Question

Explain the role of bank rate and open market operations for controlling the situation of deficient demand.

Answer 1

Open market operation is the policy that focuses on increasing and decreasing the stock of liquidity with the people, through sale and purchase of securities by the central bank. During deficient demand or deflation, the central bank tries to purchase securities. Purchase of securities injects purchasing power to the market. Consequently, aggregate demand is increased and deficient demand gets combated.

Bank rate should be reduced by central bank so that the credit creation capacity of the commercial banks gets increased. As a result, the aggregate demand, purchasing power, money suppy in the economy get increased which are necessary to control the situation of deficient demand.