Question

Explain the RBI's role in controlling the inflation in the economy.

Answer 1

Explanation:

Explain the relationship between money circulation and inflation.
Explain how RBI controls the money circulation and thus inflation.

Solution:

One of the reasons for the rise in prices is the increase in demand for goods. People may demand more of certain goods, such as gold or real estate, when they have more money. When demand is more than supply, prices rise.
Thus, RBI tries to control inflation by controlling the money circulation.

RBI is the apex body for all banks in India. Under its regulatory powers, it may ask banks to lend less or allow depositors to withdraw less. This is done by controlling the interest rate on deposits and loans.

By controlling the interest rate, the amount of money circulated in the country declines. This results in people’s tendency to consume less, which in turn reduces the demand for goods and thereby lowers the prices. However, it takes time to see the impact of steps taken by the RBI.