MEASURES TO CORRECT EXCESS AND DEFICIENT DEMAND BY DEEPTHI THOMAS
An Overview Of The Topic n n n n Topic: Measures to correct excess and deficient demand What is excess demand? What is deficient demand? What are the measures taken? Who should take the corrective measures? How is it implemented? What are the effects?
MEASURES TO CORRECT EXCESS AND DEFICIENT DEMAND There are four important ways to correct excess and deficient demand n Fiscal Policy n Monetary Policy n Foreign Trade Policy n Other Measures
MEASURES TO CORRECT EXCESS AND DEFICIENT DEMAND FISCAL POLICY TAXATION PUBLIC BORROWING PUBLIC EXPENDITURE BUDGET MONETARY POLICY RESERVE RATIO BANK RATE OPEN MARKET OPERATION MARGIN REQUIREMEN T MORAL SUASION DIRECT ACTION FOREIGN TRADE POLICY IMPORT SURPLUS POLICY EXPORT SURPLUS POLICY OTHER MEASUR ES WAGE POLICY FULL UTILIZATIO N OF EXISTING RESOURCES
FISCAL POLICY n n Policy of government relating to public expenditure, taxation and management of public debt. The policy adopted for correcting excess demand (inflationary gap) and deficient demand (deflationary gap) is known as counter cyclical fiscal policy. Fiscal policy adopted to control inflation is called antiinflationary fiscal policy. Fiscal policy adopted during deficient demand is known as anti-deflationary fiscal policy. Classified into discretionary measures and non-discretionary measures.
DISCRETIONARY MEASURES n n The measures which are adopted by the government using its discretion and will. The policy regarding public expenditure on road construction, education, health care, maintenance of law and order, defense of the country, rural electrification, etc.
NON DISCRETIONARY MEASURES n n n It refers those in-built stabilizers of income which come into operation automatically. Progressive income tax and transfer payments like unemployment allowance, old age pension, etc. They are non-discretionary because they operate automatically when economic activity goes upwards or downwards.
TAXATION Excess Demand: - By increasing taxes, the purchasing power of people are reduced. This will reduce aggregate demand inflationary pressure. Deficient Demand: - In order to encourage investment and consumption, taxes especially corporate tax and income tax rates are reduced.
PUBLIC BORROWING Public borrowing or public debt is the borrowing of the public authorities. Excess Demand: - Government borrows money from the public. This will reduce purchasing power of the public and hence aggregate demand will be reduced. Deficient Demand: - In order to leave more money with the public and to increase effective demand, government will reduce size of public borrowing. It will also repay old public debts during this period.
PUBLIC EXPENDITURE Government demand is an important component of aggregate demand. Excess demand: - When government reduce its expenditure during inflation, there will be reduction in aggregate demand hence in inflationary pressure. Deficient demand: - During the time of deficient demand, public expenditure on roads, defense, health care, etc. will be increased. It will also increase transfer payments like old-age pension, unemployment allowances, etc. to increase effective demand.
SURPLUS AND DEFICIT BUDGET Excess Demand: - During inflation, to reduce aggregate demand, government will present surplus budget. Surplus budget is that budget in which government revenue is greater than expenditure. Deficient Demand: - During deficit demand period, government will present enlarged budget with huge deficit. Deficit budget is the budget in which government expenditure is greater than revenue. This will push up demand.
MONETARY POLICY n n n Any conscious action under taken by the monetary authority (central bank) to change the quantity, availability or cost of money. To correct excess demand, the central bank follows antiinflationary monetary policy or ‘Dear Money Policy’ which is the policy that makes money dear or costly. Monetary policy adopted during deficient demand is known as anti-deflationary monetary policy or ‘Cheap Money Policy’ which makes money cheaper by the reduction of interest rate and by the availability of credit.
CASH RESERVE RATIO n n Member commercial banks are required under the law to maintain a minimum percentage of their demand deposit liabilities in the form of cash with the Central Bank. Commercial banks can lend only the remaining portion of these deposits.
CASH RESERVE RATIO Excess Demand: - The Central Bank increases this ratio, which in turn reduces the lending capacity of the banks and availability of credit. Deficient Demand: - In order to expand credit the cash reserve ratio, will be reduced. This will pump more money into the economy which pushes up the economic activity.
BANK RATE Discount rate or bank rate is the rate at which the Central Bank lends to the Commercial banks. Excess Demand: -Central Bank raises bank rate. This will make credit costlier. Interest rate will increase and demand for credit will fall, which reduces the purchasing power and effective demand. Deficient Demand: - Rediscounting rate or bank rate will be lowered in order to expand credit capacity of commercial banks.
OPEN MARKET OPERATION Buying and selling of government securities in the open market by the Central Bank is known as Open Market Operation. Excess Demand: - Central Bank will sell these securities in the open market. Deficient Demand: - The Central Bank will purchase back the securities from the market.
MARGIN REQUIREMENT Margin requirement refers to the percentage of down payment on borrowing to finance purchases of stock by firms. Excess Demand: -Margin requirements are fixed high. This will discourage speculation on borrowed credit. It will reduce inflationary pressure in the economy. Deficient Demand: - Margin requirements are fixed low during depression. This helps to pump more credit to the economy.
MORAL SUASION The Central Bank may issue advice, request and appeals to member banks to co-operate with the credit policy of the Central Bank. Excess Demand: - Member banks are requested to reduce the supply of credit. Deficient Demand: - The Central Bank may issue advice, request and appeals to member banks to expand credit.
DIRECT ACTION As the last resort the Central Bank may take direct action against member banks that are not fulfilling its credit policy. Excess Demand: - Direct action may be in the form of refusing rediscounting facilities, charge in penal rate of interest on loan issued, etc. Deficient Demand: - The member banks that are not fulfilling the credit expansion policy will be forced to expand credit.
FOREIGN TRADE POLICY The policy connected with import and export. Excess Demand: -Import surplus policy may be adopted. When import increases, the excess domestic purchasing power may flow out to other countries which reduces the intensity of domestic demand. Deficient Demand: -Export surplus trade policy will be followed. Export of more commodities will boost up the demand for goods in country.
OTHER MEASURES These are anti-inflationary measures WAGE POLICY During inflation, wage increase without improvement in productivity may be avoided. During inflation, trade unions will demand for wage increase. If wages are increased without increase in productivity, it will cause further increase in prices.
FULL UTILIZATION OF EXISTING IDLE RESOURCES n During inflation, measures may be adopted to utilize the existing resources to its full capacity. This measure is more useful to less developed countries, where there are large amount of under utilized resources.
CONCLUSION These are the measures taken to control inflation and deflation in India. Success of anti-inflationary and anti-deflationary policies depends on several factors. It may not produce the expected result always. However, earlier adoption of such policies is necessary to prevent an economic crash.
References n n n www. investopedia. com/articles/04/051904. asp www. economicswebinstitute. org/glossary/pubex p. htm www. rbi. org. in/home. aspx Systematic Approach To Economics Dr. Thomas kutty, Dr. Anitha