Cyclical fluctuations in business and economic activities adversely affect the process of economic development of an economy.
Therefore, the government should take preventive and corrective measures to maintain stability in economic system. Two types of measures are adopted to control business cycles.
(a) Preventive measures.
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(b) Corrective measures.
(a) Preventive measures:
The preventive measures aim at avoidance of the occurrence of business cycles and these are’
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1. To reduce the dependence of agriculture on nature:
The dependence of agriculture on nature causes fluctuations in agricultural production and which in turn causes fluctuations in national income and employment particularly in under-developed countries.
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Therefore, the government should develops irrigation facilities and take other appropriate measure to reduce the dependence of agriculture on nature.
2. Equilibrium between demand supply:
The government should maintain the balance between demand supply of score goods by imports and buffer stocks policy.
3. Check on speculative activities:
A speculation causes the cyclical fluctuations. Therefore, there should be effective check on these activities. The profiteers and hoarders be sternly dealt with. There should be check on black-making.
4. Nationalization of basic industries:
The nationalization of basic industries would help in maintaining equilibrium between demand supplies. It would also help in checking monopolies.
(b) Corrective measures:
The main corrective measures are: (1) Monetary Policy (2) Fiscal Policy and (3) Direct Controls.
1. Monetary policy:
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Monetary policy refers to the control of money supply and cost of credit in the economy. In other words monetary policy means to use the various method of credit control by the control bank.
If there is a tendency of over expansion in business activities, the Central Bank should follow the policy of credit contraction to check unnecessary expansion of business activities.
On the other hand when there are recessionary trends in the economy then central bank should resort to the policy of credit expansion to control the downward swing in business activities.
The Central Bank uses two types of credit control (i) quantative measures and (ii) selective measures of credit control.
The quantative measures are those measures which control the total credit in the economy. The main methods of quantative are-Bank Rate, Open market operations, change in Cash Reserve Ratio and Statutory Liquidity Ratio.
The selective credit control measure aim at controlling the availability of credit for specific purposes and business activities.
The main selective measures of credit controls are-change in margin requirement of loans, credit rationing, direct action and moral persuasion.
To make the monetary policy more effective all the measures of credit control be used simultaneously because each measure has its own limitations.
The monetary policy is more effective in controlling been conditions in the economy. In times of depression the business community is in the grip of pessimism due low profit expectations and hence inducement to invest is absent.
Mere expansion of credit will not increase the inducement to invest in business community. Therefore, monetary policy alone is not effective to control business cycle.
2. Fiscal policy:
Fiscal policy refers to the management of public revenue, expenditure and public debt to achieve certain objectives.
The main sources of public revenue are taxes. The fiscal policy of the government affects the business activities and inducement to invest to a great extent.
Therefore, government can control cyclical fluctuations by making appropriate change in taxation, public expenditure and public debt policies, i.e. fiscal policy.
An increase in public expenditure and cut in taxes during depression increase the aggregate demand in the economy. Increase in aggregate demand increases income and employment, and as well as it induce of the business community to increase in investment.
Thus reduction in taxes and increase in public expenditure in times of depression help in the expansion of business activities.
On the other hand a reduction in public expenditure and increase in taxes during inflation reduces aggregate demand and thus check the undesirable expansion in business activities.
Thus, judicious fiscal policies can effective control, cyclical fluctuations in the economy. The main instrument of fiscal policy is budget.
The budget controls the size of public expenditure and public revenue. In times of depression government should follow the policy deficit financing by adopting a deficit budget because in times of depression the price investment expenditure is at low level.
Therefore, the deficiency in private investment will have to made up by large capital expenditure by the government.
Government investment can be increase by deficit financing. The deficit budget has an expansionary effect of aggregate demand. The deficit in budget by secured by increasing public expenditure and reducing taxes.
In times of boom and inflation government should follow the policy of surplus budget. The surplus in the budget should by secured by both increasing taxes and reducing public expenditure.
The surplus budget would reduce the aggregate demand in the economy and thus would help in checking inflationary tendencies in the economy.
A built in flexibility should be introduced in public financial system. Built-in flexibility in public finance means automatic adjustment of expenditure and taxes in relation to cyclical fluctuations.
Progressive taxation policy be followed to introduce flexibility in the structure. Similarly government expenditure an unemployment relief, social security, etc. should automatically change inversely to cyclical fluctuations.
By built in flexibility there will automatic adjustment in budget. Built-in-flexibility integrates short-term and long-term fiscal policy.
It also helps in preventing die occurrence of trade cycles. But more built-in-flexibility is not sufficient. The government will have to take discretionary fiscal measures to control business cycles.
3. Direct controls:
For the speedy and effective control of business cycles government should resort to direct physical controls.
Direct controls include licensing, rationing of scare and essential goods, price and wage controls, export-import controls, exchange controls, control over hoarding and black marketing, control of monopolies and restrictive trade practices, etc.
But the success of direct controls depends upon the efficiency of public administration. In absence of the will and efficiency of administration, these measures may encourage black marketing, speculations and corruption. Therefore, these measures should be resorted in emergency only.