The contemporary world economy is characterized by very complicated processes that involve all countries of the world. Nonetheless, there are still significant differences between developed and developing countries. There remains an enormous gap in their development, and the process of globalization does not make the situation in developing countries any better. At this respect, the problem of monetary business is significant since it affects money and prices that are the key issues in the developing countries where the level of life is very low and people react extremely negative on slight changes in prices and monetary policy.
Obviously, this problem is worthy of research because it is necessary to better understand all the processes that currently take place in economies of developing countries since due to the process of globalization economies of all countries get more and more integrated and interdependent and economic crisis in developing countries may affect economies of developed countries. In such a situation, the research of monetary business cycles is very important especially in developing countries where the economic situation is traditionally unstable.
This is why this paper will be focused on monetary business circles, their entity, and their possible application to the developing countries of the world and their peculiarities.
The monetary business cycle
On discussing the problem of the monetary business cycle, it is necessary to briefly dwell upon the main points of the development of the theory and its most significant trends. It is important to understand the entity of the monetary business cycle to better realize its affects within developing countries.
First of all, it should be said that traditionally the theory of monetary business cycle tends to emphasise that it is a real phenomenon, technological change in particular, that “pushes economy out of equilibrium and that it is the consequent unbalanced structure of the real economy that drives the cycle” (Hawtrey 1989:225). It is noteworthy that according to the traditional theory it is horizontal unbalancedness, i.e., disproportionalities across sectors of the economy at a point in time, which drive the cycle.
However, the Anglo-American is a bit different, and it focuses on how external things such as psychology or credit, can ‘unbalance’ the economy and drive the cycle. But for Anglo-Americans the unbalancedness is vertical, i.e., there are difficulties in coordinating across time. Among the most prominent supporters of Anglo-American tradition may be named Knut Wicksell and Ralph G. Hawtrey.
In fact, Knut Wicksell was one of the first developers of the theory. It was him who underlined the role of credit in the cycle. His insight on the relationship between the ‘natural’ rate of interest and the ‘money’ rate of interest is very important. But his theory of the cumulative process was focused on money and prices and, naturally, it was quite logical to turn explicit attention to the interrelationship between money, prices and the cycle.
The person, who continued and developed the work once initiated by Knut Wicksell, was Ralph G. Hawtrey. In his works, he attempted to craft monetary theory into his vision of cycle theory. Naturally, being a Cambridge economist, Ralph G. Hawtrey supported Anglo-American tradition and, according to him, relative prices should not be of primary concern. He strongly believed that money influences what he called ‘single sector’ economy by “affecting the absolute price level” (Toporowski 1998:108). In other words, the absolute price level is key for his interpretation of the cycle theory.
Probably, Hawtrey is one of the most famous economists who has his ‘pure money’ theory. It is noteworthy that his views are significantly influenced by Wicksell’s ideas, and often his theory is referred to as Wicksellian in many aspects.
In summarising the views of both Wicksell and Hawtrey, it is necessary to underline that the chief characters, according to their views, are wholesalers and middlemen who “rely unduly on bank credit and thus highly sensitive to interest rates” (Toporowski 1998:1227). According to them, any slight injection of money which lowers the money rate of interest induces these middlemen and wholesalers to increase inventories. Naturally, they do it by borrowing from banks increases and demanding increases in production from firms.
Consequently, such increase of demands needs some time and production should react respectively to such demands. For the time to increase production is needed, “the money supply of the economy is too large for the given amount of income” (Toporowski 1998:138). As a result, such a situation leads to higher demands for goods by consumers. On the other hand, this extra demand will itself lower the inventories of these middlemen. The middlemen, in their turn, on realizing the fact that their inventories are falling, will in all probability call again upon firms to increase production and borrow money to do so that, naturally, again leads to an excess supply of money.
Eventually, the turning points of the cycle arise when “production (and thus income) finally catches up with the higher money supplies” (Toporowski 1998:140). According to Wicksell and Hawtrey, money will catch up because banks will begin to close off credit when they see their reserves being stretched too far. Then the recession begins: when banks stop lending to middlemen, these will reduce their demands on firms. Consequently, production will slow down and so will incomes, but, as Hawtrey underlines, there will be a lag again. The fall in money supply comes first, and so consumers now have excess demand for money and will lower their demands on goods. As a result, such a situation leads to the inventory build-up and a further demand by middlemen that production reduces further. Thus, the downturn continues until the banks are flushed with money once again and need to lend out. In such a way the monetary business cycle is completed.
Peculiarities of the money business cycle in developing countries
On discussing the entity of the monetary business cycle as Wicksell and Hawtrey understood it, it is now possible to apply their theoretical assumptions to the current situation in the developing countries throughout the world.
First of all, it should be pointed out that it is not always possible to fully apply Wicksell’s and Hawtrey’s theory of the monetary business cycle in the developing countries because they are unstable and this instability makes the normal and permanent development of their economies hardly possible. What is meant here is the fact that economies of developing countries are unstable because of a number of reasons from purely economic to political. By the way, the latter should not be underestimated since traditionally political events affect directly economy of developing countries, for instance, it may be elections or changes in the government. As a result without the stable economy, it is difficult to trace the cycle because the normal functioning of the economy is often violated by different factors, which may be not economic at all.
Furthermore, it is also necessary to emphasize that the socio-economic structure of the society in developing countries is very different from what is observed in developed countries and consequently from what the theorists, i.e., Wicksell and Hawtrey accounted for. At first glance, it may seem to be not very important, but in actuality, it may affect the application of the monetary business cycle directly. For instance, Hawtrey underlines the importance of middlemen and wholesalers since they play the key role in the monetary business cycle. It is they who increase inventories and unduly rely on bank credit. As a rule it is representatives of middle and upper classes along with companies who can freely rely on bank credit and use it amply while in developing countries the middle class, the main class in developed countries constituting the overwhelming majority of the population of a country, is not very significant because it is not very numerous and consequently less influential in both economic and political life of a developing country.
At the same time, banks, which are not less significant than middle class able to use credit, often are not well developed, and their credit potential is quite limited. In fact, it is quite a typical situation when the bank system of a developing country is in quite a poor state. The main reason is the low level of development of developing countries at large, and in certain cases, it is a simple lack of credit to bank system that exists in this or that developing country.
Nonetheless, it would be a mistake that Wicksell’s and Hawtrey’s views on the monetary business cycle are not applicable to developing countries. In contrast among other theorists, their ideas are quite applicable to developing countries in the modern world. First of all, it is necessary to remind that Hawtrey emphasized the impact and the role of money in a ‘single-sector’ economy. At this respect it should be said that nowadays in the situation of the economic globalisation the vast majority of developing countries is characterised by narrow specialisation and as a rule there is only one sector of economy that is well developed while all the others are either ‘satellites’ of the main one or too weak to play a significant role in the national economy at large. Such a situation is different from developed countries where the strength of economies is provided by the high development of different sectors of the economy. Such a situation in developing countries makes them very dependable on the situation in the main sector of the economy.
In practice it means that the monetary business cycle, is applied to such an economy, results in the situation when injections of money are very significant, and high inflation is quite typical for many developing countries. According to Hawtrey such injections of money lower the money rates of interest and middlemen increase inventory demanding more production. Consequently, the more money is ‘injected,’ the more production will be needed. On the other hand, the firms cannot satisfy the increased demands in products. Naturally, they need more time to produce the sufficient amount of goods. As a result money supply of the economy is too large while the income remains low. Such a situation is quite dangerous and may have very negative consequences since the monetary business cycle is quite short and the period of the recession may be too long while the progress of the economy, in stark contrast, not very significant. Eventually, it results in constant stagnation of economies of many developing countries, high level of inflation. In the context when the bank system is not very well developed, and the middle class is relatively weak it creates ample opportunities for a very serious economic crisis.
Thus, taking into account all above mentioned, it is possible to conclude that the monetary business cycle potentially may be applied to the developing countries, but there are some specific features of their economies, which make it quite difficult to apply a ‘pure’ monetary business cycle model developed by Wicksell and Hawtrey. Nonetheless, nowadays developing countries are progressing and their economies match the theory developed by the two specialists mentioned above more and more precisely. At the same time, it is necessary to remember that the theory cannot always be fully applied to practice because objectively it is hardly possible to take into considerations all the factors that may influence economic development, especially in such unstable economies as those of developing countries. However, the views of Wicksell and Hawtrey are very important, and they help better understand and systematize the processes that take place in economies of developing countries nowadays.
Hawtrey, R. G. 1989. Currency and Credit. New York: Touchstone.
Kalemli-Ozcan, S., B.E. Sorensen, and O. Yosha. 2001. “Economic Integration, Industrial Specialization, and the Asymmetry of Macroeconomic Fluctuations.” Journal of International Economics 55: 107-137.
Krugman, P. 1991. Geography and Trade. Cambridge, United States: MIT Press. 1993. “Lesson of Massachusetts for EMU.” In: T. Giavazzi and F. Torres, editors. “The Transition to Economic and Monetary Union in Europe.” New York, United States: Cambridge University Press.
Toporowski, J. 1998. Theories of Financial Disturbance. LA: McGraw Hill.
Wicksell, K. 1967. Interests and Prices. New York: Routledge.
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