Question

Explain the concept of 'deflationary gap'. Also explain the role of 'margin requirements' in reducing it.

Answer 1

In the diagram, AB represents the deflationary gap or deficient demand. Deficient demand refers to the situation when aggregate demand is short of aggregate supply corresponding.

Margin requirement refers to the difference between the current value of security offered for loan and the value of loan granted. During deficient demand or deflation, the central bank decreases the margin in order to increase the credit creation capacity of the commercial bank and as a result, the money supply in an economy gets increased and the deficient demand or deflationary gap is combated.