Methods of regulating money supply
(i) Bank Rate
(ii) Cash Reserve Ratio
(iii) Statutory Liquidity Ratio
(iv) Repo Rate
(v) Reverse Repo Rate
(vi) Open Market Operation
(vii) Margin Requirements
Detailed Answer:
The following are the two principal methods of credit control used by central bank:
(i) Repo Rate: Repo rate is the rate at which the central bank lends money to the commercial banks. The increase (or decrease) in repo rate is often followed by increase (or decrease) in the market rate of interest. Accordingly, the cost of credit (also called the cost of capital) changes in the market. During inflation, the cost of capital is increased by increasing the repo rate. This reduces the flow of credit, as desired. On the other hand, during deflation the cost of capital is reduced by reducing the repo rate. This increases the flow of credit.
(ii) Open Market Operations: Open market operations refers to sale and purchase of securities by the central bank in the open market. To increase money supply (as during deflation) securities are purchased by the central bank. On the other hand, to decrease money supply (as during inflation) securities are sold off. By buying the securities, the central bank releases liquidity and hence, a rise in capacity to create credit of the commercial banks. By selling the securities, liquidity is sucked from the economy and hence, a reduction in capacity to create credit of the commercial banks.
