Question

Identify the monetary measures being referred to in the following statements. Discuss whether the tool would be used during a situation of excess demand or deficient demand.

Selling off government securities (G-Sec) to public by the central bank.

Hint:

Selling G-Sec by the central bank is Open Market Operations. It takes money out of the economy, so it is used to fight excess demand.

Answer 1

Step 1: Understand what is asked:
The statement describes a central bank action: it sells government securities (G-Sec) to the public.
We must name the monetary tool and say whether it suits excess demand or deficient demand.
Monetary tools are the steps the central bank takes to change the money supply and credit in the economy.

Step 2: Identify the tool:
Buying and selling of government securities by the central bank in the open market is called Open Market Operations (OMO).
Here the central bank is selling, so the tool is Open Market Operations (selling of securities).

Step 3: Trace what the sale does:
The public and banks pay the central bank for the securities they buy.
This money moves out of the banks and out of the hands of the public into the central bank.
So bank reserves fall, banks can lend less, and the money supply in the economy goes down.
Less money means less spending power, so aggregate demand falls.

Step 4: Decide the demand situation:
A fall in aggregate demand is what we need when demand is more than the output available at full employment.
That is the situation of excess demand, where the central bank wants to cool the economy and check price rise.
In deficient demand the bank would do the opposite: buy securities and push money into the economy.

Final Answer:
The measure is Open Market Operations (selling of G-Sec). It is used in a situation of excess demand, because it cuts the money supply and reduces aggregate demand.