How does the bank rate help in correcting the deficient demand in an economy?

When the aggregate demand is less than the aggregate supply at the full employment level, the economy is facing a situation of deficient demand. It can be explained with the following diagram:

● In figure X and Y-axis represents national income and aggregate demand.

● O or the 45-degree line shows the aggregate supply.

● The aggregate demand falls from AD’ to AD. AB is the deflationary gap.

● This is because, at Y of full employment, the aggregate demand is less than the aggregate supply.

● Bank rate is the rate at which the central bank lends money to the commercial bank.

● If there is a deficient demand in the economy the bank rate will be decreased by the Central bank.

● With the reduction in the central bank rate, the commercial dance will reduce the market rate of interest.

● This will make the cost of borrowing lower from the commercial banks to the consumers and the interested.

● This will lead to an increase in the demand for credit which will lead to more liquidity in the hands of the people.

● The consumption expenditure and investment expenditure will increase which will ultimately increase the aggregate demand.

● Thus the problem of deficient demand in the economy short