MEASURES OF CONTROLLING EXCESS DEMAND(INFLATION)

AND DEFICIT DEMAND (DEFLATION)

Monetary measures
A. Quantitative
B. Qualitative

A. Quantitative tools

I. Bank rate: it is the rate at which the central bank lends money to the commercial banks for
their long-term needs.
Excess demand- bank rate is increased which increases the cost of borrowing from the central bank.
This will cause the banks to increase their lending rates, which discourages borrowers from taking
loans, thus reducing the volume of credit, and corrects excess demand.

Deficit demand- bank rate is decreased which decreases the cost of borrowing from the central
bank.
This will cause the banks to decrease their lending rates, encourages borrowers to take loans, thus
increasing the volume of credit, and corrects deficit demand.

II. Repo rate: it is the rate at which central banks lends money to commercial banks to meet
their short-term needs.
Excess demand- Repo rate is increased which increases the cost of borrowing from the central bank.
This will cause the banks to increase their lending rates, which discourages borrowers from taking
loans, thus reducing the volume of credit, and corrects excess demand.
Deficit demand- Repo rate is decreased which decreases the cost of borrowing from the central
bank.
This will cause the banks to decrease their lending rates, encourages borrowers to take loans, thus
increasing the volume of credit, corrects deficit demand.

III. Reverse repo rate: the rate at which the commercial banks deposit their surplus funds with
the central bank.
Excess demand- Reverse repo rate is increased, which encourages the commercial banks to deposit
their surplus funds in the central bank.
This reduces the lending capacity of the commercial banks, reducing the volume of credit and thus
reducing aggregate demand.
Deficit demand- reverse repo rate is decreased which discourages the commercial banks to deposit
their surplus funds with the central bank.
This increases the lending capacity of the commercial banks, increasing the volume of credit and thus
increasing aggregate demand.

IV. Open market operation (OMO): refers to the sale and purchases of securities in the open
market by the central bank.
Excess demand- central bank sells securities, which reduces the credit available with the commercial
banks and decreases their ability to give credit.
Money supply and aggregate demand falls.

Deficit demand- central bank purchases securities, which increases the credit available with the
commercial banks and increases their ability to give credit.
Money supply and aggregate demand rises.

V. Legal reserve requirements (LRR): obligation of commercial banks to maintain legal reserves

a. cash reserve ratio: certain percentage of total demand deposits that commercial banks have
to keep as a reserve in the form of cash, with the RBI.
b. Statutory liquidity ratio: certain percentage of demand deposits of the commercial banks,
held in the form of liquid assets, with themselves.

- Excess demand- Increase in CRR and LRR , which implies more cash to be
deposits with central bank, reduces cash available and reduces banks ability to
give loans for investment.
This decreases aggregate demand.

- Deficit demand- Decrease in CRR AND LRR, which implies

2) Qualitative tools

I. Margin requirements: refers to the diff. between the amount of loan and market value of
the of the collateral offered for the loan by the borrower.

Excess demand- increase in margin requirements will reduce the public borrowings which
reduces aggregate demand.

Deficit demand- decrease in margin requirements will increase the public borrowings which
increase aggregate demand.

II. Moral suasion: persuasion and pressure that Rbi applies on other banks to get them to fall in
line with its policy.

Excess demand- advise discourage lending.

Deficit demand- advice encourage lending.

III. Selective credit controls