Inflationary Gap refers to the excess of Aggregate Demand over Aggregate supply at full employment level of income. It is called Inflationary Gap because it brings in Inflationary tendencies.
Legal reserves refer to that part of bank deposits which Commercial Banks are legally required to keep in the form of cash partly with them selves (Statutory Liquidity Ratio) and partly with the Central Bank (cash reserve ratio), In case of Inflationary Cap, the Central Bank can increase the Legal Reserve Ratio (LRR) so that less money is available to the balks for lending. Borrowings are reduced. AD falls.
