To arrest deflation, attempts are made to raise the volume of aggregate effective demand. As the aggregate demand expenditure falls short of the aggregate supply of output, the prime step of fighting deflation is to step up effective demand. Effective demand can be increased partly by encouraging consumption expenditure and partly by increasing investment expenditure. Various measures can be taken to improve consumption and investment demand in the economy.
(1) Reduction in taxation: –
The Govt, reduces the burden of taxation and numbers of taxation as well. This will increase the purchasing power of the people. As a result the demand for goods and services will increase.
(2) Redistribution of Income: –
MPC or marginal propensity to consume can be raised by redistributing wealth and income in favour of the poor. Since MPC of the poor people is high, such a measure will help increasing the aggregate demand in the economy.
(3) Repayment of Public debt; –
During deflationary condition the government should repay the old public debt. This will increase the purchasing power of the people and push up effective demand.
(4) Public works programme: –
Public works programme should be undertaken by the Govt. Public works programme will increase the purchasing power in the hands of general public. But it is also important the public works should in no way private investment. Public works should supplement and not supplant private investment.
(5) Deficit financing: –
To have expansionary effect the Goat’s public work programme should be financed by the method of deficit financing i.e. by printing new money. The Govt should follow deficit budget and cover this deficit through deficit financing. Deficit financing makes available of adequate funds for developmental programmes without adversely affecting private investment.
(6) Reduction in interest rate: –
By following cheap money policy, the monetary authority reduces interest rate which stimulates investment and thereby expands economic activity in the economy.
7) Credit expansion: –
The Central Bank should a very libcmiistic policy so that the Commercial banks will be able to expand the volume of credit. Institutional credit should be made easily available to the private entrepreneurs.
(8) Regulation of Production: –
Production in the -economy should be regulated in such a way that the problem of over production will not arise. The volume of production should be adjusted with the existing demand to avoid over production.
It is worth noting that neither the fiscal policy nor the monetary policy can check deflation in isolation. A proper coordination and management of fiscal, monetary and other measures are essential to arrest, deflationary tendency in the economy.