What Are Economic Fluctuations?

Economic fluctuations are simply fluctuations in the level of the national income of a
country representing growth or contraction. A market economy is not static. It's dynamic.
A rise in national income means an economy is growing, while a decline in national
income means that an economy is contracting. The current economic model describing
economic fluctuations in a market economy is the business cycle.

Types of Unemployment

•Frictional unemployment

•Structural unemployment

•Cyclical unemployment

Frictional Unemployment

•The frictionally unemployed are people who are between jobs or just entering or
reentering the labor market

–Usually weeks or months pass before positions are filled

–At any given time, about 2 or 3 percent of the labor force is frictionally unemployed

Structural Unemployment

•A person who is out of work for a relatively long period of time, say, a couple of years,
is structurally unemployed. Some examples are

–Steelworkers and coal miners who are out of work because local steel plants and coal
mines have closed

–Clerical workers, typists, inventory control clerks who have been made obsolete by a
computer system

–People who are functionally illiterate and who are virtually shut out of the labor force

•One in five adult Americans is functionally illiterate

•Our educational system turns out 1 million more functional illiterates every year

–About 2 to 3 percent of our labor force is always structurally unemployed

Cyclical Unemployment

•Cyclical unemployment is anything above the sum of frictional and structural

unemployment

–Caused by the ups and downs in our economy known as the business cycle

•Fluctuations in our unemployment rate are due to cyclical unemployment

Theories of the Causes of Inflation

•Demand-Pull Inflation

•Cost-Push inflation

Demand-Pull Inflation

•When there is excessive demand for goods and services, we have demand-pull
inflation

–This occurs when people are willing and able to buy more output than our economy
can produce because our economy is already operating at full capacity.

Demand-Pull Inflation

•Demand-pull inflation is often summed up as “too many dollars chasing too few

goods”

Cost-Push Inflation

•There are three variants of cost-push Inflation

–The wage-price spiral

–Profit-push inflation

–Supply-side cost shocks

Cost-Push Inflation: The Wage-Price Spiral

–Wages constitute nearly two-thirds of the cost of doing business

–Whenever workers receive a significant wage increase, this increase is passed along
to consumers in the form of higher prices

–Higher prices raise everyone’s cost of living, engendering further wage increases.

Cost-Push Inflation: Profit Push

–Because just a handful of firms dominate many industries, they have the power to
administer prices rather than accept the dictates of the market forces of supply and
demand

–To the degree that they are able, these firms will respond to any rise in cost by passing
them on to their customers.

Inflation as a Psychological Process

•If people believe prices will rise, they will act in a way that keeps prices rising

•To break the back of inflationary psychology, policymakers need to bring down the
rateof inflation for a sufficiently long period of time for people to actually expect price
stability

•This has happened in the recent past only after successive recessions have “wrung”
inflation out of the economy.

Creeping Inflation and Hyperinflation

•Inflation is a relative term

–Creeping inflation in one country would be hyperinflation in another

•Once we cross the line between creeping inflation and hyperinflation—which keeps
shifting—we run into trouble

–It becomes increasingly difficult to conduct normal economic affairs

–Prices are raised constantly

–It becomes impossible to enter into long-term contracts

–No one is sure what the government might do

The Effects of Inflation Inflation is a sustained increase in the general level of prices.
When inflation is on the rise, it costs more to purchase a typical bundle of goods and
services. Of course, even when the general level of prices is stable, some prices will be
rising and others will be falling. During a period of inflation, however, the impact of the
rising prices will outweigh the impact of falling prices. Because of the higher prices (on
average), a dollar will purchase Potential output The level of output that can be
achieved and sustained in the future, given the size of the labor force, its expected
productivity, and the natural rate of unemployment consistent with the efficient operation
of the labor market. Actual output can differ from the economy’s potential output
Inflation, therefore, can also be defined as a decline in the value (the purchasing power)
of money.

Conclusion

•One thing the economy has rarely been able to attain simultaneously is a low
unemployment rate and stable prices

Fiscal policy refers to the "measures employed by governments to stabilize the

economy, specifically by manipulating the levels and allocations of taxes and
government expenditures. Fiscal measures are frequently used in tandem with
monetary policy to achieve certain goals."[1] In the Philippines, this is characterized by
continuous and increasing levels of debt and budget deficits, though there have been
improvements in the last few years.[2]

The Philippine government’s main source of revenue are taxes, with some non-tax
revenue also being collected. To finance fiscal deficit and debt, the Philippines relies on
both domestic and external sources.

Monetary policy is the monitoring and control of money supply by a central bank, such
as the Federal Reserve Board in the United States of America, and the Bangko Sentral
ng Pilipinas in the Philippines. This is used by the government to be able to control
inflation, and stabilize currency. Monetary Policy is considered to be one of the two
ways that the government can influence the economy – the other one being Fiscal
Policy (which makes use of government spending, and taxes).[1] Monetary Policy is
generally the process by which the central bank, or government controls the supply and
availability of money, the cost of money, and the rate of interest.

Instruments of Monetary Policy:

The instruments of monetary policy are of two types: first, quantitative, general or
indirect; and second, qualitative, selective or direct. They affect the level of aggregate
demand through the supply of money, cost of money and availability of credit. Of the
two types of instruments, the first category includes bank rate variations, open market
operations and changing reserve requirements. They are meant to regulate the overall
level of credit in the economy through commercial banks. The selective credit controls
aim at controlling specific types of credit. They include changing margin requirements
and regulation of consumer credit. We discuss them as under:

Bank Rate Policy:

The bank rate is the minimum lending rate of the central bank at which it rediscounts
first class bills of exchange and government securities held by the commercial banks.
When the central bank finds that inflationary pressures have started emerging within the
economy, it raises the bank rate. Borrowing from the central bank becomes costly and
commercial banks borrow less from it.

The commercial banks, in turn, raise their lending rates to the business community and
borrowers borrow less from the commercial banks. There is contraction of credit and
prices are checked from rising further. On the contrary, when prices are depressed, the
central bank lowers the bank rate.

It is cheap to borrow from the central bank on the part of commercial banks. The latter
also lower their lending rates. Businessmen are encouraged to borrow more.
Investment is encouraged. Output, employment, income and demand start rising and
the downward movement of prices is checked.

Open Market Operations:

Open market operations refer to sale and purchase of securities in the money market by
the central bank. When prices are rising and there is need to control them, the central
bank sells securities. The reserves of commercial banks are reduced and they are not in
a position to lend more to the business community.

Further investment is discouraged and the rise in prices is checked. Contrariwise, when
recessionary forces start in the economy, the central bank buys securities. The reserves
of commercial banks are raised. They lend more. Investment, output, employment,
income and demand rise and fall in price is checked.

Changes in Reserve Ratios:

This weapon was suggested by Keynes in his Treatise on Money and the USA was the
first to adopt it as a monetary device. Every bank is required by law to keep a certain
percentage of its total deposits in the form of a reserve fund in its vaults and also a
certain percentage with the central bank.

When prices are rising, the central bank raises the reserve ratio. Banks are required to
keep more with the central bank. Their reserves are reduced and they lend less. The
volume of investment, output and employment are adversely affected. In the opposite
case, when the reserve ratio is lowered, the reserves of commercial banks are raised.
They lend more and the economic activity is favourably affected.

Selective Credit Controls:

Selective credit controls are used to influence specific types of credit for particular
purposes. They usually take the form of changing margin requirements to control
speculative activities within the economy. When there is brisk speculative activity in the
economy or in particular sectors in certain commodities and prices start rising, the
central bank raises the margin requirement on them.

The result is that the borrowers are given less money in loans against specified
securities. For instance, raising the margin requirement to 60% means that the pledger
of securities of the value of Rs 10,000 will be given 40% of their value, i.e. Rs 4,000 as
loan. In case of recession in a particular sector, the central bank encourages borrowing
by lowering margin requirements.

Conclusion:

For an effective anti-cyclical monetary policy, bank rate, open market operations,
reserve ratio and selective control measures are required to be adopted simultaneously.
But it has been accepted by all monetary theorists that (i) the success of monetary
policy is nil in a depression when business confidence is at its lowest ebb; and (ii) it is
successful against inflation. The monetarists contend that as against fiscal policy,
monetary policy possesses greater flexibility and it can be implemented rapidly.