Question

Refer the given image carefully:

Explain any two measures that can be taken by the Central Bank to control the indicated macroeconomic problem.

Answer 1

The situation described involves “deficient demand” or a “deflationary gap.” In this scenario, aggregate demand is below the level required for full employment, leading to an increase in the value of money and a decline in the general price level.

Central Bank Interventions: To stimulate the economy and increase demand, the Central Bank can use the following quantitative tools:

1. Reduction in the Repo Rate: The Central Bank can lower the rate at which it lends to commercial banks. This makes bank credit cheaper for consumers and investors. As borrowing costs fall, spending on consumption and investment rises, thereby boosting aggregate demand.
2. Purchase of Securities (Open Market Operations): The Central Bank can buy government bonds from the open market. This process injects liquidity (cash) into the banking system. With increased reserves, banks can lend more freely, increasing the money supply and encouraging higher spending across the economy.