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Consider the following statements regarding instruments of Monetary Po

June 1, 2025 by rawan239

Consider the following statements regarding instruments of Monetary Policy:

1. The Central Bank can increase the money supply by increasing the bank rate
2. The Central Bank can increase the money supply by purchasing securities from the public
3. The Central Bank can decrease the money supply by increasing the cash reserve ratio

Which of the statements given above is/are correct ?

2 only

2 and 3 only

1 and 3 only

1, 2 and 3

This question was previously asked in

UPSC CAPF – 2024

Download PDF Attempt Online

Statement 1 is incorrect. Increasing the bank rate is a contractionary monetary policy tool. A higher bank rate makes it more expensive for commercial banks to borrow from the central bank, which tends to decrease the money supply in the economy as banks lend less. Statement 2 is correct. When the central bank purchases securities from the public or commercial banks through Open Market Operations (OMO), it injects money into the banking system, thereby increasing the money supply. Statement 3 is correct. Increasing the Cash Reserve Ratio (CRR) requires commercial banks to hold a larger proportion of their deposits as reserves with the central bank. This reduces the amount of funds available with banks for lending, thus decreasing the money supply in the economy.

Central banks use various instruments like the bank rate, open market operations (OMO), and reserve ratios (CRR, SLR) to control the money supply and credit conditions, influencing inflation and economic activity.

OMOs are often the most frequently used tool. A purchase of securities is expansionary, and a sale is contractionary. Changes in CRR have a significant impact as they affect the lending capacity of the entire banking system. The bank rate serves as a benchmark rate for long-term lending.

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