How does RBI control money supply
How does RBI control money supply ? Pursue this article delight to get through all of that.
The Reserve Bank of India (RBI) is India’s central bank, also known as the banker’s bank. RBI is that organ of our country which is independent which means it has its own right to take decision and there will be little interference by the GOI in the decision making of RBI. The master of all banks, the savior of government in case of debts, the lender of last resort. RBI is the main key of Indian economy to unlock the doors of development, inflation, employment and growth also. Let’s get to know how does RBI control money supply.
Money Supply Control methods of RBI
Quantitative Control Measures of RBI
The Reserve Bank of India controls the money supply in the country using various “Monetary Policy Measures”.
Monetary Policy Measures is the use of certain instruments to regulate the supply of money in the economy and our apex bank RBI has the responsibility of formulating the nation’s monetary policy. Metrics for major monetary policy measures are :
1. Repo rate: Repo rate is the interest rate at which central bank of a country lends money to commercial banks . There is also Reverse Repo Rate, i.e. the rate at which commercial banks lend to central bank. Repo and reverse repo rates form a part of the liquidity adjustment facility. In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. So, it becomes costlier for banks to borrow money from RBI which leads to less supply of money in the market. Hence, people have less money in their hands followed by less demand. Thus helps in arresting inflation. Similarly, if inflation is under control bank decreases rate to avail more liquidity in the market and purchasing power increases so consumption increases and finally demand increases. This helps in growing economy and industrial output.
2. Open Market Operations: Buying and Selling of Government securities by the central banks from or to the public and commercial banks. To reduce the supply of money in the economy, the bank sells securities to customers. This takes money away from the customers into the hands of the central bank, and reduces the money supply.
To increase money supply, the central bank buys securities with cash. Hence, the customers who sell securities get back cash in return. Now they are free to utilize the cash and inject the same back into the economy. Hence, this leads to the increase in money supply.
3. CRR & SLR(Cash Reserve Ratio and Statutory Liquidity Ratio): CRR is percentage of deposits that have to kept with the Central Bank. SLR is the percentage of total deposits that banks have to maintain as liquid cash with themselves. By reducing CRR and SLR, banks have more money to lend, thus increasing money supply.
Apart from above Quantitative Measures, RBI also control money supply through various Qualitative or Selective Credit Control Measures
Qualitative or Selective Credit Control Measures of RBI
Credit Rationing: Under this method (in the scenario of higher inflation) credit is given to only those sectors which are very crucial for the economy (productive lending).
Change in Lending Margin: Under this method the banks provide loans only upto a certain percentage of the value of the mortgaged property. The gap between a mortgaged property and loaned amount is called the lending margin.
Moral Suasion: The moral suasion is the method of persuading and convincing the commercial banks to advance credit in accordance the directive of the RBI. More or less under this method RBI urges to commercial banks to co-operate in managing the money supply in the economy.
Final Takeaways :
Having the right quantity of money in circulation is crucial to ensuring a stable and sustainable economy. Through Policy rates (Repo, Reverse-Repo, Marginal Standing Facility Rate) the RBI controls the cost of money (for borrowing and lending). Through reduction or increase in CRR (Cash Reserve Ratio) RBI controls the quantum of money (liquidity) available in the system.
If the inflationary pressure is on the rise, RBI will tighten both the cost and quantum of liquidity available- that is RBI will increase the CRR and/or increase the repo rate (the rate at which banks borrow from the Central Bank). This mechanism shrinks the volume of money supply in the system thereby reducing the inflationary pressure in the economy.
Conversely during periods of deflation (continuous fall in prices) the RBI will relax the quantum and the cost of credit (money, liquidity) available. This mechanism increases the volume of money supply in the system thereby providing an incentive to invest and spend more. This will help the economy to come out of its sluggishness.
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