Measures to rectify the situation of deficient demand. In view of adverse effects as stated above, there is great need to close the deflationary gap. Aggregate demand has to be increased by an amount equal to deflationary gap. The most important measures to remedy such a situation are fiscal policy, monetary policy and foreign trade policy. Even then some important measures are briefly discussed below:

1.    Fiscal Policy (Increase investment and reduce taxes). Fiscal policy comprises expenditure policy and taxation policy of the government. Government has legal powers to impose taxes and to spend. 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 medical 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 taxes on expenditures on buildings, etc. should be reduced. If possible, tax on lower income groups be abolished. This will increase their disposable income for spending. In addition, subsidies, old age pension, unemployment allowance and grants, interest free loans should be given.

(iii) Deficit financing (printing of currency-notes) should be encouraged as additional currency causes additional purchasing power.

(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. Mind, credit generally refers to the finance provided to others at a certain rate of interest. The aim of monetary policy in times of depression is to cause an increase in the investment expenditure by firms. Thus 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. At present (February 2012) bank rate (also called Repo Rate) is 8.5%.

(ii)    Open Market Operation (Buy securities). These refer to buying and selling of government securities which influence money supply in the economy. During depression, Central Bank buys Government bonds and securities from commercial banks by paying 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 lowers 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.

The above-mentioned three measures are quantitative credit control measures since they affect the quantity of cash and credit available in the economy.

(b) Qualitative Measures

There are qualitative measures also which regulate credit for specific purposes. They channelise credit into priority sectors and impede its use in undesirable sectors of economy as explained below.

(iv) Margin Requirement (Reduce it). To check depression, Central Bank reduces margin requirement which encourages borrowing because it induces businessmen to get more credit against their security.

(v) Moral Suasion. In a situation of deficient demand, Central Bank persuades, requests, appeals or advises its member banks to be liberal in lending and expand credit facilities.

(vi) Rationing of credit and sometimes direct action are also resorted to promote social justice while checking state of depression.

3. Foreign trade policy (Enlarge export surplus). In national accounting, it was made clear that exports are a part of domestic investment. So additional exports, like domestic investment, increase income and spending. Exports constitute foreign demand for domestic products. More exports have the effect of increasing aggregate demand. Therefore, when an economy suffers from deficient demand, it can reduce its deflationary gap by creating and increasing export surplus (excess of exports over imports). All efforts should be made to encourage export and discourage imports for generating more employment and income. For this the country may set apart for export a part of its domestic product which is in demand abroad.