Why does the central bank purchase government securities in the open market to increase the lending capacity of commercial banks to reduce the deflationary gap?
Understand the Problem
The question is exploring the relationship between government purchases of securities and the central bank's ability to influence the lending capacity of commercial banks, particularly in the context of reducing deflationary gaps. It is asking for a reason or explanation behind this action.
Answer
The central bank purchases government securities to increase money supply, lower interest rates, encourage borrowing, and reduce the deflationary gap.
When the central bank purchases government securities in the open market, it increases the money supply. This action lowers interest rates, encourages borrowing and investing, increases economic activity, and helps reduce the deflationary gap by boosting overall demand.
Answer for screen readers
When the central bank purchases government securities in the open market, it increases the money supply. This action lowers interest rates, encourages borrowing and investing, increases economic activity, and helps reduce the deflationary gap by boosting overall demand.
More Information
Purchasing government securities is part of an expansionary monetary policy and is a common tool used by central banks to stimulate the economy during periods of low inflation or deflation.
Tips
A common mistake is thinking that buying securities decreases the money supply. It actually increases it.
Sources
- Explain Deflationary Gap and the role of 'Open Market Operations' - byjus.com
- What Are Open Market Operations (OMOs), and How Do They Work? - investopedia.com
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