Question

Consider an economy. This economy’s real GDP is constant. The government decides to buy out the government bonds from the commercial banks. What macroeconomic variables will such policy affect? Explain why. Would this effect be different if there was more output produced in the same year? What concept explains this?

Answer 1

The concepts of open market operation (OMO) which RBI used for smooth the liquidity throughout the year and also regulate the money circulation in the economy. It is the sale and purchase of government securities like bonds, treasury bills by central bank of a country. Government purchase the bonds to maintain the fiscal policy. Here we used the concept of reverse repo rate. The interest rate which impose upon during the government purchase bond or any other securities from the commercial banks. This is the fiscal policy by the authority which used to control the money supply in the economy. Taxation is the most important variable which affect through this policy. The purchase of government securities increased because of expansionary monetary policy. Government tried to increase their revenue through taxation and other payments. The fiscal policy can boost the employment level, stabilize the economic growth and development, it raise the standard of living and maintain the equilibrium of balance of payment.
Assume that if there is huge increase in the level of output in the same year. If the output increased, it leads to an increase in national income. So people spend more and also people having more money in hand. There is a need for contraction fiscal policy implemented to avoid the inflation in the economy. Government implement tax rates in higher level to collect cash from public and reduce the transfer payments. Through this the authority can control the money supply in the economy.