Monetary Policy

Decreasing the Bank Rate encourages commercial banks to borrow more from the RBI. This leads to: Increased liquidity in the banking system. Lower lending rates for consumers and businesses, boosting borrowing and spending. Higher aggregate demand, which helps in correcting deflationary pressures. Thus, reducing the Bank Rate is an effective monetary policy tool to combat deflation.

A deflationary gap arises when aggregate demand in the economy falls short of aggregate supply at the full employment level, leading to underutilization of resources, unemployment, and slow economic growth. Margin requirement is an effective instrument of credit control used by the Central Bank to influence borrowing for investment and consumption. Here's how it helps in a deflationary situation:
Meaning of Margin Requirement: Margin requirement is the difference between the market value of the security offered for loans and the loan amount granted. A lower margin implies that the borrower has to contribute less from their own funds and can borrow more.
Encouraging Borrowing: In a deflationary situation, the central bank reduces the margin requirements. This makes it easier for borrowers to get higher loans against the same security.
Boosts Investment and Consumption: With easier access to credit, both consumers and producers are likely to spend more. Producers can invest in new projects, and consumers can buy durable goods, thus increasing overall demand.
Multiplier Effect: As aggregate demand increases, it stimulates production, generates employment, and raises income levels. This sets off a positive multiplier effect in the economy, reducing the deflationary gap.
Targeted Sectoral Impact: Margin requirements can be adjusted for specific sectors like housing or automobiles to boost demand in targeted areas of the economy.
Thus, margin requirements serve as a powerful monetary tool to tackle deflationary conditions by stimulating credit creation and reviving economic activity.

Statement 1: Open Market Operations (OMO) refer to the buying and selling of government securities (G-Secs) in the open market by the Central Bank — in India, the Reserve Bank of India (RBI). It is a key monetary policy instrument used to control the money supply and liquidity in the economy. When the RBI buys government securities, it injects liquidity into the banking system; when it sells them, it absorbs liquidity. Hence, this statement is true. Statement 2: When the Central Bank wants to decrease the money supply (tighten liquidity), it sells government securities to commercial banks and other financial institutions. When these banks purchase securities, they pay the RBI, which reduces their reserves and thus, their capacity to lend. This leads to a contraction in the overall money supply in the economy. Therefore, this statement is also true. Since both statements are correct and align with the principles of monetary control via OMO, the correct answer is Option (C).

\text{Increasing the bank rate increases the cost of borrowing for commercial banks, leading them to reduce their lending. This results in a decrease in the money supply.}