Question

Read the following statements carefully:
Statement 1: Open Market Operations refers to purchase/sale of Government Securities (G-Sec) by the Central Bank.
Statement 2: To decrease money supply, Central Bank will sell the Government Securities to commercial banks.

• A. Statement 1 is true and Statement 2 is false.
• B. Statement 1 is false and Statement 2 is true.
• C. Both Statements 1 and 2 are true.
• D. Both Statements 1 and 2 are false.

Hint:

OMO is a powerful tool used by the Central Bank to control inflation and liquidity. Selling G-Secs reduces money in circulation, while buying G-Secs increases it.

Answer 1

The Correct Option is C

Statement 1: Open Market Operations (OMO) refer to the buying and selling of government securities (G-Secs) in the open market by the Central Bank — in India, the Reserve Bank of India (RBI). It is a key monetary policy instrument used to control the money supply and liquidity in the economy. When the RBI buys government securities, it injects liquidity into the banking system; when it sells them, it absorbs liquidity. Hence, this statement is true. Statement 2: When the Central Bank wants to decrease the money supply (tighten liquidity), it sells government securities to commercial banks and other financial institutions. When these banks purchase securities, they pay the RBI, which reduces their reserves and thus, their capacity to lend. This leads to a contraction in the overall money supply in the economy. Therefore, this statement is also true. Since both statements are correct and align with the principles of monetary control via OMO, the correct answer is Option (C).