Question

Discuss two monetary measures to correct an inflationary gap.

Answer 1

Two monetary measures to correct an inflationary gap are:

1. Increase in the Bank Rate: The central bank raises the bank rate, which is the interest rate at which it lends to commercial banks. A higher bank rate discourages borrowing by making loans more expensive. This reduces the amount of credit extended by banks to consumers and businesses, leading to a decline in consumption and investment expenditure, ultimately reducing aggregate demand and inflationary pressures.
2. Open Market Operations (Sale of Securities): The central bank sells government securities in the open market. When banks and the public purchase these securities, money is withdrawn from the economy, reducing the available purchasing power. This contraction in liquidity decreases lending capacity of banks and reduces overall demand, helping to control inflation.