Question

Explain the concept of deflationary gap and role of open market operation in reducing this gap.

Answer 1

Answer:

Explanation:IN case of deflationary gap

1 Government or central bank indulges itself in the purchase of securities . 2 as a result of this purchasing power of the system increase. 3 this result in the expansion of credit.4 credit become cheaper &the problem deficient demand will be solved

Answer 2

Answer:

Deflationary Gap-Deflationary gap is the deficiency of AD required to maintain full employment equilibrium Deflationary gap occurs when AD < AS (corresponding to full employment level).

Explanation:

Open market operation is the policy that focuses on increasing and decreasing the stock of liquidity (or cash balances) with the people as well as with the Commercial Banks, through sale and purchase of securities by the Central Bank. During the situations of Deflationary Gap, when cash balances need to be increased (to stimulate the level of Aggregate Demand), the Central Bank starts buying securities. Purchase of securities injects purchasing power into the money market. Cash balances of the Commercial banks start picking up. This enhances their capacity to create credit. Consequent upon the greater flow of credit flow' in the economy, Aggregate Demand is increased Deflationary gap is corrected.