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Questions
Explain how credit rationing helps to control credit in an economy.
How is ‘rationing of credit’ used as a method to control credit in the economy?
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Solution
Credit rationing is a qualitative credit control method used by central banks to limit the maximum amount of loans available to specified industries or commercial banks.
- Ceiling on Loans: The Central Bank sets a strict loan ceiling for specified industries or commercial banks. Once this limit is reached, banks are unable to make additional loans to that sector, even if borrowers are ready to pay higher interest rates.
- Sector-Specific Allocation: It directs loans to priority sectors (such as agriculture or small businesses), while depriving speculative or non-essential sectors of extra funds.
- Controls Inflation: By restricting the absolute amount of credit that commercial banks can create, it directly reduces the total money supply and purchasing power in the economy, effectively lowering inflationary pressure.
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