Question

Explain the role of the following in correcting 'deficient demand' in an economy: (i) Open market operations. (ii) Bank rate.

Answer 1

1) Decrease in bank rate: During deflation bank rate is decreased. As a follow-up action, the commercial banks lowers the market rate of interest. This increases the demand for credit and thus deficient demand or deflation can be combated.

2) 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 increases purchasing power from the market. Consequently, aggregate demand is increased and deficient demand or deflationary gap gets combated.