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प्रश्न
Explain the concept of ‘inflationary gap’. Also explain the role of ‘legal reserves’ in reducing it.
उत्तर
Inflationary gap refers to the difference (or gap) between the actual level of aggregate demand and the full employment level of demand that arises due to excess demand. This gap measures the amount of surplus in the level of aggregate demand.
In the above figure, the full employment equilibrium is at point E, where Aggregate Demand curve, AD1 and Aggregate Supply curve, AS intersect. At this equilibrium point, OY represents full employment level of income and EY is aggregate demand at the full employment level of output.
Now, let us suppose the actual aggregate demand for output is FY, which is higher than EY. The vertical distance between the actual level of aggregate demand FY and the full employment level of output EY that is, FE represents the inflationary gap.
Role of Legal Reserve Ratios to Correct Inflationary Gap
Legal Reserve Ratio (LRR) comprises of CRR and SLR.
CRR refers to the minimum proportion of the total deposits that the commercial banks have to maintain with the central bank in form of reserves. When there is inflationary gap in an economy, the central bank raises the CRR. Increase in CRR implies that the commercial banks are left with lesser amount of funds to lend out to the public. This implies that the lending capacity of the banks reduces, leading to a fall in the money supply in the economy. The fall in money supply reduces the level of aggregate demand. Thus, the inflationary gap is corrected.
SLR refers to the minimum percentage of assets to be maintained by the commercial banks with themselves in the form of either fixed or liquid assets. Similar to CRR, in order to correct the situation of inflationary gap, the central bank raises the SLR. A rise in the SLR restricts the commercial banks to pump additional money into the economy. This results in a fall in the money supply which subsequently leads to a reduction in inflationary gap.
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संबंधित प्रश्न
Answer the following question.
Explain, using a numerical example, how a reduction in reserve deposit ratio, affects the credit creation power of the banking system.
______ is the main source of money supply in an economy.
The ______ creation is called credit creation.
Credit creation by the commercial bank is determined by ______.
Access to adequate and timely credit at affordable rates is critical for the rural poor to alleviate high cost debt and invest in livelihood opportunities. Despite the Government of India's best efforts, financial inclusion of the rural poor has been beset with multiple challenges. Lack of adequate banking infrastructure and human resources in rural areas, unplanned expansion leading to unviable bank branches and low levels of financial literacy amongst the rural populace have been some of the key challenges.
The most vulnerable communities, who often had no formal credit history or ability to provide collateral, have often been the worst affected. Inability to access loans from banks meant that the poorest had to resort to moneylenders for loans at unreasonably high rates of interest that invariably led them into a toxic debt trap.
In this context, the SHG-Bank Linkage programme, formalised by the National Bank for Agriculture and Rural Development (NABARD) in 1995, synthesizes 'formal financial systems' (in terms of a formal institution providing credit) with the 'informal sector' (comprising of rural poor with no formal credit history), has emerged as a preferred vehicle for providing financial services to the hitherto unbanked poor.
Community Based Repayment Mechanisms (CBRMs) have been institutionalised at branches involved in financing SHGs to monitor and ensure timely repayment of loans by SHGs. The number of SHGs with outstanding bank loans stands at nearly 5 million today, implying that the program has brought formal banking services to over 50 million women.
Why is it important to ensure access to cheap formal sector credit to the rural poor?
Access to adequate and timely credit at affordable rates is critical for the rural poor to alleviate high cost debt and invest in livelihood opportunities. Despite the Government of India's best efforts, financial inclusion of the rural poor has been beset with multiple challenges. Lack of adequate banking infrastructure and human resources in rural areas, unplanned expansion leading to unviable bank branches and low levels of financial literacy amongst the rural populace have been some of the key challenges.
The most vulnerable communities, who often had no formal credit history or ability to provide collateral, have often been the worst affected. Inability to access loans from banks meant that the poorest had to resort to moneylenders for loans at unreasonably high rates of interest that invariably led them into a toxic debt trap.
In this context, the SHG-Bank Linkage programme, formalised by the National Bank for Agriculture and Rural Development (NABARD) in 1995, synthesizes 'formal financial systems' (in terms of a formal institution providing credit) with the 'informal sector' (comprising of rural poor with no formal credit history), has emerged as a preferred vehicle for providing financial services to the hitherto unbanked poor.
Community Based Repayment Mechanisms (CBRMs) have been institutionalised at branches involved in financing SHGs to monitor and ensure timely repayment of loans by SHGs. The number of SHGs with outstanding bank loans stands at nearly 5 million today, implying that the program has brought formal banking services to over 50 million women.
Which of the following is a crucial area of improvement for rural banking?
Explain the role of legal reserve ratio and Bank rate in correcting inflationary gap in an economy.
''The process of credit creation by commercial banks comes to an end when the total of required reserves become equal to the initial deposits."
With the help of a numerical example, prove that the given statement is true.
The ratio of total deposits that a commercial bank has to keep with Reserve Bank of India is called ______.
Read the following statements - Assertion (A) and Reason (R). Choose one of the correct alternatives given below:
Assertion (A): Credit Creation comes to an end when total cash reserves become equal to the initial deposits.
Reason (R): The value of money multiplier is determined by Legal Reserve Ratio (LRR).
Match the following:
| Column I | Column II | ||
| A. | Formula of Money Multiplier | (i) | Inverse |
| B. | Money multiplier = 4 | (ii) | Money multiplier = 10 |
| C. | Relationship between LRR and money multiplier | (iii) | LRR = 0.25 |
| D. | LRR = 0.1 | (iv) | `1/"LRR"` |
What is meant by credit creation?
State the advantage of a credit card over currency notes.
What is meant by primary deposits?
What are secondary (derivative) deposits?
What is money multiplier?
How money multiplier is related to Legal Reserve Ratio?
Why are the banks required to keep only a fraction of deposits as cash reserves?
