How the government expenditure policy and revenue policy help in rectifying the situation of deficient demand?
Answers
Answer:
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.