Question

If RBI wants to decrease the money supply in order to check inflation it will __________.

• A. sell bonds
• B. increase CRR
• C. hike bank rate
• D. all or any of the above three

Answer 1

The correct option is D all or any of the above three

If Reserve Bank of India wants to decrease the money supply in order to check inflation then they will use the quantitative measures of their monetary policy which includes:

(i) Selling bonds in open market: Open market operation (OMO) is a monetary policy by the central bank in which the bank deals in the sale and purchase of securities and bonds in the open market to control the supply of money in the economy. By selling the securities and bonds, the central bank soaks liquidity from the economy that reduces the purchasing power in the economy which controls the situation of inflation.

(ii) Increase in CCR: Cash Reserves Ratio (CRR) refers to the proportion of total deposits of the commercial banks which they must keep as reserves with the central bank in the form of cash. By increasing the cash reserve ratio, the commercial banks has to maintain more cash with the central bank which reduces their credit creation capacity and therefore money supply in the economy also reduces which corrects the situation of inflation.

(iii) Hiking bank rate: Bank rate is the rate charged on the loans offered by the Central bank to the commercial banks without any collateral. Bank rate is a quantitative credit control measure under the monetary policy of the government as it controls the overall supply of the money in the economy. During inflation, bank rate is increased to reduce the total money supply in the economy by reducing the amount of credit creation by the commercial banks.