In order to correct the situation of deflation :

Question

Accepted Answer

In order to correct the situation of deflation, the correct action is for the central bank to purchase securities, as indicated by Option 3. Here's a detailed explanation of why this is the correct approach:

1. **Explanation for Option 3: Securities are purchased by the central bank.**
   - **Monetary Policy Tool:** When the central bank purchases securities, it is engaging in an expansionary monetary policy. This action increases the money supply in the economy because the central bank pays for these securities, injecting liquidity into the financial system.
   - **Impact on Interest Rates:** By increasing the money supply, the central bank can lower interest rates. Lower interest rates make borrowing cheaper for businesses and consumers, encouraging spending and investment.
   - **Stimulating Economic Activity:** Increased spending and investment can lead to higher demand for goods and services, which helps to counteract deflationary pressures by pushing prices upward.
   - **Boosting Confidence:** The central bank's actions can also boost confidence in the economy, encouraging further economic activity and helping to stabilize prices.

2. **Explanation for why the other options are incorrect:**

- **Option 1: Securities are purchased by the commercial banks.**
     - Commercial banks purchasing securities does not directly increase the money supply in the same way central bank actions do. While it may have some impact on the banks' balance sheets, it does not have the broad economic impact needed to address deflation.

- **Option 2: Securities are under possession by the commercial banks.**
     - Simply holding securities does not affect the money supply or interest rates. This option does not involve any active policy measure that would address deflation.

- **Option 4: Securities are sold by the central bank.**
     - Selling securities is a contractionary monetary policy action, which would decrease the money supply and potentially increase interest rates. This would be counterproductive in a deflationary situation, as it could further suppress economic activity and exacerbate deflation.

In summary, Option 3 is the correct answer because purchasing securities by the central bank is a strategic move to increase the money supply, lower interest rates, and stimulate economic activity, all of which are essential steps in combating deflation.