To fight deflation, attempts must be made to raise the volume of aggregate effective demand. It will output, income and employment in the economy, Effective demand can be increased partly by consumption expenditure and partly by increasing investment expenditure. Various measures to increase consumption and investment expenditures in the economy.
1. Reduction in Taxation:
The government should reduce the number and burden of various taxes levied on commodities. This will increase the purchasing power of the people. As a result, the demand for goods and services will increase. Moreover, sufficient tax relief should be given to businessmen to encourage investment.
2. Redistribution of Income:
Marginal propensity to consume can be raised by a redistribution of income and wealth from the rich to the poor. Since the marginal propensity to consume of the poor is high and that of the rich is low, such a measure will help increasing the aggregate demand in the economy.
3. Repayment of Public Debt:
During deflation period, the government can repay the old public debts. This will increase the purchasing power of the people and push up effective demand.
The government should give subsidies to induce the businessmen to increase investment.
5. Public Works Programme:
The government should also directly undertake public works programme and thus increase expenditure in public sector. Care should, however, be taken that the public works policy of the government does not adversely affect investment in the private sector; it should supplement, and not supplant, private investment. For this, it is important that only those projects should be selected for the government’s public works policy, which is either too big or not so profitable to attract private investment.
6. Deficit Financing:
In order to have significant expansionary effects, the government’s public works schemes should be financed by the method of deficit financing, i.e,, by printing new money. The government should adopt a budgetary deficit (excess of government expenditure over its revenue) and cover this deficit through deficit financing. Deficit financing makes available to the government sufficient resources for its developmental programmes without adversely affecting investment in the private sector.
7. Reduction in Interest Rate:
By adopting a cheap money policy, the monetary authority of a country reduced the interest rate, which stimulates investment and thereby expands economic activity in the economy.
8. Credit Expansion:
The central bank and the commercial banks should adopt a policy of credit expansion to promote business and industry in the country. Bank credit should be made easily available to the entrepreneurs for productive purposes.
9. Foreign Trade Policy:
To control deflation, the government should adopt such a foreign trade policy that, on the one hand, increases exports, and, on the other hand, reduces imports. This kind of policy will go a long way in solving the problem of overproduction, and help overcoming deflation.
10. Regulation of Production:
Production in the economy should be regulated in such a way that the problem of over-production does not arise. Attempts should be made to adjust production with the existing demand to avoid over-production.
In short, fiscal policy alone or monetary policy alone is not sufficient to check deflation in an economy. A proper co- ordination of fiscal, monetary and other measures is essential to effectively deal with the deflationary situation.