Deflation tends to get self-corrected on account of the fact that, in absolute terms, demand cannot fall below a certain level. Another factor worth noting is that while it may be possible to choke off inflation.
(i) Drastically reducing the availability of credit.
(ii) A hefty increase in rate of interest.
(iii) An effective system of price controls and rationing, reversing these measures may network to remedy a deflation.
Thus, for example, if credit is made more easily available and at a low rate of interest, still the investors cannot be forced to borrow and invest. The reason for their not investing lies in’ deficiency of effective demand. Investment will not pick up unless marginal efficiency of capital increases. This implies that the authorities should take up the policy of directly increasing public expenditure. Similarly, when it comes to price controls, it may be possible to fix the maximum prices of selected items, but it is very difficult to fix and enforce minimum prices. The public at large cannot be forced to pay more when it does not want to. The policy of minimum prices can be applied only where producers are buying inputs like labor. But if that is done, it will only increase the cost of production and the phenomenon of deficiency of demand will become stronger.
It follows, therefore, that Keynesian view that only fiscal measures can be really effective in curing deflation has a greater weight in it. When government increases its expenditure, there is a direct injection of expenditure and demand in the economy. It is more so if the government expenditure is incurred on such welfare measures as benefit the poorest of the people since they have the highest marginal propensity to consume. Keynes also adds that the government should not worry about the “productive” nature of its expenditure. The objective should be to create demand and that is best done when the expenditure incurred is under heads of “consumption” and “non-developmental”, etc.
Another remedial measure in reviving investment and demand is a reduction in rate of interest. However, Keynes found that this measure could work only up to a limit. Once the rate touches what the market thinks as the “floor level”, it refuses to fall further and loses its value as a remedial measure.
In addition, the authorities can also adopt the policy of tax concession and subsidies. They can use these measures so as to make certain investments (particularly, the labor-intensive ones) profitable enough. The authorities should rely more on deficit spending for meeting their expenditure needs and, in the process, lower both direct and indirect taxes. However, as regards customs, export duties should be lowered or abolished so as to encourage exports while import duties should be raised to protect the domestic industry and employment.
The developments in post-Keynesian economics suggest that the authorities should adopt a policy of increasing the size of their budget. This, in itself, is expansionary in effect. And if in addition, the government also resort to deficit financing, the expansionary impact is further enhanced.