Money and Banking (part – II)

Bank Rate and open market operations OMOs are instruments of monetary policy while public debt and public revenue are related to fiscal policy.

The open market operations of the Reserve Bank of India refer to the sale and purchase of government securities and treasury bills by RBI in the open market. The Central Bank use this as primary tool of monetary policy. To increase money supply in the economy, the RBI purchases the government securities and to decrease money supply in the economy, the RBI sells government securities in the market.

The open market operations of the Reserve Bank of India refer to the sale and purchase of government securities and treasury bills by RBI in the open market. The Central Bank use this as primary tool of monetary policy. To increase money supply in the economy, the RBI purchases the government securities and to decrease money supply in the economy, the RBI sells government securities in the market.

The variable reserve rates and open market operations (OMOs) are important tools of the Central Bank's (RBI) monetary policy and play an essential role in regulating money supply in the economy. Through variable reserve rate RBI controls and regulates the credit flow, while, through Open Market Operations, the RBI buys and sells government securities, in order to regulate the supply of money. Both are the RBI's quantitative measures under the monetary policy to regulate credit control.

'Sterilization' refers to the process by which the RBI takes away money from the banking system to neutralize the fresh money that enters the system. To ease the threat of currency appreciation or inflation, Central Banks often attempt what is known as the 'sterilization' of capital flows. In a successful sterilization operation, the domestic component of the monetary base (bank reserve plus currency ) is reduced to offset the reserve inflow, at least temporarily . The classical form of sterilization has been through the use of open market operations, that is, selling Treasury bills and other instruments to reduce the domestic component off the monetary base. Hence , option (a) is the correct answer.

Simultaneous purchase and sale of government securities by the RBI under open market operations (OMOs) is popularly known as Operation Twist. It involves buying long- term securities while selling short-term securities to keep borrowing costs down. Operation Twist is a program of quantitative easing used by the RBI that was first introduced by the Federal Reserves in US in 1961. It is aimed at stimulating economic growth through lowering long-term interest rates. The main objective of this operation is to promote long-term investments. Hence, both (A) and (R) are true and (R) is the correct explanation of (A).

When the RBI wants to increase the money supply in the economy, it purchases government securities (under OMOs) from the market. Borrowing by the government from the Central Bank is also a tool to increase the money supply in the economy, while deposit of currency in commercial banks by the public and sale of government securities to the public by the Central Bank will reduce the money supply in the economy . Hence , option (c) is the correct answer.

The steps generally taken by the RBI to tackle inflation includes a rise in Bank Rate and Repo Rate (the rates at which banks borrow from the RBI), a rise in Cash Reserve Ration (CRR) and /or Statutory Liquidity Ratio (SLR) , a reduction in rate of interest on cash deposited by banks with RBI and selling of government securities. They steps have been taken as monetary instruments by the RBI to control the credit creation and reduce the money supply in the economy in order to tackle the inflation. Purchase of government securities will increase the money supply in the economy .