Trade Cycles

The argument is something like this: Most of the business is done with burrowed muney. When business prospects are good, the banks freely extend credit facilities. Assured of cheap and easy credit facilities, the businessmen go on expanding their business, entering  into further and further commitments. A huge superstructure of credit is built up. This superstructure can be maintained by the continuance of cheap money conditions. if not their further extension. But a point is reached. When banks think that they have gone a bit tuo far in the matter of advances. Probably their reserve ratio has fallen dangerously low. In defenseless, they apply the brake, curb further expansion • of credit, and begin to recall advances. This sudden suspension of credit facilities proves a t nub-shell to the business community.  Businessmen have been counting on the renewal-of overdrafts and cash credit facilities. But contrary t o their expectation, moneys are being called in. They have to sell off their stocks in order to repay. This general desire for liquidity   presses the market, for the stocks arc being unloaded all round. Some firms, weaker links of the chain, fail to meet nonobligatory and bring to grief those whom they could not pay. Very solvent firms may fail, simply because they do not receive timely financial assistance from tile   nks. Thus, the monetary phenomena of hoarding and
dishoarding, credit expansion and credit contraction have a lut tn do with business cycles. since they represent a succession of inflationary and deflationary processes.

 No doubt banking institutions play an important part in building up trade activity. But it is a bit unkind to say that they cause a crisis. The most that we call say is that they aggravate matters. They prop up a boom by an over-issue of credit and they accentuate a depression by its suspension. But neither the h(XIIII 1101’the depression originates with them. Secondly, a world phenomenon like a modern slump cannot be attributed tu the isolated action uf banks in one country. A trade cycle cannot. therefore, be exclusively attributed to the misbehavior of money.

is borne out by thc fact that investment goods industries expand faster than consumption goods industries during the upward phase of thc cycle, During the depression, investment goods indusu ics suffer more than consumption goods industries. But why do investment goods industries expand fils tel’ than  consumption goods industries in the boom phase of the cycle? On this point, there is a difference of opinion among the various theorists, who believe in the over-investment theory. Some economists like Hayek, Machlup, Ropkc and Robbi;ls trace this 10 tile banking system. Though they do not regard the trade cycle to be a purely monetary phenomenon. yet they believe that the disparity in the growth rates of consumption goods industries am] investment goods industries  could not occur, if the banking system were not clastic. According to this version, an increase in investment opportunities is fed by a low rate of interest. In this way, there is encouragement to   and more roundabout methods uf production. Resources AreAreas increasingly withdrawn Iruru consumption goods industries through a process of “forced saving”.The over-investment theory correctly states that fluctuations in the  ate of invest rent arc t e main cause of trade cycles. However. the theory fails to offer a convincing explanation as to why investment fluctuates in so regular a manner. Many authors trace  back fluctuations ill investment to the behaviour uf the banking system and that we have already is not a very satisfactory answer.