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How to Control Deficient Demand?

Last Updated : 06 Apr, 2023
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Measures to control Deficient Demand

When demand is not sufficient to fully utilise resources, it is referred to as Deficient Demand. In simple terms, when planned aggregate expenditure is less than aggregate supply at full employment, the situation of deficient demand arises.

The problem of deficient demand arises when the current aggregate demand is less than the aggregate demand required for full employment equilibrium. It occurs due to a decrease in the money supply and accessibility to credit. A change in the level of the economy’s aggregate demand can be used to solve this problem. There are several ways that can be used to correct deficient demand such as:

1. Increase in Government Spending:

Government spending is a significant component of aggregate demand. This action, which the government refers to as its Expenditure Policy, is a component of its fiscal policy. Government invests a significant amount of money in developing things like highways, flyovers, buildings, railway lines, etc. A change in such spending has a direct impact on the amount of aggregate demand in the economy and helps in the management of excess and deficient demand conditions. Government spending on public works should be increased as much as possible in order to manage the condition of deficient demand. This will enhance aggregate demand and help to correct the issue of deficient demand.

2. Decrease in Taxes:

Taxes are the government’s principal source of income. This measure is an element of Fiscal Policy and is described as the Revenue Policy of the Government. The government charges many types of direct and indirect taxes on the general public. Government tax changes have a direct impact on the level of total demand and help in balancing excess and deficient demand in the economy. In case of deficient demand, Government decreases tax rates and even eliminates some taxes. It increases the purchasing power of people, making them capable of spending more on consumption and investment because of an increase in their disposable income. It increases overall demand and helps in managing the condition of deficient demand.

3. Increase in Money Supply/Accessibility of Credit:

With the help of its Monetary Policy, the Reserve Bank of India (RBI) is able to control the money supply in the economy. It is a policy used by the Central Bank of an economy to control the amount of credit or the money supply. During deflationary periods, the Central Bank uses its Monetary Policy to ensure easy access to credit and lower the cost of borrowing money.

(I) Quantitative Instruments

These instruments are designed to increase the total volume of credit that is in existence. The principal tools or measures are:

1. Decrease in Bank Rate: Bank Rate refers to the rate at which the central bank lends money to commercial banks in order to satisfy their long-term requirements. When there is deficient demand, the central bank decreases the bank rate to increase credit availability. It causes the market interest rate to decline, causing people to borrow more money. In the end, it causes the aggregate demand to rise.

2. Reduction in Repo Rate: Repo rate is the interest rate at which the central bank loans money to commercial banks to cover their short-term requirements. The central bank reduces the repo rate to increase the availability of credit during periods of deficient demand. It causes interest rates to decline, which encourages people to take out more credit and raises aggregate demand.

3. Decrease in Reverse Repo Rate: This is the interest rate at which commercial banks can deposit excess funds with the Central Bank for a shorter period of time. The Central Bank may decrease the Reverse Repo Rate to solve the problem of deficient demand. It discourages Commercial Banks to deposit their excess cash with the Central Bank. It will increase the ability of commercial banks to lend money. Due to this, investment and consumption spending may increase, which would increase aggregate demand.

4. Open Market Operations or Sale of Securities: The selling and purchasing of securities in the open market by the central bank are referred to as Open Market Operations. It has a direct impact on the economy’s money supply. When there is a deficiency of demand, the central bank purchases securities from the market. It has an impact on the bank’s ability to extend credit and increases aggregate demand in the economy.

5. Increase in Legal Reserve Requirements: Commercial banks are required to keep legal reserves. A fall in these reserves is a direct way to increase credit availability. Legal reserves consist of two parts:

  • Cash Reserve Ratio (CRR): It is the minimum amount of net demand and time liabilities that commercial banks are required to maintain with the central bank.
  • Statutory Liquidity Ratio (SLR): This term refers to the minimum proportion of net demand and time liabilities that commercial banks must keep on hand. 

The central bank reduces CRR or/and SLR to correct deficient demand. It increases commercial banks’ effective cash resources and enhances their ability to create loans. In the end, it helps in raising the amount of credit available to the economy and decreases the deficiency in demand.

(II) Qualitative Instruments

These tools are designed to control the flow of credit. The following are important qualitative tools or measures:

1. Decrease in Margin Requirements: The term Margin Requirement describes the difference between the market value of the offered security and the value of the amount lent. When there is deficient demand in the economy, the central bank reduces the margin, which increases the ability of banks to create credit in exchange for the same level of security. As a result, borrowing becomes more attractive to borrowers, which increases aggregate demand.

2. Moral Suasion (Advice to Encourage Lending): The Central Bank uses a combination of persuasion and pressure to convince other banks to act in a way that is consistent with its policy. Discussions, letters, lectures, and tips to banks are used to exercise moral persuasion. The central bank advises, requests, or persuades commercial banks to provide credit. It increases credit availability and aggregate demand.

3. Selective Credit Controls (Withdraw Credit Rationing): This technique involves the central bank instructing other banks to provide or refuse credit to specific sectors for a given set of purposes. In times of deficient demand, the central bank withdraws credit rationing and makes efforts to promote credit.

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