With reference to inflation in India, which of the following statements is correct?
Contents9
- AControlling the inflation in India is the responsibility of the Government of India only
- BThe Reserve Bank of India has no role in controlling the inflation
- CDecreased money circulation helps in controlling the inflation
- DIncreased money circulation helps in controlling the inflation
Show answer
Answer: (C) Decreased money circulation helps in controlling the inflation
This question tests basic understanding of the relationship between money supply and inflation.
Option
(c) is correct: Decreased money circulation helps in controlling inflation.
The logic is straightforward — inflation is essentially 'too much money chasing too few goods.'
When there is excess money in the economy, people have more purchasing power, demand for goods and services rises faster than supply can keep up, and prices increase.
When the RBI decreases money circulation (through tools like raising repo rate, CRR, SLR, or selling government securities through OMOs), there is less money available for spending, aggregate demand falls, and price pressures ease.
Why are the other options wrong?
(a) 'Controlling inflation is the responsibility of Government of India ONLY' — this is incorrect because BOTH the government and RBI share the responsibility.
The government controls inflation through fiscal measures (subsidy management, import policy, supply-side interventions), while RBI controls it through monetary policy (interest rates, money supply).
Since 2016, India even has a formal Inflation Targeting framework where RBI is mandated to keep CPI inflation at 4% (±2%).
(b) 'RBI has NO role in controlling inflation' — this is clearly wrong.
RBI's primary function is to maintain price stability (control inflation) while keeping economic growth in mind.
This is the very purpose of monetary policy.
(d) 'Increased money circulation helps control inflation' — this is the OPPOSITE of the truth.
More money in circulation leads to MORE inflation, not less.
Answer: (c).
RBI uses money supply control as its primary tool to manage inflation - when there's less money circulating, people spend less and prices stop rising rapidly.
This tests the core monetary policy concept that inflation happens when 'too much money chases too few goods' - reducing money supply breaks this cycle.
Money Supply and Inflation Relationship
Indian Economy money circulation inflation
Money Supply-Inflation Nexus: Core Mechanism & Policy Implications
Decreased money circulation reduces inflation by lowering aggregate demand
Inflation occurs when too much money chases too few goods
RBI uses monetary policy tools to control money supply and inflation
Both government (fiscal) and RBI (monetary) share inflation control responsibility
The relationship between money supply and inflation follows a fundamental economic principle: when more money enters the economy, people have greater purchasing power, demand for goods rises faster than supply can adjust, and prices increase.
Money Supply Impact on Inflation
%%{init: {"flowchart": {"wrappingWidth": 460}}}%%
flowchart TD
s1["`**RBI Decreases Money Supply**
Through repo rate hike, CRR increase, or OMO sales`"]
s2["`**Less Money Available**
Banks have less funds to lend, credit becomes costlier`"]
s3["`**Reduced Aggregate Demand**
Consumers and businesses spend less due to higher borrowing costs`"]
s4["`**Lower Price Pressure**
Demand-supply balance improves, inflation falls`"]
s1 --> s2
s2 --> s3
s3 --> s4RBI Tools to Control Money Supply
Tool | To Reduce Money Supply | Impact on Inflation | Mechanism |
|---|---|---|---|
Repo Rate | Increase rate | Inflation ↓ | Higher borrowing cost reduces demand |
CRR | Increase percentage | Inflation ↓ | Banks hold more reserves, less lending |
SLR | Increase percentage | Inflation ↓ | Banks invest more in govt securities |
OMO | Sell govt securities | Inflation ↓ | Sucks out excess liquidity from market |
Trap: Option D says increased money circulation controls inflation — this is the opposite of reality
Trap: Option A uses the word 'ONLY' — inflation control is shared between govt and RBI, not exclusive
Trap: Option B completely negates RBI's role — RBI's primary mandate is price stability
Classic Confusion: Students mix up cause-effect — more money causes inflation, less money reduces it
Inflation Control: Government vs RBI Roles
Indian Economy Government of India Reserve Bank of India
Institutional Framework for Inflation Management in India
Both Government and RBI share inflation control responsibility — not exclusive to either
RBI uses monetary policy (interest rates, money supply) to control inflation
Government uses fiscal policy (subsidies, taxes, supply management) for inflation control
Since 2016, India has formal Inflation Targeting framework with RBI maintaining CPI at 4% (±2%)
Government vs RBI: Inflation Control Methods
Institution | Policy Type | Key Tools | Examples |
|---|---|---|---|
Government of India | Fiscal Policy | Supply-side interventions | Subsidies, import policy, buffer stocks, MSP |
Reserve Bank of India | Monetary Policy | Money supply & interest rates | Repo rate, CRR, SLR, OMO operations |
Both (Coordination) | Policy Mix | Synchronized approach | Govt reduces deficit while RBI tightens money supply |
India's Inflation Targeting Framework
Flexible Inflation Targeting adopted in 2016 after Urjit Patel Committee recommendations
RBI mandated to maintain CPI inflation at 4% with tolerance band of ±2% (i.e., 2-6%)
Monetary Policy Committee (MPC) with 6 members decides repo rate based on inflation target
If inflation breaches target for 3 consecutive quarters, RBI must explain to government
Trap: UPSC uses 'ONLY' in options — inflation control is never exclusive to one institution
Trap: 'RBI has NO role' — RBI's primary mandate is price stability, this option is clearly wrong
Memory Aid: Think 'BOTH-FIM' — Both institutions, One uses Fiscal, Other uses Monetary policy
RBI Monetary Policy Instruments
Indian Economy Reserve Bank of India repo rate CRR
RBI's Monetary Policy Toolkit: Quantitative & Qualitative Measures
Repo Rate is the key policy rate — RBI's primary tool for inflation control
CRR and SLR directly control how much money banks can lend
OMO (Open Market Operations) inject or absorb liquidity from banking system
Reverse Repo Rate is the rate at which RBI borrows from banks
RBI controls money supply through quantitative tools (affecting money quantity) and qualitative tools (affecting credit direction). When inflation rises, RBI typically tightens policy by raising rates and reserve requirements.
Key Monetary Policy Instruments
Tool | Current Rate/Requirement | To Control Inflation | Transmission Mechanism |
|---|---|---|---|
Repo Rate | Policy rate decided by MPC | Increase rate | Higher lending rates → reduced borrowing → lower demand |
Reverse Repo Rate | Repo rate minus 25 bps | Increase rate | Banks park more funds with RBI → less lending |
CRR | Currently around 4% | Increase % | Banks hold more reserves → reduced lending capacity |
SLR | Currently around 18% | Increase % | Banks invest more in govt securities → less private lending |
MSF | Repo rate plus 25 bps | Increase rate | Emergency borrowing becomes costlier for banks |
OMO Operations
# Open Market Operations
## OMO Sales
- RBI sells govt securities
- Absorbs excess liquidity
- Reduces money supply
- Controls inflation
## OMO Purchases
- RBI buys govt securities
- Injects liquidity
- Increases money supply
- Stimulates growthRate Direction Trap: Higher rates = lower inflation, Lower rates = higher inflation — don't reverse this
CRR vs SLR: CRR is cash with RBI, SLR is investment in govt securities by banks
OMO Confusion: OMO sales reduce money supply, OMO purchases increase money supply