How does central bank control credit creation by commercial banks through open market operations? Explain.

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Solution

Open market operations refers to buying and selling of securities in an open market, in order to affect the money supply in the economy. The selling of securities by Reserve Bank of India will wipe out extra cash balance from the economy, thereby limiting the money supply resulting in controlled credit creation. To summarize,
$S e l l i n g o f s e c u r i t i e s i n t h e o p e n m a r k e t = E x t r a c a s h b a l a n c e ↓ = M o n e y s u p p l y ↓ (c o n t r o l l e d c r e d i t c r e a t i o n)$

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