Some of the measures to rectify the situation of deficient demand are: 1. Fiscal policy, 2. Monetary Policy, 3. Export Promotion!
Deficient demand, i.e., aggregate demand falling short of ‘output at full employment level’ causes great impact.
It leads to depression marked by overproduction, rise in unemployment, and fall in prices and income, and idleness of resources. It indicates deflationary gap which hurts employers and adversely affects productive activity.
With fall in price, employers reduce wages leading to conflicts and lockouts. Such a situation must be avoided. Hence, there is great need to close the deflationary gap. Aggregate demand has to be increased by an amount equal to deflationary gap.
The most important measures to remedy such a situation are fiscal policy, monetary policy and foreign trade policy. Since deficient demand is opposite of excess demand.To rectify excess demand should be attempted in the reverse direction to remedy the situation of deficient demand. Even then some of the important measures are discussed below:
1. Fiscal policy (Increase investment and reduce taxes):
Fiscal policy comprises of expenditure policy and taxation policy of the government.
Government has legal powers to impose taxes and to spend. The object of fiscal policy is to increase aggregate demand.
Main tools of fiscal policy are:
(i) Expenditure policy,
(ii) Revenue policy,
(iii) Deficit financing and
(iv) Public borrowing.
(i) Expenditure Policy (Increase expenditure):
The objective of expenditure policy should be to pump more money in the system that gives a fillip to the demand. During period of deficiency in demand, the government should make large investments in public works like construction of roads, bridges, buildings, railway lines, canals and provide free education and health facilities, although it may enlarge budget deficit. The aim is to give more money in the hands of people so that they should also spend more. Keynes in fact advocated deficit budget to step up aggregate demand.
(ii) Revenue Policy (Reduce tax rate):
Taxes on personal incomes and corporate incomes should be reduced to encourage private consumption and investment. If possible, tax on lower income groups is abolished. This will increase their disposable income for spending. In addition, subsidies, old-age pension, unemployment allowance and grants should be given. Incentives like interest free loans, instalment schemes, etc. should be given to consumers to boost aggregate demand.
(iii) Deficit financing (Printing of currency/notes) should be encouraged.
(iv) Government borrowing from public should be discouraged so as to increase aggregate demand.
2. Monetary Policy (Reduce bank rate and cash-reserve ratio):
Monetary policy is the policy of the central bank of a country to control credit and money supply. The aim of monetary policy in times of depression is to cause an increase in the investment expenditure by firms.
The credit is made cheap and easily available in the following ways:
(a) Quantitative Measures:
(i) Bank rate (Reduce it):
Bank Rate is the rate at which central bank lends to the commercial banks. The banks, in turn, increase or decrease lending rates of interest accordingly. To check depression, the central bank reduces bank rate thereby enabling the commercial banks to take more loans from it and, in turn, give more loans to producers at a lower rate of interest.
(ii) Open Market Operation (Buy securities):
Central bank buys government bonds and securities from commercial banks by paying them in cash to increase their cash stock and lending capacity.
(iii) Cash-Reserve Ratio (Reduce CRR):
Central bank lowers rate of cash-reserve ratio thereby increasing bank’s capacity to give credit. Similarly, central bank decreases Statutory Liquidity Ratio (SLR) to increase availability of credit. Among these three instruments of monetary policy, the instrument of bank rate is more effective to lift the economy out of recession.
The above-mentioned three measures are quantitative credit control measures since they affect the quantity of cash and credit available in the economy.
(b) Qualitative Measures:
Qualitative credit control measures. There are qualitative measures also which regulate credit for specific purposes. They channelise credit into priority sectors and impede its use in undesirable sectors of economy as explained below.
(i) Margin Requirement (Reduce it):
To check depression, central bank reduces margin requirement of loan which encourages borrowing because it induces businessmen to get more credit against their security.
(ii) Moral suasion:
In a situation of deficient demand, central bank persuades, requests, appeals or advises its member banks to be liberal in lending and expand credit facilities.
(iii) Rationing of credit:
It means fixation of credit quotas for different business activities. Through credit rationing, central bank can promote social justice while checking state of depression.
(iv) Direct action:
The central bank may resort to direct action against those banks which do not comply with its directions.