What is meant by inflationary gap? State three measures to reduce this gap.
CBSE DELHI - OUTSIDE DELHI - FOREIGN SET 1 2018
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The extent at which present aggregate demand is greater than the aggregate demand which is required for full employment level, is known as inflationary gap. This gap is termed as Inflationary Gap because price of goods and services increases in this condition. This condition can be found in economy in the case of Excess Demand. In such cases Aggregate Demand would be more than Aggregate Supply.
Inflationary Gap $=\ce{ AD_1 - AD_f = LY_f - EY_f = LE}$
Inflationary Gap $=\ce{ AD_1 - AD_f = LY_f - EY_f = LE}$
- Increase in $\text{CRR}:$ Central bank increase the $\text{CRR}$ to control the condition of excess demand, due to this commercial bank has to keep more ratio of its deposits with central bank which decreases their credit creation ability and hence the credit creation also decreases which in turn decreases the money supply and aggregate demand of economy.
- Increase in $\text{SLR}:$ Central bank increases the $\text{SLR}$ to control the condition of excess demand, due to this commercial bank has to keep more ratio of its deposits with itself, which decreases their credit creation ability and hence the credit creatin also decreases which in turn decreases the money supply and aggregate demand also decreases.
- Selling of Securities in Open Market: Central bank starts to sale the securities in open market with the help of commercial banks, this will decreases the availability of cash with commercial banks and hence decreases the credit creation ability of commercial banks. Which would further decreases the credit creation and money supply in an economy and hence aggregate demand also decreases.
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