Macro economics: Stabilisation policy

1. STABILISATION POLICY
Prof. Prabha Panth
Osmania University,
Hyderabad

2. 2
Need for Stabilisation
• Trade cycles cause many difficulties to the
population.
• During upswing inflation occurs, this
affects low and middle income groups,
people with fixed incomes.
• During Recession and Depression the
entire economy suffers due to
unemployment.
Prabha Panth

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What is Stabilisation Policy
Stabilisation policy is a set of measures
introduced by the Government to stabilise the
economy.
It includes:
a) business cycle stabilisation and b) crisis
stabilisation.
Business Cycle Stabilisation Policy:
• Counter cyclical measures to control and
prevent fluctuations in NY, employment and
output.
• To counter effect impacts of trade cycle
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Objectives
1. Price Policy – to stabilise prices:
prevent and control wide fluctuations in
the price level
2. Employment Policy – to achieve full
employment, or to prevent involuntary
unemployment,
3. Growth Policy – to achieve steady
growth, ensure that the economy grows
steadily.
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1. Monetary Policy :
Monetary policy: or Central Bank Policy:
should be used to avoid the occurrence of
booms and slumps.
Includes:
a) banking and credit policy
b) loans and interest rates
c) the monetary standard and
d) public debt and its management.
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1. Quantitative Measures:
1. Change in Bank Rate: increases the rate of
interest during inflation, decreases during
recession.
2. Reserve Ratio: Increased during inflation,
and decreases during recession.
3. Open Market Operations: Central Bank buys
bonds and shares to release money into the
market during Recession. During inflation it
sells its shares and bonds to remove excess
money from the market
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2. Qualitative Measures:
The qualitative or selective control seeks to
regulate particular type of credit.
Its object is to stimulate, restrict or stabilise bank
advances for specific business schemes.
3. Deficit Financing:
On the request of the Central Govt, the Central
Bank can increase the supply of currency
during deflation.
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Limitations of Monetary Policy
– Will commercial banks follow the CB’s
orders?
– If expected profits > increase in rate of
interest, loans will continue to increase.
– Expectations of higher prices will cause more
expenditure, worsening the situation.
– In Deflation, investment will not increase even
if rate of interest falls.
– Liquidity trap.
– CB should have enough shares for OMO.
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2. Fiscal Policy
• Keynes, and Post Keynesians like Hansen
and Dillard suggested increasing
government spending and decreasing tax
rates to stimulate aggregate demand.
• Fiscal policy, is also known as the contra-cyclical
management of public finance, may be operated
both through public revenues and public
expenditure.
• Also called Pump Priming or Functional Finance
by Lerner.
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• Fiscal policy consists of three elements,
1. Public Expenditure or Policy of public works,
2. Taxation
3. Public Debt
a) Public Expenditure
• During depression:
– private investment is low.
– So Govt or Autonomous investment has to increase
through large capital outlay by the state. This will lead
to recovery.
– In Depression, the Govt should have a deficit budget
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• During the upward swing of the cycle:
– the state will have to cut down its spending
programme.
– During recovery or inflation, Govt should reduce
expenditure and can have surplus budget.
b) Taxation
• During depression, taxes should be lowered.
– To stimulate business investment more liberal
allowances for depreciation and obsolescence, etc.,
should be granted
• During Boom: Taxes should be raised.
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3. International Measures
• Trade cycle is an international phenomenon
• International aspect creates complications
and makes crisis control more difficult.
1. Import export policy: During depression, the
economy should export goods for which there
is no internal demand. This will increase
incomes and expenditure.
2. Devaluation: To encourage trade, local
currency is devalued to make its goods
cheaper in the international market.
Prabha Panth