Excess demand refers to a situation in which aggregate demand exceeds aggregate supply corresponding to fall employment.
The two fiscal measures to reduce excess demand are as follows:
(i) Government Expenditure: It is the principal component of fiscal policy. When there is excess demand government expenditure on public works, education, defence, maintenance of law and order should be reduced. A reduction by government will reduce pressure on aggregate demand and which will shift downward.
(ii) Increase in taxes: The Government should levy new taxes and enhance the rate of the existing ones. This will reduce disposable income of the people and hence reduction in aggregate demand.
(iii) Public Borrowing/Public Debt: By borrowing from the public, the government creates public debt. When there is a situation of excess demand (or when AD needs to be reduced), the government steps up public borrowing by offering attractive rate of interest. This reduces liquidity with the people. Accordingly, aggregate expenditure also reduces.
