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BUSINESS CYCLE

ANATOMY OF A CRISIS Wall Streets financial engineers had packed these loans into complicated financial instruments called CDOs (Collateralized Debt Obligations)

Low in come sub-prime households borrowed heavily from banks and finance companies to buy homes

They were defaulting heavily on their debt obligations

American and European Banks invested heavily in these products

The size of sub-prime housing loan market was huge at about $ 1.4 Trillion

Housing loans turned bad , the instruments that were based on these loans would lose value

CDO price started plummeting as defaults on US home loans arose

Falling prices dented banks investment portfolios and these losses destroyed banks capital

This began to hurt the flow of funds to the REAL ECONOMY

PHASES OF BUSINESS CYCLE

Steady growth line

Peak

DEPRESSION Line of cycle

Trough

PHASES OF BUSINESS CYCLE

1. EXPANSION 2. PEAK 3. RECESSION 4. TROUGH

5. RECOVERY AND EXPANSION

Increase in
Output Employment Investment EXPANSION Aggregate demand

Bank credits
Wholesale & Retail prices

Per capita output


Standard of living

Characterized by Slackening in expansion rate PEAK Highest level of prosperity Downward slide in economic activities The phase of recession begins

Downward slide in growth rate becomes rapid and steady Output, employment, prices etc. register a rapid decline

RECESSION

When the growth rate goes below the steady growth rate depression sets in

Depression begins when Growth is less than zero Total output, employment, prices, bank advances etc. Decline during subsequent period Depression lasts as long as growth rate stays below the stagnated growth rate

DEPRESSION

Phase during which the downward trend in the economy slows down and eventually stops
Economic activities once again register an upward movement TROUGH Period of severe strain on the economy Economy registers a continuous and rapid upward trend in output,employmenr, etc. It enters the phase of recovery

RECOVERY & EXPANSION

In the recovery phase the growth rate may still remain below the steady growth rate. When it exceeds this rate, the economy enters the phase of expansion And prosperity

CHARACTERISTICS OF DIFFERENT PHASE OF BUSINESS CYCLES

BUSINESS CYCLE
BOOM/PROSPERITY

RECOVERY

RECESSION

DEPRESSION

DEPRESSION
PRICE LEVEL FALLS STOCKS ACCUMULATE

PRODUCTION DECREASES

PRODUCTION FALLS PRODUCTIVE ACTIVITY SLOWS DOWN DEMAND FALLS

UNEMPLOYMENT INCREASES

PURCHASING POWER DECREASES

RECOVERY
DURING DEPRESSION ONLY CONSUMER GOODS ARE PURCHASED DURABLE GOODS REMAIN UNSOLD OLD DURABLE GOODS EITHER GET CONSUMED OR BECOME OBSOLETE PURCHASE OF GOODS AGAIN BECOMES NECESSARY PRODUCERS PURCHASE THESE GOODS

FULL EMPLOYMENT

PROGRESS IN BOTH INDUSTRIES

ENCOURAGEMENT TO PRODUCE CONSUMER AS WELL PRODUCTIVE GOODS


GREATER PRODUCTION OFCAPITAL GOODS INCREASE IN DEMAND FOR CONSUMER GOODS INCREASE IN EMPLOYMENT PRODUCTION IS ENCOURAGED

BOOM

EMPLOYMENT INCREASE

THERE IS OVERALL PROSPERITY

WAGES RISE

AS A RESULT THE LEVEL OF EMPLOYMENT, INCOMES AND TRADE ALSO RISE

DEMAND INCREASES

LEVEL OF INVESTMENT INCREASES

PRICES RISE

PROFITS RISE MORE THAN WAGES

RECESSION

INCREASED DEMAND DURING BOOM

BEGINNING OF DEPRESSION

BRINGS IN LESS EFFICIENT MEANS OF PRODUCTION

PRICES OF COMMODITIES RISE SHARPLY

MONEY MARKET ALSO BECOMES COSTLIER

COST OF PRODUCTION GOES UP

DEMAND FOR LOANS PUSHES UP INTREST RATES

QUANTITY OF INVESTMENT BEGINS TO DECREASE

What causes recession

Decrease in spending by consumers due to lack of faith in the economy Less consumption would mean decline in demand for products

Which perpetuates the cycle due to limited spending

Which leads to high levels of unemployment

Which leads the manufacturers to cut down on production

Lower production would lead to job cuts

Recession Specific to USA Years of rise in property prices

Housing bubble burst in 2006


Value of properly began to decline People found themselves unable to repay their loans

Banks were reeling under the shock of huge defaults, foreclosure and write off

NEED FOR CONTROLLING BUSINESS CYCLES Harm to business community Create unemployment and poverty

Business Cycles

Hence the need to create stabilization Through Government Intervention

MEASURES TO CONTROL BUSINESS CYCLES OR STABILISATION POLICIES

Monetary Policy

Fiscal Policy

Direct Controls

RBI measure to avert Indian recession

Conventional Measures

Unconventional Measures

--- Cut in CRR to release Rs. 40,000 crores


--- Cut in SLR would release Rs. 40,000 crores --- Cut in Repo rates to make borrowing from RBI cheaper

--- Access to special refinance at 7.5% for 90 days


--- Allowing banks to borrow against Govt. securities --- Release money for Govt. spending

MONETARY POLICY QUANTITATIVE OR GENERAL METHODS MEANT TO CONTROL AVAILIBILITY OF CREDIT IN GENERAL

BANK RATE

CASH RESERVE REQUIREMENT

STATUTORY OPEN MARKET LIQUIDITY OPERATIONS RATIO

REPO/ REVERSE RATE

BANK RATE POLICY


RBI DECREASES BANK RATE
COST OF BORROWING DECREASES

COMMERCIAL BANKS ALSO REDUCE THEIR LENDING RATES INDUSTRIALISTS AND BUSINESSMEN FEEL ENCOURAGED TO BORROW FROM COMMERCIAL BANKS THIS WOULD EXPAND CREDIT

INCREAES IN THE SUPPLY IN THE ECONOMY


INCREASES AGGREGATE DEMAND AND MONEY EXPENDITURE

CASH RESERVE RATIO

COMMERCIAL BANKS ARE REQUIRED TO KEEP RBI A CASH RESERVE OF 8% OF THEIR TOTAL DEMAND AND TIME DEPOSITS

WHEN RBI DECREASES THE CRR THE LENDING CAPACITY OF COMMERCIAL BANKS GETS INCREASED MONEY SUPPLY INCREASES EXPENDITURE INCREASES

STATUTORY LIQUIDITY RATIO

APART FROM CASH RESERVE REQUIREMENTS COMMERCIAL BANKS HAVE TO MAINTAIN LIQUID ASSETS IN THE FORM OF CASH, GOLD, AND APPROVED SECURITIES EQUIVALENT TO 25% OF THEIR DEMAND AND TIME DEPOSITS

LOWER SLR REDUCES COMMERCIAL BANKS ABILITY TO GRANT LOANS AND ADVANCES TO BUSINESS AND INDUSTRY

MONEY SUPPLY EXPANDS EXPENDITURE INCREASES

OPEN MARKET OPERATIONS

BUYING AND SELLING OF ELIGIBLE SECURITIES IN THE MONEY MARKET

TO INFLUENCE THE VOLUMES OF CASH RESERVES WITH THE COMMERCIAL BANKS TO INFLUENCE THE LOANS AND ADVANCES THESE BANKS CAN MAKE TO INDUSTRY AND COMMERCE

MONETARY POLICY

SELECTIVE & DIRECT CREDIT CONTROLS


PURPOSE

MEANT TO REGULATE THE FLOW OF CREDIT FOR SPECIFIC PURPOSES TO CONTROL THE ALLOCATION OF CREDIT BETWEEN ITS VARIOUS USES

MINIMUM MARGINS FOR LENDING AGASINST SPECIFIC SECURITIES

CEILING ON AMOUNTS OF CREDIT FOR CERTAIN PURPOSES

DISCRIMINATOR Y RATE OF INTEREST ON CERTAIN TYPES OF ADVANCES

OPEN MARKET OPERATIONS


RBI BUYS SECURITIES IN THE OPEN MARKET IT MAKES PAYMENT BY WAY OF CHEQUES DRAWN ON A BANK

THE CASH BALANCE OF THE BANK IN QUESTION GETS INCREASED

THE COMMERCIAL BANK INCREASES ITS LENDING THUS CREDIT EXPANDS

MONEY SUPPLY INCREASESAND EXPENDITUR INCREASES

SLELECTIVE AND DIRECT CREDIT CONTROLS MAGINS FOR LENDING AGAINST SPECIFIC SECURITIES

THE MARGINS TO BE MAINTAINED AGAINST SEURED ADVANCES

DISCRIMINATORY RATE OF INTEREST CHARGED ON CERTAIN TYPE OFADVANCES

Raises Bank Rate


Sells securities in open market Raises Reserve Ratio Applies selective controls

Policy during boom

Controls excess money supply in the economy

Reduces bank rate and interest rates of banks Buys securities in the open market

Policy during recession /depression

Lowers margin requirements


Encourages banks to lend more to consumers, businessmen traders

Increases Demand

FISCAL POLICY

Taxes

Govt. Expenditure

FISCAL POLICY

Govt. reduces unnecessary expenditure Raises personal, corporate & commodity taxes

Tends to reduce income and aggregate income Reduces demand for goods and services Stabilizes the economy

Policy during boom

Borrow from public

Govt. increases public expenditure

Raises aggregate demand, output, income employment and prices

Policy during depression

Reduces taxes

Stimulates demand

Budget deficit policy

DIRECT CONTROLS

Allocation of resources

Price stability

To affect particular consumers and producers Rationing Wage control Quotas Price Control Export duties Monopoly control Licensing Exchange control

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