Monetary policy tools

The RBI controls the money supply through monetary policy. It is also the lender of last resort: it lends to banks in trouble, so that people do not lose faith in the banking system.

Its tools:

• Quantitative tools (they change the amount of money): the cash reserve ratio (CRR), the bank rate, and open market operations.
• Qualitative tools (they guide where credit goes): moral suasion (persuading banks), and margin requirements.

Open market operations: the RBI buys or sells government bonds in the market.

• When the RBI buys bonds, it pays money to the sellers, which adds to banks' reserves: money supply rises.
• When it sells bonds, buyers pay the RBI, and banks' reserves fall: money supply falls.

Outright operations are permanent. Repo operations come with an agreement to reverse them: the RBI lends to banks against bonds, which the banks repurchase later. The rate is the repo rate; when the RBI borrows from banks, the rate is the reverse repo rate. These are now the RBI's main tool.

Bank rate: the rate at which the RBI lends to banks. Raising it makes banks' borrowing dearer, so they lend less, and money supply falls.

In 2016, demonetisation withdrew the old ₹500 and ₹1,000 notes from circulation.