When the Reserve Bank of India buys government bonds from the market, how does that affect money supply in the economy?
When the Reserve Bank of India buys government bonds from the market, how does that affect money supply in the economy?
Solution
Option 1 -> When RBI buys bonds, it pays money to sellers, injecting cash into the economy.
Option 2 -> This occurs when RBI sells bonds, withdrawing money from circulation.
Option 3 -> The transaction actively changes money supply, so it cannot remain constant.
Option 4 -> Bond purchases by RBI don't affect government assets; bonds are already issued.
Hence, Option 1: Increases Money Supply -> When the Reserve Bank of India purchases government bonds from the market through open market operations (OMO), it pays money to the bond sellers (banks, financial institutions, or individuals). This payment injects liquidity into the banking system and the broader economy. The money that was previously held in bonds (which are not considered liquid money) now becomes cash in circulation, thereby expanding the money supply. This is an expansionary monetary policy tool used to stimulate economic activity, increase lending capacity of banks, and lower interest rates. -> correct
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