Which of the following action(s) by the Government would lead to contraction of money supply in the economy? 1. Purchase of Treasury Bills by the central bank from public 2. Sale of Treasury Bills by the central bank to public 3. Sale of foreign exchange by the central bank 4. Purchase of foreign exchange by the central bank Select the correct answer using the code given below:
- (a)1 and 4 only
- (b)1 and 3 only
- (c)2 and 3 only
- (d)2 only
Correct — C, 2 and 3 only. Both of the actions in the key take rupees out of circulation, and both of the rejected ones put rupees in. Statement 2 is an open market operation on the sale side. Treasury Bills are short-dated government securities, and when the central bank sells them to the public the buyers pay for them, so rupees leave the public's hands and the banking system's reserves and come to rest on the central bank's books. The RBI describes exactly this: 'When the RBI feels that there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity.' NCERT puts the same point in one line — selling of a bond by the RBI leads to a reduction in the quantity of reserves and hence in the money supply. Statement 3 works through the other side of the central bank's balance sheet. Reserve money is created against the RBI's assets, and its net foreign assets are one of those sources; when the RBI sells dollars in the foreign exchange market it receives rupees in exchange, so its foreign assets shrink and so does the rupee base on which the money supply is built. Statement 1 is the same open market operation run the other way — a purchase releases liquidity — and statement 4 is a forex purchase, in which the RBI pays out rupees and its foreign assets grow. Both are expansionary, so neither can belong in the answer.
- (a)1 and 4 only — The exact inverse of the correct pair. Buying Treasury Bills from the public pays rupees out, and buying foreign exchange pays rupees out as well; these are the two expansionary actions in the list, not the contractionary ones.
- (b)1 and 3 only — Half right. The forex sale in statement 3 does contract the money supply, but statement 1 is a purchase of Treasury Bills, which injects liquidity rather than absorbing it.
- (d)2 only — Correct as far as it goes and the strongest distractor, because the open market sale is the obvious contractionary move. It stops one statement short — a sale of foreign exchange drains rupees just as surely, which is why the RBI's own sterilisation operations pair the two.
The money supply rests on reserve money, which the central bank creates when it acquires assets. Open market operations are the standard lever: the RBI describes them as market operations conducted by way of sale or purchase of government securities to or from the market, with the object of adjusting rupee liquidity on a durable basis. A sale absorbs liquidity, a purchase releases it. Foreign exchange transactions move the same dial through the RBI's net foreign assets — buying dollars pays out rupees and expands the base, selling dollars takes rupees in and contracts it. When a large capital inflow forces the RBI to buy dollars, it often sells securities to neutralise the rupees it has just released; that pairing is called sterilisation.
The reliable test is to ask, for each action, in which direction the rupees travel. If the central bank is receiving rupees — because it has sold something, whether a bill or a dollar — the money supply contracts. If it is paying rupees out, the money supply expands. That single question sorts all four statements without any memorised list. Two things about the printed item are worth noting honestly. The stem asks about action 'by the Government', yet every one of the four actions is a central-bank action; the two are distinct institutions, and the slip is incidental to what is being tested. The RBI's own published description of open market operations speaks of government securities rather than of Treasury Bills specifically, but Treasury Bills are short-dated government securities and are among the instruments used, so the mechanism is the one the question intends.
- RBI: open market operations are 'the market operations conducted by the RBI by way of sale/purchase of G-Secs to/from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis'.
- RBI: 'When the RBI feels that there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity', and it buys securities when conditions are tight.
- NCERT: 'Selling of a bond by RBI … leads to reduction in quantity of reserves and hence the money supply.'
- Reserve money is created against the RBI's assets, and its net foreign assets are one of those sources — so a sale of foreign exchange shrinks the rupee base.
- Sterilisation is the pairing of the two: the RBI offsets rupees released by a forex purchase with an open market sale of securities.
Every sale by the central bank drains rupees; every purchase releases them. The answer is the two sales.
- Reading the direction backwards. A central-bank purchase of securities is expansionary, not contractionary; only the sale drains liquidity.
- Stopping at the securities leg and forgetting that a foreign exchange sale also takes rupees out of the system.
- Confusing government borrowing with central-bank operations; the stem says 'Government' but every option describes an RBI action.
As a which-of-these-expands-or-contracts statements item, or as a definitional one-liner on open market operations, sterilisation or the cash reserve ratio.
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
- (a) 1 only
- (b) 2 and 4 only
- (c) 1 and 3
- (d) 2, 3 and 4
Answer(c) 1 and 3
The same test with the sign reversed. UPSC lists the identical pair of open market actions and asks which expands the money supply, keying the purchase and rejecting the sale — the mirror image of what CDS wants here.
When the Reserve Bank of India announces an increase of the Cash Reserve Ratio, what does it mean?
- (a) The commercial banks will have less money to lend
- (b) The Reserve Bank of India will have less money to lend
- (c) The Union Government will have less money to lend
- (d) The commercial banks will have more money to lend
Answer(a) The commercial banks will have less money to lend
A second contractionary instrument in the same toolkit. Raising the reserve ratio locks up a larger share of deposits at the central bank, so less is left to lend on — a different lever from an open market sale, pulling the money supply the same way.
CDS_GK_2023_I_Q652023Which one of the following is a measure that can be used by the Government for combatting inflation?
- (a) Increasing the non-planned expenditure on defence, police, etc.
- (b) Providing more subsidies on exports
- (c) Increasing the rate of interest on savings and fixed deposits
- (d) Reduction in the cash reserve ratio (CRR)
Answer(c) Increasing the rate of interest on savings and fixed deposits
CDS asked the same contraction-or-expansion judgement one session earlier, dressed as an anti-inflation measure. Raising deposit rates pulls money out of spending, while cutting the reserve ratio releases lendable funds — the same direction test that decides all four statements here.
- practice — not a real PYQ
An open market operation in which the Reserve Bank of India purchases government securities from the public will most likely
- (a)reduce the money supply
- (b)increase the money supply
- (c)leave the money supply unchanged
- (d)reduce the money supply only if the cash reserve ratio is raised at the same time
Answer(b) increase the money supply — the RBI pays rupees to the sellers, releasing liquidity into the system; it is the sale of securities that absorbs liquidity.
- practice — not a real PYQ
Sterilisation by the Reserve Bank of India is best described as which one of the following?
- (a)Raising the cash reserve ratio to reduce bank lending
- (b)Neutralising the liquidity effect of its foreign exchange operations through open market operations
- (c)Withdrawing high-denomination currency notes from circulation
- (d)Lending to commercial banks against government securities
Answer(b) Neutralising the liquidity effect of its foreign exchange operations through open market operations — the rupees released when the RBI buys dollars are taken back by selling securities.