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Revision: Macro Economics >> Central Bank Eco HSC Commerce (English Medium) 12th Standard Board Exam Maharashtra State Board

Definitions [3]

Define the following concept.

Open Market Operation

Open market operations refer to the sale and purchase of government and other approved securities by central bank in the money and capital markets.

Open Market Operations (OMOs) are employed by Central Banks, such as the RBI, to control the money supply. Buying and selling government bonds on the open market changes liquidity, interest rates, and the economy. Central Bank purchases of securities increase market liquidity and lower interest rates. Selling assets reduces market liquidity and raises interest rates.

Definitions: Central Bank

"A bank which constitutes the apex of the monetary and banking structure of the country." — De Kock
"A central bank is "The bank in any country is one which has been entrusted the duty of regulating the volume of currency and credit in that country." — Bank for International Settlements

Reverse Repo Rate

Reverse Repo Rate is the rate of interest at which the Central Bank borrows funds from other commercial banks for a short duration. The commercial banks deposit their short term excess funds with the Central Bank and earn interest on it.

Reverse Repo Rate is used by the Central Bank to absorb liquidity from the economy. When it feels that there is too much money floating in the market, it increases the reverse repo rate, meaning that the Central Bank will pay a higher rate of interest to the banks for depositing money with it.

An increase in the Reverse Repo Rate causes the banks to transfer more funds to the Central Bank, because banks earn attractive interest rates and also their money is in safe hands. This results in the money withdrawn out of the banking system, thus banks are left with lesser funds.

Thus, by lowering repo rate, Central Bank injects liquidity in the banking system and by increasing reverse repo rate, it absorbs the liquidity from the banking system.

Key Points

Key Points: Central Bank as a Controller of Credit

The Central Bank controls currency and credit to maintain monetary stability.
It regulates money supply through quantitative and qualitative credit control measures.
Credit control helps in achieving price stability, economic stability, and exchange rate stability.
The ultimate aim is high employment and economic growth (in India, done by the RBI).