How does the central bank create …

1. Open Market Operation

1. Buying and selling of government securities in the open market by the central bank  is known as open market operations.
2. Open market operations have a impact on the lending capacity of the banks.
3. It is an important mean of controlling the money supply.
4. During inflation or excess demand situation, the main motive of the Central Bank is to reduce the money supply. To suck excess liquidity from the market the Central Bank sells bonds, government securities and treasury bills.
5. Due to low money supply, there is fall in the volume of investment, income and employment resulting in lower demand.
6. During deflation the main motive of the Central bank is to increase the money supply and to increase the money supply the Central Bank buys bonds, government securities and treasury bills.

2. Bank Rate Policy :

1. It refers to the rate at which the central bank lends money to commercial banks as the lender of the last resort.
2. The central bank advances loans against approved securities or eligible bills of exchange.
3. An increase in bank rate increases the costs of borrowing from the central bank. It forces the commercial banks to increase their lending rates, which discourage borrowers from taking loans.
4. It reduces the ability of commercial banks to create credit. A decrease in the bank rate will have the opposite effect.