Question

As you know, the government, through various tax cuts and spending programs, sometimes tries to influence the state of the economy. What measures does the government have at its disposal and how do you think these actions would influence existing expansionary and recessionary gaps? Do you think these efforts are effective in the long term?

Answer 1

Ans. Government generally follows some qualitative and quantitative measures to control the different gaps arose in the economy. these gaps may be expansionary gaps or inflationary gaps or may be deflationary gaps. In both the situations government follows the policy in different ways.

In case of inflation many quantitative measurements are taken into consideration such as bank rate policy in which at the time of inflation bank rate is increased by central bank of the country due to which commercial bank can take loan at higher rate which is avoided by the commercial banks. In turn commercial banks increases interest rate on loan for common people which discourages common people to take loan from banks which reduces the consumption of people hence reduced demand is there to control the inflationary gap.While in the situation of deflationary gap the bank rate is reduced to increased the money supply in the economy. so new investment take place in the economy for more growth.

Another measure is open market operations in which central bank sale and purchase securities with commercial banks. In case of inflation central bank sale its securities to commercial banks at easy terms and conditions so money is withdrawn from the commercial banks and easy availability of loan is reduced at commercial banks.while in deflation central bank purchases securities from commercial bank to provide them more money to loan out to people.

some other measures such as margin requirements, credit rationing etc are also followed to control the situations.

yes these measures are effective for a longer time period since if money supply is reduced at the time of inflation then no new projects would be started for some time due to lesser loan activities. This postponement will give time to compensate increased demand with decreased supply or vice versa.