Hawtrey views about Trade Cycle

Hawtrey views trade cycle as a purely monetary phenomenon. According to him, inventory cycles result from fluctuations caused in the desired ratio of stocks to sales in response to changes in the rate of interest. In Hawtrey explanation of the trade cycle, merchants wholesalers particularly play a dominant role. A rise in the rate of interest charged by the banks on their loans for merchants by raising the cost of holding inventories lowers the desired ratio of stocks to sales while a fall in the rate of interest tends to raise this ratio. when banks possess excess cash reserves and are anxious to utilise these reserves they reduce the interest rate in order to induce entrepreneurs to borrow funds to increase inventory and promote expansion. When merchants decide to increase their desired ratio of stock to sales consequent upon the fall in the rate of interest they place fresh orders with the manufacturers who in turn increase the scale of their production creating added demand for factors of production resulting in the increase in incomes of factor owners who in turn spend a part of their additional income on the purchase of consumer goods reflected in the brisk sales and fast depletion of merchants inventories inducing them to place further orders with the manufacturers. The cumulative expansion boom continues as long as the banks continue to extend liberal credit facilities as the low interest rate to the merchants . however the banks cannot continue with this liberalism for ever as their capacity to lend is circumscribed by the extent of excess cash reserves they possess.

In the process of credit creation eventually the limit is reached when the banks can lend no more in fact they begin to recall their old loans and raise the rate of interest. This is enough to create panic and merchants impatiently start reducing their inventory holdings and cancel the unexecuted orders pending with the manufacturers who in turn take no time in curtailing their scale of operations turning workers out of employment, faced with unemployment the workers and other factor owners curtail their spending reducing the aggregate effective demand in the process. Soon the markets for consumer goods present a deserted look with merchants sitting idle. The intractable recession grips fast the economy in its hold. The cumulative process of contraction confronts the banks as their loans are paid back with excess reserves to employ while they once again lower the rate of interest. And at this point the process of revival and expansion starts over again. In short in Hawtrey analysis of the cyclical fluctuations the commercial banking system and merchant wholesaler are all too important and trade cycle is a replica of an outright money inflation and deflation. Unfortunately the monetary theory does not offer a complete analysis of the complex phenomenon of trade cycle in the making of which the non monetary factors also significantly matter.