Question

Explain the meaning of inflationary gap and deflationary gap. Explain any one measure by which these gaps can be reduced.

Answer 1

Excess demand or inflationary gap is the excess of aggregate demand over and above its level required to maintain full employment equilibrium in the economy.

Deficient demand or deflationary gap refers to the situation when aggregate demand is short of aggregate supply corresponding.

One measure of correcting inflationary and deflationary gaps is:

1) Margin requirement refers to the difference between the current value of the 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. Whereas, during an inflationary gap the margin requirement is increased by the central bank.