Based on the following diagram answer the question :

To deal with the gap E'F, the central Bank will ________________.

Sells securities in the open market

The correct answer is option (4) : Sells securities in the open market

Explanation :

The gap E'F represents a situation of excess demand in the market. To control excess demand in the market, the RBI would aim to reduce the money supply and curb inflation. Among the options provided, the correct measure would be to sell securities in the open market. Selling securities in the open market, a form of Open Market Operations (OMOs), helps to absorb liquidity from the banking system, thus reducing the money supply and controlling excess demand.This, in turn, can help control inflationary pressures and bring the economy closer to full employment.

• Decrease the Bank Rate: : The Bank Rate is the rate at which the central bank lends money to commercial banks. If the RBI decreases the Bank Rate, it makes borrowing cheaper for banks, leading to an increase in the money supply as banks can lend more to businesses and consumers. This would increase demand, which is contrary to the goal of controlling excess demand. Therefore, this option is not suitable for controlling excess demand.

• Decrease the Cash Reserve Ratio (CRR): The Cash Reserve Ratio is the percentage of a bank's total deposits that must be kept in reserve with the central bank. If the RBI decreases the CRR, banks have more funds available to lend, increasing the money supply and boosting demand. This again is contrary to the goal of controlling excess demand. Therefore, this option is not suitable for controlling excess demand.

• Decrease the Repo Rate: The Repo Rate is the rate at which the central bank lends short-term money to commercial banks. If the RBI decreases the Repo Rate, it lowers the cost of borrowing for banks, leading to an increase in the money supply as banks can lend more to businesses and consumers. This would increase demand, which is contrary to the goal of controlling excess demand. Therefore, this option is not suitable for controlling excess demand.