Anti Recessionary Policy to Remove Cyclical Unemployment –
When aggregate demand falls short of aggregate supply at full employment level of resources, a deflationary gap emerges in the economy. This gap arises due to inefficient investment demand means investment falls short to the amount of saving at full employment level of income. Investment demand depends on the expected rate of profit. When businessmen have adverse expectations about future profits, expected rate of return on capital falls causing a decline in investment demand. The decline in investment demand leads to a multiple fall in overall aggregate demand resulting in unemployment of resources, especially unemployment of labour. This is called recession or depression. To pull the economy out of recession or depression various measures are used which raises aggregate demand.
1. Deficit Budgeting – Expanding Aggregate Demand –
Deficit budgeting is a fiscal measure to correct the demand deficiency. Deficit budgeting can be done by two ways. First, government can increase its expenditure (public expenditure) on goods and services without imposing new taxes or without increasing the rates of old taxes. Increase in the public expenditure will have a multiplier effect on raising income and employment which means income and employment will rise by much more than that of the public expenditure depending upon the magnitude of multiplier. The magnitude of the multiplier is denoted by k which depends upon the marginal propensity to consume.
k = 1/(1 – mpc)
The greater the marginal propensity to consume, higher the multiplier and therefore the greater the effect of public expenditure on income and employment.
For example – if government increases its expenditure by 5000 chores and multiplier is 3, then national income and output will expand by 15000 crores and there will be three fold increase in the employment of labour, given the labour output ratio.
For the maximum effect on the income and employment, deficit budget should be financed not by borrowing from the general public but by creating new money (by issuing new notes) by the Central Bank of the country. This will lead to the expansion in money supply and increase the aggregate demand in the economy.
2. Reduction in Taxes – Increasing Disposable Income –
Reducing taxes is another fiscal measure to raise aggregate demand. With reduction in taxes people’s disposable income will rise and consequently their spending on goods and services will rise. Reduction in corporate taxes increases the profitability of investment due to which aggregate demand (consumption demand + investment demand) will increase. This will help the economy to get out of the recession or depression.
3. Monetary Policy – Expanding Credit –
Three types of monetary measures can be taken to raise aggregate demand. First measure works to raise the cost of credit, and other two increase the availability of credit.
By bank rate or cost of credit –
When there is a depression in the economy, the Central Bank of the country tries to overcome it by lowering the bank rate. When bank rate is lowered, the market rate of interest also falls due to which borrowing costs declines, which induces the businessmen to investment more which in turn increases the aggregate demand and helps the economy to get out of the recession or depression.
By availability of credit –
Another method to increase aggregate demand is through expanding the credit supply by lowering the cash reserve ratio. With lower cash reserve ratio banks will have more available funds which they will lend to business firms for investment purposes and this will increase the investment and aggregate demand in the economy which in turn will increase the income and employment. In this same way, statutory liquidity ratio (SLR) can also be lowered to increase the availability of credit by banks.
4. Export Promotion to Raise Aggregate Demand –
Aggregate demand can also be increased by exporting goods. When domestic demand for goods is limited or decreased due to some adverse factors, the goods can be sold abroad. But the growth of exports of a country depends on various factors.
First and most important factor is the prices of the goods to be exported. We or a country can export those goods which can be produced comparatively at lower costs and therefore can be sold abroad at competitive prices.
Second and another most important factor is the quality of the goods to be exported. If the quality of the exported goods superior, they can favorably compete with the goods of the other countries.
Another important factor is the trade agreements and trade tariffs between the trading countries. Free trade will increase the exports while trade tariffs will adversely effect the exports.
Aim Institute of Economics 