Measure to Correct Deficient Demand

Measure to Correct Deficient Demand

Following measures may be adopted to correct the deficient demand:

FISCAL MEASURE

Increase in Government Spending:

 During deficient demand, the government should increase expenditure on public works like construction of roads, flyovers, buildings, etc. This will increase the aggregate demand and will help to correct the situation of deficient demand.

Decrease In Tax

Government should decrease the rate of direct taxes (improve progressive tax system) 

 Increase subsidy

MONETARY MEASURE

Two major instruments are:

(i) Quantitative Instruments;

(ii) Qualitative Instruments

Quantitative Instruments;

1. Bank Rate

During deficient demand, the central bank reduces the bank rate in order to expand credit. It leads to fall in the market rate of interest which induces people to borrow more funds. It ultimately leads to increase in the aggregate demand.

Repo Rate: 

Repo rate relates to the loans offered by the RBI to the commercial banks not without collateral. During deficient demand  repo rate is decreased.

Reverse Repo Rate:

It is the rate at which the central bank (RBI) borrows money from commercial bank.During deficient demand  reverse repo rate is decreased

2. Open Market Operations (Purchase of securities):

 During deficient demand, the central bank starts purchasing securities from the open market. It increases the money supply and increases level of aggregate demand in the economy.

3. Decrease in Legal Reserve Requirements (LRR)

There are two components of legal reserves:

(i) Cash Reserve Ratio (CRR):

It is the minimum percentage of net demand and time liabilities, to be kept by commercial banks with the central bank.

(ii) Statutory Liquidity Ratio (SLR):

It is the minimum percentage of net demand and time liabilities, to be kept by commercial banks with themselves.

 The central bank decreases CRR or/and SLR. It increases their credit creating power. It will raise the level of borrowings and helps to minimise the deficiency in demand.

(ii) Qualitative Instruments:

1. Decrease in Margin Requirements:

Margin requirement refers to difference between the market value of security offered and the value of amount lent. During deficient demand, central bank reduces the margin, 

 It encourages the borrowers to borrow more money and raises the level of aggregate demand.

2. Moral Suasion (Advise to Encourage Lending):

 During deficient demand, the central bank advises, requests or persuades the commercial banks to encourage credit. It helps to raise availability of credit and aggregate demand.

3. Selective Credit Controls (Withdraw Credit Rationing):

During deficient demand, the central bank withdraws rationing of credit and make efforts to encourage credit.