Question

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Explain the role of following
in Correcting excess demand in economy
i) Bank Rate
ii) open market operation
iii) through LRR
iv) Decrease in market requirement

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Answer 1

Answer:

1.... Bank rate : A rise in the bank rate increases the cost of borrowing for the commercial banks from the central bank. ... To curtail excess demand the central bank sells securities in the open market. By selling the securities in the open market, the central bank withdraws excess money from the economy.

2..... Open Market Operations : refer to the buying and selling of securities either to the public or to the commercial banks in an open market. To curtail excess demand the central bank sells securities in the open market. By selling the securities in the open market, the central bank withdraws excess money from the economy.

3...... Through LLR : To control excess demand, the central bank increases the bank rate. A rise in the bank rate increases the cost of borrowing for the commercial banks from the central bank. The commercial banks in turn raise the lending rate (the rate at which they provide loans) for their customers.

4.... Decrease in market requirment : During excess demand or inflation, the central bank tries to sale securities. Sale of securities reduces purchasing power from the market. Consequently, aggregate demand is decreased and excess demand or inflationary gap gets combated.