Economics

Howtrey’s Monetary Theory Of Trade Cycle And Its Limitations

Howtrey’s Monetary Theory Of Trade Cycle: Prof. Hawtrey regards business cycle as purely a monetary phenomenon. According to him the basic cause of business cycles is the expansion and contraction of money. Bank credit plays an important role in business activity. Hawtrey states that business expansion starts when the bank lower the rate of interest on loans. Lower interest rates induce the businessmen to borrow more from the banks.

According to Hawtrey businessmen borrow more from the banks and invest more money in the business. Production, employment and incomes increase. As a result price level goes up. Thus, a cumulative process of upward movement in economic activity takes place leading to prosperity. But prosperity does not continue far long. At a certain stage the banks will begin to reduce credit due to the following reasons :

1. Due to raise in prices in the boom period expenses will fall. The foreign exchange reserves will fall. This will effect the economic development of the country adversely.

2. Due to indiscriminate credit expansion in the boom period, the cash reserves of the commercial banks reach a low level.

Due to the above reasons banks can’t give any more credit. To control inflation, banks begin to recall the loans. They also increase the rate of interest on loans. When bank credit is reduced and the loans are recalled, businessmen are forced to sell their stocks and repay bank loans. Selling of stocks of goods leads to a fall in prices. Due to higher rates of interest as well as fall in prices, businessmen do not hold stocks and no further orders are given to the manufacturers. As a result demand will fall. When demand falls producer will reduce the production.

When production falls, employment and incomes will fall. Consequently, prices will fall. Thus, a cumulative process of downward movement in economic activity takes place leading to contraction. Again after sometime revival takes place. Banks reserves increase during the contraction period because there was no demand for bank loans. They reduce their rate of interest. Businessmen are induced to borrow. Thus, business revival starts.

Thus, according to Hawtrey the changes in the monetary factors and Bank credit are mainly responsible for business cycles.

Criticism of Howtrey’s Monetary Theory Of Trade Cycle:

Hawtrey’s theory is criticized on the following grounds.

1. According to Hawtrey, borrowing depends on the rate of interest. But it is not true. If the business conditions are good they can take more loans from banks even at a higher rate of interest. If business conditions are bad, even a low rate of interest does not induce the businessman to borrow.

2. According to Hawtrey the depression conditions can be cured by expanding bank credit. But it is not true. Economic History shows that depression could not be cured by merely expanding bank credit. Therefore, bank credit is not the cause for trade cycles.

3. Hawtrey does not explain why banks increase or reduce credit.

4. According to Hawtrey economic expansion begins to decline when banks increase the rate of interest. But it is not true. Changes in the rate of interest may not reduce the business expansion.

5. According to Hawtrey, Bank Credit plays an important rule in the business expansion. But it is not true, Modern Joint stock companies do not depend very much on bank loans. They build up reserves from their profits and use them for business expansion. Therefore, bank credit does not play such a vital role as Hawtrey thought.

6. According to Hawtrey investment changes due to the changes of rate of interest. But according to Keynes, investment changes due to the changes in marginal efficiency of capital and due to changes in the rate of interest.

7. Expansion and contraction of money alone can’t explain business cycles.

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