Class 12 Macro Economics Notes · CBSE

Policy Measures to Correct Excess Demand

9.4 Policy Measures to Correct Excess Demand — fiscal and monetary tools to reduce aggregate demand and control inflation. CBSE Class 12 Macroeconomics notes with policy flow diagrams.

Last updated: 22 Aug 2026

Notes

Overview of Policy Measures

The problems of excess and deficient demand occur when the current aggregate demand is more or less than the aggregate demand required for full employment equilibrium. These problems can be solved by bringing a change in the level of aggregate demand.

Three Main Measures: Change in Government Spending, Change in Taxes, and Change in Money Supply or Availability of Credit.

Policy Measures to Correct Excess Demand

Government Spending

Part of Fiscal Policy

Decrease to reduce aggregate demand

Taxes

Part of Fiscal Policy

Increase to reduce disposable income

Money Supply

Monetary Policy (RBI)

Reduce credit availability

Fiscal Policy Measures

Fiscal Policy is pursued by the government. It has two components - the Expenditure Policy (government spending) and the Revenue Policy (taxation).

Monetary Policy Measures

Monetary Policy is pursued by the RBI (Central Bank). It uses quantitative instruments (affecting total credit volume) and qualitative instruments (regulating direction of credit).

Increase in Bank Rate - The rate at which the central bank lends to commercial banks for long-term needs. An increase raises the cost of borrowing, forcing commercial banks to increase lending rates, which discourages borrowers and reduces credit availability.

Increase in Repo Rate - The rate at which the central bank lends to commercial banks for short-term needs. An increase raises borrowing costs, reduces credit creation, and decreases aggregate demand.

Increase in Reverse Repo Rate - The rate at which commercial banks deposit surplus funds with the Central Bank. An increase encourages banks to park funds with the Central Bank, reducing their credit-creating power.

Open Market Operations (Sale of Securities) - The Central bank sells government securities, reducing reserves of commercial banks and adversely affecting their credit creation ability.

Increase in Legal Reserve Requirements - CRR (minimum percentage kept with central bank) and SLR (minimum percentage maintained with themselves). An increase reduces effective cash resources and limits credit-creating power.

Key Point: During excess demand, the RBI uses a Tight Money Policy (also called dear money policy) to restrict the flow of credit and reduce aggregate demand in the economy.

Key Takeaways

Fiscal Policy (government) uses Expenditure Policy (reduce spending) and Revenue Policy (increase taxes) to correct excess demand.
Monetary Policy (RBI) uses quantitative instruments (Bank Rate, Repo Rate, CRR, SLR, OMOs) and qualitative instruments (Margin Requirements, Moral Suasion, Credit Controls).
During excess demand, the RBI follows a Tight Money Policy to restrict credit flow.
Both fiscal and monetary policies work together to bring aggregate demand back to the full employment level.