Which of the following is not an appropriate policy for a central bank to follow

Question

Which of the following is not an appropriate policy for a central bank to follow if the economy is plagued with deflation?

increasing the target interest rate on overnight loans

using expansionary monetary policy to drive down interest rates

consistently pursuing policy to promote the credibility of the central bank

explicitly and credibly targeting inflation

increasing the target interest rate on overnight loans

using expansionary monetary policy to drive down interest rates

consistently pursuing policy to promote the credibility of the central bank

explicitly and credibly targeting inflation

Explanation / Answer

CORRECTION ANSWER: A (increasing the target interest rate on overnight loans)

Major ways to control deflation are as follow: 1. Monetary Policy 2. Fiscal Policy

1. Monetary Policy : To control deflation, the central bank can increase the reserves of commercial banks through a cheap money policy. They can do so by buying securities and reducing the interest rate.

2. Fiscal Policy: Fiscal policy through increase in public expenditure and reduction in taxes tends to raise national income, employment, output, and prices. An increase in public expenditure during deflation increases the aggregate demand for goods and services and leads to a large increase in income via the multiplier process, while a reduction in taxes has the effect of raising disposable income thereby increasing consumption and investment expenditures of the people.

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