According to Prof. R. G. Hawtrey, a British economist, there is direct relationship between volume of money supply and the economic activity. Wherever there is change in the flow of money or money supply changes, there will be business fluctuations. Here, he means the credit creation by the banking system i.e., expansion in bank credit leads to demand and so the upswing of business cycle starts. On the other hand, when there is decrease in money supply through contraction of bank credit, it leads to down swing and thus leads to depression.
Expansion of bank credit happens when interest rates are reduced, which means, the loans are cheaper. Due to liberal loans, the profit margins change as they are very sensitive to the change in interest rate.
Thus, investment increases and so the employment, which in turn increase the income and demand. This increase in demand leads to increase in price and profit margins. Therefore, the upward trends start i.e., the upswing starts. But as each phase has the germs of other phase, the turning point starts. When bank changes its policy of credit expansion, the cash reserve with the bank reduces.
The leading rates are increased to discourage the demand for fresh loans and they start calling to return loans. The producers start disposing off their stock to repay loans. The restricted policy on credit and high rate of interest discourages a new investment, which leads to downswing. The income falls and cash starts coming back to the bank. But as the cash reserve with the bank improves, again the bank starts using liberal attitude towards credit creation and so the revival starts. This takes the economy to expansion or prosperity. According to R G Hawtrey flow of money supply is the sole cause for business fluctuations. This theory was not unchallenged. Some limitations are –
Business cycle is a very complex phenomenon and we cannot attribute it completely to credit creation by banking system.
Bank plays an important role in the financing of business but it cannot be the only reason for business crisis. It can just aggravate the situation.
Too much of importance is given to bank credit. Many times traders don’t borrow from bank but plough back their profit.
Investment not only depends on interest rates but on the rate of return also. Hawtrey has totally ignored MEC.
This theory has totally ignored the non monetary factors like innovation, climatic conditions, psychological factors etc.
This theory also has been taken from business cycle chapter of Managerial Economics SMU MBA MB0026 book in the continuation of Over-Investment theory and Schumpeter theory.
Expansion of bank credit happens when interest rates are reduced, which means, the loans are cheaper. Due to liberal loans, the profit margins change as they are very sensitive to the change in interest rate.
Thus, investment increases and so the employment, which in turn increase the income and demand. This increase in demand leads to increase in price and profit margins. Therefore, the upward trends start i.e., the upswing starts. But as each phase has the germs of other phase, the turning point starts. When bank changes its policy of credit expansion, the cash reserve with the bank reduces.
The leading rates are increased to discourage the demand for fresh loans and they start calling to return loans. The producers start disposing off their stock to repay loans. The restricted policy on credit and high rate of interest discourages a new investment, which leads to downswing. The income falls and cash starts coming back to the bank. But as the cash reserve with the bank improves, again the bank starts using liberal attitude towards credit creation and so the revival starts. This takes the economy to expansion or prosperity. According to R G Hawtrey flow of money supply is the sole cause for business fluctuations. This theory was not unchallenged. Some limitations are –
Business cycle is a very complex phenomenon and we cannot attribute it completely to credit creation by banking system.
Bank plays an important role in the financing of business but it cannot be the only reason for business crisis. It can just aggravate the situation.
Too much of importance is given to bank credit. Many times traders don’t borrow from bank but plough back their profit.
Investment not only depends on interest rates but on the rate of return also. Hawtrey has totally ignored MEC.
This theory has totally ignored the non monetary factors like innovation, climatic conditions, psychological factors etc.
This theory also has been taken from business cycle chapter of Managerial Economics SMU MBA MB0026 book in the continuation of Over-Investment theory and Schumpeter theory.