UPSC Prelims 2012 · Question 77 of 98
UPSC Prelims 2012 question on Money Supply Increase Measures
- ExamUPSC CSE
- Year2012
- PaperGeneral Studies Paper I
- SubjectIndian Economy
- TopicMoney Market
- DifficultyHard
- TypeStatement
Which of the following measures would result in an increase in the money supply in the economy?
1. Purchase of government securities from the public by the Central Bank.
2. Deposit of currency in commercial banks by the public.
3. Borrowing by the government from the Central Bank.
4. Sale of government securities to the public by the Central Bank.
Select the correct answer using the codes given below:
Show answer
Answer: C. 1 and 3
Verdict
Correct Answer: 1 and 3 only
Analysis
Money supply increases when new liquidity is injected into the economy.
It does not increase merely when money changes form, such as from cash to bank deposits.
Statement by statement
1. Purchase of government securities from the public by the Central Bank — Correct
When the RBI buys government securities from the public or banks, it pays them money.
This increases liquidity in the economy and expands money supply. This is an expansionary Open Market Operation.
2. Deposit of currency in commercial banks by the public — Incorrect
This only changes the form of money from currency with the public to bank deposits.
Since both currency and demand deposits are part of money supply, total money supply does not increase directly.
3. Borrowing by the government from the Central Bank — Correct
When the government borrows from the RBI, new money may be created and injected into the economy.
As the government spends this money, the overall money supply increases.
4. Sale of government securities to the public by the Central Bank — Incorrect
This is the opposite of purchase of securities.
When the RBI sells securities, it takes money out of circulation, thereby reducing liquidity and money supply.
Extra UPSC info
* Open Market Operations refer to buying and selling of government securities by the RBI.
* Buying securities increases money supply; selling securities reduces money supply.
* M1 includes currency with the public and demand deposits with banks.
* M3 is the broad money measure and includes M1 plus time deposits with banks.
* Expansionary monetary policy increases liquidity through tools like OMO purchase, repo rate cut, CRR cut and SLR cut.
* Contractionary monetary policy reduces liquidity through OMO sale, repo rate hike, CRR hike and SLR hike.
How to crack it
Money supply increases when the RBI buys securities or creates money through government borrowing, not when existing money merely changes form or is withdrawn from circulation.