Question

Which monetary policy is adopted to control inflationary gap?

• A. Dear money policy
• B. Cheap money policy
• C. Both (A) and (B)
• D. None of these

Hint:

To control an inflationary gap, central banks often use dear money policies, increasing interest rates to reduce consumer and business spending.

Answer 1

The Correct Option is A

Step 1: Understanding the Inflationary Gap:
An inflationary gap occurs when the actual output of the economy exceeds its potential output, leading to inflation. The government or central bank must take measures to reduce demand to bring the economy back to equilibrium and control inflation. Step 2: Monetary Policies to Control Inflationary Gap:
- Dear Money Policy (Option A): This policy aims to reduce inflation by making borrowing more expensive. The central bank increases interest rates or sells government bonds to reduce the money supply, thereby reducing demand in the economy. This is used to control an inflationary gap.
- Cheap Money Policy (Option B): This policy, in contrast, is used to stimulate the economy by lowering interest rates, making borrowing cheaper. It is typically used in a deflationary gap, not an inflationary gap. Step 3: Conclusion and Answer:
The correct answer is (A), as the dear money policy is designed to control inflationary pressure by tightening the money supply.