Explain the concept of deflationary gap. Explain any two measures by which Central Bank can attempt to reduce this gap.
Deflationary gap is the short fall in Aggregate Demand from the level required to maintain full employment equilibrium. Central Bank can reduce this gap by adopting following two measures:
(i) Bank rate Central Bank should decrease the bank rate. It will lower the rate of interest and credit ยป becomes cheap. Accordingly, the demand for credit expands and Aggregate Demand increases.
(ii) Open market operations By buying the government securities, the Central Bank injects additional purchasing power into the system which results in the expansion of credit. As a result, Aggregate Demand increases.