Question

How can ‘deficient demand’ be tackled?

What policy measures would you suggest to overcome the situations of deficient demand?

Answer 1

Given the negative effects of inadequate demand on income, output, and employment, there is an urgent need to address deficient demand. To address the problem of insufficient demand, aggregate demand must be increased by an amount equivalent to the deflationary gap. There are several strategies to address an economy's insufficient demand. The most significant methods for overcoming such a predicament are fiscal, monetary, and international trade policies.

1. Fiscal Policy:
   1. Taxation: The government should lower direct taxes on individual income and business earnings. A reduction in personal income taxes, such as income tax, will enhance personal disposable income and thus consumption expenditure. Corporate earnings tax cuts will improve the incentive to invest. Reduced indirect taxes, such as excise duties and GST, will encourage families to boost aggregate consumption expenditure. This will improve corporate prospects and encourage investment spending.
   2. Public Expenditure: The government should lower direct taxes on individual income and business earnings. A reduction in personal income taxes, such as income tax, will enhance personal disposable income and thus consumption expenditure. Corporate earnings tax cuts will improve the incentive to invest. Reduced indirect taxes, such as excise duties and GST, will encourage families to boost aggregate consumption expenditure. This will improve corporate prospects and encourage investment spending.
   3. Public Borrowing: Public borrowing should be discouraged. This will result in higher income and purchasing power for the population, who will be enticed to raise aggregate consumption spending.
   4. Deficit Financing: The government should follow a policy of deficit financing. This increases the government's ability to spend. As a result, aggregate demand will rise.
2. Monetary Policy: Expansionary monetary policy should be pursued so as to increase consumption expenditure and also to stimulate investment in the economy:
   1. Bank Rate: To address the problem of low demand in the economy, the country's central bank should lower interest rates. A fall in the bank rate would result in a decrease in the rate of interest charged by commercial banks to their customers. A lower cost of credit from banks would increase the amount borrowed from them. This will have an expansionary effect on the economy since consumers and investors will increase their borrowing from banks, resulting in an increase in aggregate demand.
   2. Open Market Operations: The central bank should pursue a programme of purchasing government bonds and securities from both commercial banks and the public. When the central bank buys government assets from public and commercial banks in cash, the economy's cash flow improves. This will raise commercial banks' cash holdings. To that end, banks will expand their loans and advances. This will boost the economy.
   3. Cash Reserve Ratio: To address the issue of weak demand, the cash reserve ratio must be decreased. A fall in the CRR requires commercial banks to hold less cash with the central bank. As a result, commercial banks' cash flow improves, increasing their ability to make loans and advances. This will boost the economy. As a result, aggregate demand will rise.
3. Export Promotion Measures: To encourage exports, the government should use a variety of export promotion measures, such as subsidies and tax breaks for exporters. Export promotion efforts will enhance demand for domestic products in international markets, helping to eliminate insufficient demand.