Discussion
If RBI wants to increase the credit flow it buys ______:
Answer: A
Correct answer: Government Securities
To increase the flow of credit the RBI buys government securities from banks and the public, paying cash and taking the paper onto its own books. The banks' reserves rise, and with larger reserves they can support more lending.
The transaction is the mirror of the contractionary sale, and government paper is used for the same reasons - a deep market, no credit risk, and the ability to transact in size. Buying shares or corporate debentures would expose the central bank to credit risk and to accusations of favouring particular companies.
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