Define Inflationary Gap. State, how the Central Bank of an economy can control the situation of inflationary gap, using any monetary policy measure.

Question

Accepted Answer

**Inflationary Gap** is the excess of actual aggregate demand over the aggregate demand required for full employment equilibrium. It leads to rise in general price level (inflation).

**Central Bank can control inflationary gap using monetary policy measures:**
- **Increase in Repo Rate:** Raises cost of short-term borrowing for commercial banks, who increase lending rates, reducing credit uptake and aggregate demand
- **Sale of Government Securities (Open Market Operations):** Reduces reserves of commercial banks, limiting their credit creation capacity
- **Increase in CRR:** Directly reduces funds available with banks for lending
- **Moral Suasion:** Central Bank advises banks to restrict credit for speculative purposes