Consider the following statements 1 Thi...........

Economic Affairs Types of Banks and Banking

Consider the following statements

1. This is the process by which the RBI takes away money from the banking system to neutralise the fresh money that enters the system.

2. This process will be carried out by selling the government bonds that it holds in its books.

3. RBI employs this process if the RBI does not want to cut rates.

4. This process is part of open market operations.

The above statements characterize which of the following processes?

Sterilisation

Moral suasion

Inflation control

Monetary policy

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Explanation:

• It refers to the process by which the RBI takes away money from the banking system to neutralise the fresh money that enters the system that will push up bond prices. Since bonds carry an inverse price-yield relationship, higher bond prices means lower yields. The problem is that lower yields will force the RBI to cut interest rates further.

• If the RBI does not want to cut rates, it will reduce (sterilise) liquidity that causes the yields to fall. It will do so by selling the government bonds that it holds in its books. This means that sterilisation is possible only to the extent that the RBI holds government bonds in its portfolio.

• This process of selling government bonds to reduce liquidity is part of its open market operations.