Question

Explain one monetary measure to correct deficient demand.

Answer 1

Expansionary monetary policy should be pursued so as to increase consumption expenditure and also to stimulate investment in the economy:

1. Bank Rate: To address the economy's inadequate demand, the country's central bank could lower interest rates. A fall in the bank rate would result in a similar decrease in the interest rates charged by commercial banks to their customers. A lower cost of credit from banks would result in more credit being borrowed from them. This will have an expansionary effect on the economy as consumers and investors borrow more from banks, resulting in an an increase in aggregate demand.
2. Open Market Operations: The central bank should pursue a programme of purchasing government bonds and securities from both commercial banks and the public. When the central bank buys government assets from public and commercial banks in cash, the economy's cash flow improves. This will raise commercial banks' cash holdings. To that end, banks will expand their loans and advances. This will have an expansionary impact on the economy.
3. Cash Reserve Ratio: To address the issue of weak demand, the cash reserve ratio must be decreased. A fall in the CRR requires commercial banks to hold less cash with the central bank. As a result, commercial banks' cash flow improves, increasing their ability to make loans and advances. This will boost the economy. As a result, aggregate demand will rise.