Which of the following would lead to a fall in the money supply in th…

Which of the following would lead to a fall in the money supply in the economy?

Answer & explanation

Correct answer: option 3

The correct answer is Option (3) → Both (1) and (2)

Both actions take money out of the system. A higher CRR makes banks call back loans, and a reverse repo withdraws money.

Option (1) The RBI raises the Cash Reserve Ratio from 20 per cent to 25 per cent. — True. Banks must keep more of their deposits as reserves, so they can lend less. They call back some loans, and money supply falls.

Option (2) The RBI sells securities through a reverse repo, with an agreement to buy them back later. — True. The buyers pay the RBI for the securities, so money is withdrawn from the system until the RBI buys them back.

A repo works the other way: the RBI buys securities and puts money into the system.

NCERT (2026-27): “3.4 Policy Tools to Control Money Supply … It should be evident by now that if the Central bank changes the reserve ratio, this would lead to changes in lending by the banks which, in turn, would impact the deposits and hence, the money supply. … But the banking system would now be able to loan Rs 300 only. It would have to call back some loans to meet the increased reserve requirements. Hence, money supply would fall. … Selling of a bond by RBI (to private individuals or institutions) leads to reduction in quantity of reserves and hence the money supply. … However, there is another type of operation in which when the central bank buys the security, this agreement of purchase also has specification about date and price of resale of this security. This type of agreement is called a repurchase agreement or repo. The interest rate at which the money is lent in this way is called the repo rate. Similarly, instead of outright sale of securities the central bank may sell the securities through an agreement which has a specification about the date and price at which it will be repurchased. This type of agreement is called a reverse repurchase agreement or reverse repo. The rate at which the money is withdrawn in this manner is called the reverse repo rate. …”