is also a steep fall in Prices and wages. The former decline because of pessimistic expectations on the part of producers and consumers. While the producers. are eager to dispose of the finished products to escape the fury of further price 8. M.W. Lee : Economic Fluctuations (1955), P. 42. 9. Haberler : Ibid (1958), P, 252. MFO CCI. | CFS tend 4, hy, ion of 4 furtan 2% : ‘not demand interruppag nn ced with the Met fas 8 for the recover ™ cash to meet w,% ced to liquidate ng , when the pr; Jn wages is mainty x loyment in the decline, the consum Purchases in anticipat Prices. The lack of suprs dwindling of sates and an wen ot ‘The entrepreneurs fa financial institution. and necessity of obligations, are for; of their inventorie: declining. The fall widespread unempl the decline in production ang omy mpl entire economy is not uniform, ee then, decline in prices is also not uniform, Ther Prices fall much more sharply than ie ma which tend to be relatively more Tigi. in eg the prices of manufactured B00dS vis-auvis get agricultural raw mat latter decline relativ, ony * m te rials, it must be which make maladju: Pronounced. As a continues to de! duration. istments more Fesult thereof, den, presses y control for a considerably knee and partly because the fi reluctant to advance ‘credit at the old sesle. Ts type of stalemate causes the depression to penit for a relatively longer period. Depression’ catises a very serious distortion a the distribution of national dividend. The es Prices directly affect the entrepreneurial profs : ebbearance of losses causes the baskruptss business firms. The real wages of the — retain their jobs are high inspite of a decline ng Wages, since prices fall relatively more than in wage rates, ee No doubt, depression very badly ea economic life of a country, it does aren mean that it will penpetuate itself permanca se the phase of depression, the eit their purchases of capital stock even for inancial institutioas zt— cg oF Bt pent, Afler a stage, the requirements of op onee is for replacement a Well as additions cap Fenive capacity become so insistent that fresh 0 ee plant, machinery and equipment are yes ‘This stimu Jates the productive activity, which al. THs an expansion in employment, income eat Thus the system achieves a state of ana (Meer rning point of the cycle from ie rosperity. During this phase, the fem indicates some signs of USINESS CYCLES egonomic 8 werent slow ingore omployment bringing about an increase om incomes, The prices too are more or less stable inal iy stages of recovery so that real incomes inf Srropotion (0 a rise in money wages. The fosiness activity starts experiencing a state of ves a6 tne share of profits in the national fividend rises while those of interests and wages femain low. The appearance of new demand for capital goods, the existence of low interest rates, the willingness of financial institutions to extend more credits and the hopeful expectations about fuure make way for the expansion of new investment acivity. The bullish conditions appear in the stock ~ exchange markets. New issues of shares are floated and there is a more and more brisk pace of business expansion. During the phase of recovery, the expansion of ouput and factor incomes tends to) prop up the ‘aggregate expenditure. ‘As the effective demand increases, the expansion of income, production and employment have a, self-reinforcing character. The cumulative process of recovery continues to forge head until it merges with a general state of prosperity. AS regards this phase’ of the cycle, one fact ‘must be kept in mind that a state of depression can ot get automatically transformed into economic - teeovery. The recovery is a:very slow and halting Process. Unless the economic system, through ¢tlterat stabilisation policies, is geared to overcome on entrepreneurial pessimism, there cannot, ange ibe any hope of the revival of the economic to gid: The economic system, left to itself, is likely i ee near trough for an inordinately, Jong Peri foe at above discussion may some time lead to tha gets Motion about the nature of fluctuations Se are always orderly and regular. It is true that very often prosperity, recession, depr recovery occur in this sequence but this is not a rule, The instances are available, when the phases of a business eycle occur in an irregular manner. Generalisation can not also be made about the definite length of each phase of the busines It is quite likely that a fairly stable depressier undergo recovery or relapse into further rece: as it happened in England in 1924. Similarly a revival may not merge into prosperity. St may rather be terminated at an carly stage and there may be a Tecurrence of recession as happened in U.S.A in 1937. About the duration of the different phases of a cycle, it is possible that a fairly stable depression may be followed by a slow recovery as was the case during the ‘thirties’ or a highly unstable depression may be followed by quick recovery as occurred in 1921. In the same way, there may be a highly unstable prosperity as happened in 1919 or at times the prosperity may be fairly stable, as happened during 1924-29. However, these confounding irregularities of the fluctuations in respect of their order or duration are of great significance since they impress upon the necessity of an appropriate analytical framework for the study of the problem of cyclical variations and for th evolution of a pragmatic: anticyclical stabilisatioi policy. 26.5. The Purely Monetary Theory This theory of business cycles is mainly developed by R.G. Hawtrey, who enjoys the reputation of adhering most uncompromisingly to a purely monetary explanation of business cycle. In his words, “The trade cycle is a purely monetary phenomenon, because general demand is itself a monetary phenomenon.” He maintains that changes in the ‘flow of money’ is the sole and sufficient cause of changes in economic. activity. The flows of money are approximately equal to consumer outlays which may be termed as MV, if V is the income velocity of circulation of money. It implies that consumer outlays are related directly to the changes in the quantity. of money. If the quantity of money. and credit-are expanded, demand exceeds anticipations, stocks decrease and larger orders are placed for replenishment of stocks. This brings about a rise in prices, production, employment and factor incomes. In an opposite situation, a reduction in the quantity of money causes a contraction in demand. Stocks26.11. Samuelson’s Model of Business Cycles Samuelson 1d 1 The national incomé or output (Y,) of period ¢ is. composed of the autonomous government spending, G,,. induced consumption spending (C,) and the induced Private investment (I). * YrGeGith “(0 For the purpose of analysis, we assume that consumption is a function of the previous income Greve ee) where a is the propensity to consume. Investment in the current time period is assumed as a function of the change in consumption im the current time period over that of the preceding time period. where B is the accelerator. sath Since C, is the function of Yi 1, a , is the function of Ae ihe = BAY, -aY,») >: i iii) Sibel (i) and (iii) into (i) Y= G+ oY,4 + BAY, — aY;2) =G,+ a¥.)"+ oBY.1-aBY.2 J. Ort Yi + OB) BY 1-2 ih452 Ya (1+ B) ao Yi 2 Y= 1fG,=Rs. 1500 crore, Y,.1 = Rs. 3000 crore, Yi.2 = Rs, 2500 crore, «= 0.5 and B= 2, the current income or output can Be determined. YeG,+¥un (1 +B) a—aBY.2 = 1500 +3000 (1 +2) 0.5-0. 5 2 x 2500, = 1500 + 4500-2500 =Rs.3500 crore Given G, =1 Re. and the different ‘Values of and B, the growth sequences of income can be shown through Table 26.2. TABLE 26.2 Sequences of Income Growth for Selected Values ofcand B 3 fy a=05; a=05 3 5 B=2 1 1.00 1.00 1.00 1.00 2 2.00 2.50 2.80 5.00 3 3.75 4:84 17:80 4 4125 6.352 56.20 3 2.25 | 3.4375 | 6.6256] ),..169.84 6 2.00 | 2.0313] 35.3037 500.52 7 |rosea] 1.875] 9141 | 2.5959]. 1459.59 8 |1.9922] 1.875 | -0.1172 |-0.6918] .4227.704 9 1.9961 | 1.9375 | -0.2148 |-3.3603 |2241.1216 With different values of a and B, various super- multiplier effects can be noted and these values will cause different types of fluctuations. (@ \fa~=0.5 and B = 0, there will simply be pure multiplier effect with income approaching an asymptotic level (see Fig. 26.8). In this case the acceleration co-efficient is zero. Y TIME Fig. 268 (® Ifa =0.5 and B = 1, there will be damped MACRO-ECONoy fluctuations falling in magnitude the multiplier level and have a j to that level (see Fig. 26,9), Ay ‘thy My 0 Sndeney, waite obi y Fig. 26.9 SN) Ifa = 05 andB-=2, these alas yy generate lregular cycles about. the multiplier fey where the unchanged amplitudes repeat thensa indefinitely (see Fig. 26,10). TNE Fig. 26.10 (@- If a,= 0.6 and B = 2, the explosive qc will be generated in case of which variations sb! the multiplier level become more and more its over time (see Fig:26.11). y ) OL a oe ‘ Fig. 26.11 ; (6) Ifa = 0.8 and f = 4, there wil increasing income level gradually am 6.12! compound interest rate of growth (see Fi tt ye an ere Fig. 26.12 aM has depicted the different types of or on the different magnitudes of cand erent regions demarcated in Fig. 26.13. “Fig: 26.13, Region A is relevant when o.= 0.5 and f = 0. In tiscase a single impulse of expenditure will result in2 gradual approach’along an asymptotic income sh The growth in income is simply due to the, liplier effect. Region B represents a situation when a=05 and B = 1 and.a constant continual level of aionomous spending results in damped fluctuations” itnatonal income. Iq = 0.6 and.B =.2, a. constant level of ‘Monomous spending results. in explosive. or ever- ‘steang fluctuations represented, by region C.. If palf'ae B = 4,;a,constant level of spending an ever-increasing national, income Prosthng a. compound interest rate of, growth. Saale dose of investment likewise will make Reatpn nt upto infinity ata compound interest ‘age. This represented by region D. This bjarituslson model, provides a simple, and lanation of the essential mechanism of the | be ¢ tng le and, therefore, has a great appeal eons F i i anomists., Hansen believes that, the A na of a.and B in a realistic situation Place the economy in region B. Probab Be, Re US Sha rk hackle: A Scheme of Economic Theory (1965); P. 100: 453. Criticism : Samuelson’s theory of business cycles is criticised on the following grounds : ® This model rests upon crude and mechanical concepts of multiplier and accelerator. Therefore, this model of business cycle is itself criticised as very mechanical. (i). In this model, Samuelson has assumed con-, stant values of « and B co-efficients. This is not true in actual reality. (if) In this model, nothing has been stated about the periodicity of business fluctuations. It does not fully qualify as a proper theory of business cycle. (iv). In this model, the fluctuations are. supposed to, - take place around a constant equilibrium path.. It is completely unrealistic. (v), This, model_ fails. to integrate the theory of business cycle:with the forces of economic growth. (vi) No ceiling and floor limits are prescribed for fluctuations. i ‘ (vii): This theory overlooks the effect of monetary changes upon cyclical fluctuations. (vili) Samuelson’s business cycle theory does not take into consideration tlie effect of expectations upon the business cycle: in (x)! Samuelson assumedia closed economy. He didnot analyse’the cyclical variations in ansopen economic-system. 26.12. Hicks? Theory of Business Cycle Although the treatment of fluctuations by both Hicks and Samuelson is in terms of the interaction tween accelerator and multiplier, yet Hicksian treatment is a modification over Samuelson’s approach in two respects : @ Ceitings and floors : Samuelson’ analysis suggests the possibility of non-scillatory expansion, compound interest growth and oscillatory changes of equal, falling and rising amplitudes, ‘The non. oscillatory growth eases, Hicks suggests, should be ignored, since they contadict the fact that GNP nonmally takes an oscillatory path. Similarly the constant amplitude of eyele has a low probability of occuring, since it can happen under a unique situation ofthe product of MPC and the acceleration coveicient being equal to unity. Thus ony two cases of oscillatory changes remain damped cjeles + -and explosive cycies. In both these cases, Samuclson does not prescribe’ any upper, or lower limit of ‘Auctuations, Even out of these two cases, the damped cycle seems tobe unrealistic as it presumes a disappearance of fuctutons overtime which Contrary othe historical experince. Explosive eyeen too encounter similar difficulties, Such eyeeg However, can be made oft into realty, ifthe limi, on the amplitude of the cycle are prescribed so that “itis kept within bounds, k k E F MACRO-ECONOMIC ANALYGg (i) Rising trend of cycle: Another spy feature of Hicks’ theory is that the cycle is igus as taking place around a rising trend. In this theory growth factors have been fully synthesized 2) oyelerinducing frees. Ia growing economic syn all the economic variables influenced by the poe, growth factors lke autonomous investment, incre, in population and technical improvements follow ¢ slowly rising trend. Hick has analysed the cycle the background ofa rising trend, Thus, his analy is more proximate to reality than that of Safnuelso who analysed fluctuations around a constant trend, Given a constant percentage rate of autonomous investment, fora fairly stable accelerator ang multiplier, there is an equilibrium growth path for income that exhibits the same constant percentage + rate of growth as autonomous investment does, OUTPUY INVESTMENT {LOG SCALE) Fig. 26.14 The vertial axis in Fig, 26.14, measuring outpit and investment is’marked logatithinically, so that ® Constant percentage’ chatige in’ the’ vatiable ‘on’ the “Vertical axis is indicated by a Straight line.”AA shows autonomous’ investment rising at a’ constant Petcéntage rate: The line EB denotes the equilibrium path of ‘output. Tt depends’ pon ‘AA, since it deduced by applying super-multiplier to it The ine CC represents the full employ cellng ot the productive capacity ofthe economy It is the upper limit of the cycle’ and it increas Over time as there is a growth of popula’ aulonomous investment and technological av Explaining the exact nature of fill employes ceiling, Hicks writes, I" shall follow Keynes ! 37. 1R. Hicks: A Contribution othe Theory ofthe Trade Gye (1956)-P:96, ar og BUSINES pat tere is some point at which output jyelastic jn response to‘an increase in ema 38 Elaborating upon the ceiling. ae Ba arconnmentsy “Such a point will reflect eh ~pottlenecks of supply, a growing scarcity pie and in general rapidly increasing costs em siness— that are characteristic of the peak ibis cycles although cycles may peak i ba ein conditions are present.”3? he line FF describes the path of floor or te cit ‘hich real income or output can ‘fall ast * ontraction phase of the cycle. prosperity * As long as output or income grows, gant equal (0 that anticipated by entrepreneurs, te syste" will, continue, to move along the EE. It is, however, practically gum path , ale forthe economy to balance itself on such sight rope. The slightest disturbance can. set into fan a chain reaction. Let vs suppose that the sen initially is in equilibrium at 4. Further we ¢ that an, outside disturbance in the form of vation takes place and a burst of autonomous ‘After the burst. is over investment follows: vrrgonous investment reverts t0 its old path. This. ment investment will raise income through the nar effect, The increase in income, in ths will rise the induced investment through the acceleration tet A cumulative process of income growth is seated aid output of income diverges’ from the ‘qilibrium path EE!’ The multiplier-decelerator ee causes a big upward divergence. But a process of expansion is not without Although the ceiling Timitsis also°rising with clr of time, yet its rate cof growth isnot ae, the growth’ in incomé or care is rising ata much ‘faster rate.’ ‘The ceeg outa mut terefors finally hit the atsion a8 some point such as b. ‘The carrest Of a of the difficulties cess ih ‘of accelerator-multiplier tumulative iy of th full employment. “As the productive ods ‘natty system is approached, the investment Nese es cannot: Fespootid the: ineredses Mal tab eccesg opasiey of accelerator, iti thi lvestment cr capacity should be’ present in’ ahi the a industriés, while it must not eration sumer B0Ods ‘maustries.: Thus the pringiple may ‘be’ prevented from $ CYCLES om) ik yo Nicks Shoei pos ABS operating i aes mua a the expansion ip dtitjut’ or! Income ae ee ly ete upon multiplier. But multiplier a lequate to sustain an inet income or output. tn La Downturn : As the forces leading, : expansion become weak a he a he a ae ee one it must adopt a downward course, The question arises whether the downswing will be right from the point of crastt and: if the system will collapse to the equilibrium path with a sudden and catastrophic pace. The answer to this question is in the negative, For some time income or output will ereep along the ceiling limit (shown in Fig. 26.14 by the range be). The only force that aiefaing the system at the ceiling Timi is the higher Jevel of induced investment in the preceding period of expansion. Another factor, which sustains the’ system for a few periods at the coiling is the lng between changes in output and induced investment, So the lagged induced investment will s in the output at the, ceiling limit for a few (say 3 or 4) periods. Longer the investment lag, theslonger the system will creep along the ceiling before it turns. . down. When the lag is overcome, the contraction , becomes inevitable. Hicks has, however, mentioned an outside possibility when the downward moventent may get started even before the'lag is overcome, ~ ‘Whatever the case, the system must move down after the lag is over and the induced inyestmett comes to be related to, slie output of the time Wwhen it crept along the ceiling. Once the income starts * falling, induced investment also begins tO decline. Depression ? Just @ the bysine’s cycle docs, not explode inthe upward direction because of the fall employment ceiling, it cannot in the same Way” Tit direction, ‘The accelerator cay in-the downward Tee a i tannot,operate over the downswing just a8 it, does ae tony The acceleration, Pr ciple during, xP ct ‘ undergoes @ transformation and finds expression in. the principle that the. disinvestment at ne “it can be explained with the rae seis Rs, 10,000 crore Rs. 10,000 crore, 1000 crore ig 10 years. 0 crore, the frm needs Rs, 2000 crore. But this Srestnent will be Ged PY, Rs, 1000 orores456 Over the contraction phase, when the system reaches the point at EE, the question may. arise whether the decline will be arrested at this point, since EE is a stability level. However, the explosiveness of the forces that now work in reverse will plummet the economy past the equilibrium position tending towards the floor limit. : Recovery : Just as the bottom to the slump is inevitable, so recovery too must come provided the autonomous investment maintains its upward trend. But the: recovery will be delayed for some time and the economy will creep along the floor, limit FF (over the range ef). The reason is that there is the presence of vast excess capacity, Until it is utilized to some reasonable extent, the recovery will simply, elude the economy. Although: the autonomous investment may be’ rising, yet’ the continued disinvestment may almost off-set’ it causing a delay in the process of recovery.’ Once such effects are worked out, new investment begins to appear for investment moves’ above the level accounted’ for by autonomous investment. This increase in induced investment along with. ever-present autonomous investment, will make the system. move again in an upward direction through “the combined operation of multiplier and accelerator. Evaluation Many business ¢ycle theories vistilise a ¢yclical phenomenon as involving a rapid decline in’ the economic activity during the downswing, while recovery occurs in a slow and imperceptible manner. Hicksian model makes a distinct departure from other business cycle theories 'in this respect. In this model, since the accelerator undergoes transformation over the downswing, the’ decline \in output! during this phase proceeds at a slower rate’than’ the rate of expansion of output in the upswing. Hicksian theory also attempts to provide a satisfactory explanation of the turning point of the cycle. The upper turning point is explained through the exhaustion of the strength of the multiplier, accelerator interaction and the lagged response of investment. The lower turning point of the business cycle has been explained by Hicks through the absorption of the excess capacity. Hicks made a significant contribution to business cle theory by prescribing upper and lower limits “EF, Demburg and D.M, MeDougall : Macro Economics (1963), P. 232. replacement purposes and gross’ MACRO-ECOWG to the cyclical chan, » cyclical changes, Mor, combines, with an amazing deer’ Hlicky accelerator-multiplier. internets & snp economic growth, HOM With the ps __ Hicks has»greatly highti { importance of technologiog 1 is they, ‘growth factors and has pointed 2 oe? absence of these forces, the eesngett at nn tend to languish in’ depression for 93S 9, time. Dernburg and Me Dougall have Pits reasons for i. To quote them, “Firsy wit ety progress, autonomous investment panthig time, and thus a positive change in oupstt% to set the accelerator in motion, will ot ule until equipment has worn out to the pon ee? some replacement investment is necessn; go if there is no technical progress, the time slain replacement is necessary will be deferred a! no help is obtained from the obsolescence ofits, equipment. ‘The whole burden of stating acceleration going’ is thus’ placed on’ the weaiag out (depreciation) of equipment. Small wonder tz depressions are mote severe and long lasting dung periods whet long run growth factors seem to bein abeyance!40”"" Hicksian ‘theory of business cycle has be severely criticised by'a mimber of writers on varios grounds : (0 )Too-rigid +, The major deficiency in ts theory. {s, that. it is\founded upon the accelertie principle in.its rigid form. The prominent econonss like Kaldor, Shapiro and Duesenberry point ot this approach, based upon rigid, crude mechanical concepts, of accelerator and mihi’ accelerator interaction, is. highly. unsuitb business-cycle analysis and hence aC a (i) Constancy, of acceleration aie Hicks. has: attached fixed values to the act and’ multiplier which »is| quite inappront a relation between:capital and output came ations! remain‘constant over along period. The ct between these two variables differs fort in.the economy to the other. a a mite considerable "variation ; Hees sectors:. The expansion of outPH m sts sectors will invoke. different invests a ‘The assumption of a-fixed response PEN ics se and output and investment and 9utP to be quite irrelevants, ‘site on llyr of BUSINESS CYCLES nployment ceiling + Another scrious a Fan ike model brought out by Demburg 88 ll isthe full employment ceiling which Me fines aS independent of the path of output, wes del : related to the growth of population, set HL echnology’ ete, it is assumed to grow ae rate as the autonomous investment. But ed ‘and Me Dougall believe that it is not ie ro separate the long run full employment Ss fom what happens during a cycle, According Since the rate at which output increases ® mines the rate at which capital stock changes, sealing level of output will differ depending on th of output. Thus it is unrealistic to ime oe iat the ceiling rises at the same rate over = % u (a) Passive role of autonomous investment : as theory of business cycles has autonomous jresiment as ever-present, but its role is passive. Je sive propulsive agent is induced investment. itis questionable to assume that autonomous imvesment proceeds over a cycle at a constant peventage tate. The theory also overlooks the szaegic role autonomous investment can play not) dasa factor of instability but also as a source of, silly, “Indeed”, say Dernburg and Mc Dougall, “tere is reason to believe that the placing of primary saphasis on induced investment while ignoring “foctuations in autonomous investment, can be ‘ompared to the tail that wags the dog.” ; ) Periodicity of expansion and contraction : seemed to suggest that contraction phase of fecycle was longer than the expansion phase. This ‘contradicted by the post-war business cycles revealed that periodity of expansion was longer of contraction. () Neglect of monetary factors : Hicks admits monetary factors can alter the shape of the fag ut he attached less importance to the monetary hae vba other writers like Hawtrey and Hayek Nah resu it Most overlooked the fact that inflation al I before the boom is constrained by the | ben eoment ceiling, If it happens, of course, there | (vy, rut on ceiling to output in money terms. | "factor eet of interaction of monetary and Sos by Saute interaction of real and monetary mh, ‘age ignored by Hicks, may prevent: {Oooh a MeDovgal: Tid, 1963), Fp. 239-200 Ales Rg pC Dougall: Ibid, (1963), P. 240. 457 the system from approaching the full employmer ceiling. When the system rca ata fateeats (because of multiplier-accelerator interaction) than its long run rate, unemployment diminishes. Soon there are bottlenecks and labour shortages, and this situation tends to drive the wage and price level up. As these inflationary pressures are experienced, the central bank tightens the monetary conditions and brings prosperity to a premature end and thus there may be substitute ceiling of tight money in between the equilibrium line and ceiling CC. The economic system, after striking against this substitute ceiling of tight money, may adopt a downward course. (viii) Expectations : It is also felt that Hicks should have perhaps given a more significant place to expectation in his theory. The critics have, no doubt, inflicted the most damaging criticism upon Hicks’ theory, yet the importance of this theory in business cycle literature can be gauged by the appreciative comments of the same very critics about this theory. Kaldor makes a reference of “many brilliant and original pieces of analysis with which Mr. Hicks’ latest work abounds.” Duesenberry characterises this theory as “the first coherent theory of the cycle to appear in some years.” Shapiro sums up, “Hicks model remains, in a sense, the last word in business cycle theory.” 26.13. Goodwin’s Model of Economic Cycle Hicksian business cycle theory is related to the: limiting cycles and the limits on fluctuations are laid down by certain factors outside the structure of the model: Rictiard M. Goodwin has attempted to explain thei/stability of the cycle.on the basis of the conditions. within the structure ‘itself. His capital accumulation ‘model is different from Hicks’ linear model which becomes non-linear only when it meets ceiling and floor. Goodwin’s model, on the other hand,” is ‘non-linear throughout. Allen, making a mention of these features of Goodwin's model, states, “The advantage of Goodwin's model is that the non- linear elementjis built in ; the resulting oscillation maintains itself without any dependence on outside factors’ ‘or on:particular: initial (or historical) conditions."4} a + Mathematical Economics (1969), Pp. 242:458 ‘The main elements of the Goodwin model are a linear consumption function C = Cy + BY where Co, is autonomous consumption and 5 is consumption- income ratio, and net investment is taken to be equal to the ratt of change in capital stock. This net investment is the outcome of the.adjustment between actual capital K and desired capital K where desired capital is proportional to output by K = aY +b. The acceleration co-efficient has been introduced to explain net investment. The change in net investment stems from a change in output that causes a change in the desired level of capital. Thus accelerator, which is non-linear, produces an indirect dependence of investment on changes in output. To explain the path of cyclical movement, we ‘suppose that K’ is the rate of capital goods capacity output and K’’ is the rate of scrappage. Let us start from the position K = K. where the equilibrium level of output Y is determined by ¥=—12(C,+1) and the autonomous investint, so that’ the ‘system proceeds’ along ‘an equilibrium’ path: ‘This’ path ' is: analogous to’ the Hicksian EE line. While Hicks takes into account a steady rise in autonomous investment,’ Goodwin’s model is based on an increase in desired capital that results from the continuously occurring technical change. Once a divergence from equilibrium occurs, -the system will not tend towards equilibrium, again and. there will be contituous. fluctuations around the equilibrium path. : "Suppose that K'= K, an increase in investment: takes place and the propelling forces of multiplier and accelerator will push the economic system, in the upward ‘direction. Since’ the accelerator ,in _ Goodwin’s model is non-linear, investment is not. relatéd to the change in output but to the difference - capital. The investment relationship being continuous; investment is instantaneously thrust into the extreme” expansion. brings about a. situation. where 1=8K/8t=K". This restricts the growth of output and accelerator is ‘rendered discontinuous. - between the actual (K) and desired (K) stocks of! osition corresponding to this. phase, Thus) » corresponds. witha situation when = MACRO-ECONOMIg ANALY s of investment. Once K' tends! to ‘ove desired stock of capital will become e the rate of scrappage or the replaceme; K falls; the orders for capital stock and consequently the economic syste along the contraction path. ttake Ky ual ip ye Nt Tate, Thue also deere, a more During the contraction phase, K >R and gg gap between K and K is to be closed by K”. uy the same time desired capital has bee rising by tt amount of autonomous investment a. The closing gap between K and K has been explained Goodwin in terms of a gradual reduction of exces capacity, through a failure to replace and a steady occurrence of capital-using innovations. In hig words, “Excess capacity is being eliminated bat through failure to replace and the steady occurrence of capital-using innovations.”** The use of capital-using innovations during contraction,. however, seems to be highly questionable. - At the|lower turning point, Goodwin maintains that K’is equal to K.In order to initiate a recovery, it is essential to raise the level of K. The stimulant may be provided by a technological change: As long as the technological progress exists, there is 10 danger of the economic system to get stranded a the lower turning point. The-disparities in the actual and desired stock of capital resulting in fluctuations may be indicated through Fig. 26.15. KR ok Wet Fig, 26.15 Rhine apeatansty son phase Fig,’ 26.13 shows that the expansion Pl! i X semis the entif? Throughout the expansion K < K but at the peak, continuously above K while over Zz K becomes equal to K due to a decline in the rate. downswing K remains throughout greater =" r 8. “4, RM, Goodwin The Non-Linear Accelerator and the Perslstance of Business Cycles, Econometric, Jan. 1958: : aatiSS CYCLES = eres BUSINE aks and troughs, becomes equal to K. When a wath factors are not reflected in technology the there would be no net change in the stock Bate and the system will languish for a longer c val Wepression than it experiences the expansion. ifgronth factors involve technical progress, the Fy phase may be heightened since the time apy K to overtake K will be considerably eyed, Similarly over the downswing, the faion may get shortened. When growth factors pence te eyele, the subsequent peaks and troughs be atthe level higher than the earlier peaks and hs. This has been shown through Fig. 26.16. Fig. 26.16 The line aa in Fig:-26.16 represents the technological growth factor and itis analogous to | te Hicksian EE path, The upper and lower limits of {taking into account the technological growth fextors, have been ‘shown through dotted paths. P represents peaks and T troughs where K = K. The contractions in this diagram are invariably shorter ‘han the expansions. : 3 _ Criticism : The following main flaws have been Pointed out in the business cycle model propounded Goodwin. 2 - () Non-linear accelerator : Goodwin makes 4 departure from Hicks in his’ conception of {eltor which the former assumes #5 non-lineat ist Hicksian linear aécelerator. The question has ge Taised about the reasonableness of this type Accelerator, ing) Shortcomings of acceleration principle ? eee goOdwin’s ‘theory is “based Pon the Ea ion principle, the flaws, of. this principle ing the assumption that the present level of ee P evil be maintained even in futures affect this -and K. f 459 Ea 2) Unrealistic character of theory : Fig. 26.15 jows the desired stocks’ of capital through the rectangular blocks. This is unrealistic. In addition, it shows that the level of desired capital stock remains stationary over a time and that depressions are longer - than expaisions, All these are the objectionable 3s of this theory. However, these can be easily overcome by introducing lags and by involving growth factors leading to technological progress. (i) Recovery is a slow process : Goodwin's model depicts that the system will be bounced back from ceiling or trough as soon as it touches the highest or the lowest point. The empirical evidence in a very large quantum is available to prove the opposite that the recessions and recoveries may be imperceptibly slow as analysed by Hicks. (0) Fixed productive capacity of eapital goods industries : This theory recognises that the capital goods industries have a specific level of productive capacity. As a matter of fact, the productive capacity of these industries over a long period, can be substantially improved or reduced. ‘Although Goodwin's model has got certain weaknesses, yet it is regarded as @ big landmark in the endogenous explanations of the business fluctuations. . Differences between Cyclical Models of Goodwin and Hicks The business cycle models given by Goodwin and Hicks differ in the following respects = (p” Both the’ models ‘employ the acceleration prificiple. But they make use of different conceptions Prvaceelerator! In Hicksian model accelerator is considered linear but it is non-linear in Goodwin's model. m2 tai (ji) The Hicksian model is exogenous whereas “that of Goodwin is endogenotis. " (Gif) The expansion and contraction in Hicksian modeiare due to induced investment and disinvestment. These situations, Goodwin, are caused by the diverge , according to mnces between K - (i) In Goodwin's model, contraction follows immediately the peak and expansion oF recovery takes place immediately after the ‘paint of trough. While Explaning the upper and lower tuning points, Hicks, on the other hand, points out that the economic system creeps along the ceiting ‘and floor limits for a few periods.460 (vy) Hicks emphasises primarily on what causes business cycle. Goodwin, on the other hand, gives importance to analysing the time path of the cycle. (vi) There is a synthesis between cycle and growth in Hicksian model. The economic growth was linked by him to the constant rate of autongmous investment. On the other hand, economic growth in Goodwin's model ‘was attributed to technical progress. (vii)In Hicksian model, equilibrium path EE depends upon the action of autonomous investment and the investment multiplier. On the other hand, the growth path aa in Goodwin's model is determined by the changes in desired stock of capital (K) and technical progress. ; pee