What is Reserve Money? Who creates Reserve Money?

This post focuses on the reserve money and its features:

·      Currency in circulation comprises notes in circulation, rupee coins and small coins. Bank’s deposits are reserves maintained as cash reserve ratio by banks in the current account with the Reserve Bank of India.

·      It forms the basis on which money supply builds and circulates in the system.

·      Reserve Bank of India imparts liquidity by growing reserve money.

·      Reserve money is also known as high power-driven money, monetary base, base money and is represented as M0.

·      Reserve Money is sum of a country’s currency in motion and banks deposits with the RBI.

·      When Reserve Bank of India produces reserve money either by means of currency or bank reserves, it offers liquidity into the banking system which so supplies money to the economy.

RBI Creates Reserve Money

Let us now discuss the role of RBI in creating reserve money:

·      Currency in circulation involves creating reserve money by printing currency and bank deposits makes reserve money by accepting bank reserves which are preserved as part of cash reserve ratio.

·      Reserve Bank of India makes reserve money by purchasing domestic assets via OMOs, Liquidity Adjustment Facility operations.

·      Reserve Bank of India makes reserve money via bank assets by increasing Cash Reserve Ratios.

·      Reserve Bank of India patterns currency by buying foreign currency assets, gold or domestic assets.

·      Reserve Money is the obligation of the Reserve Bank of India. Two liability constituents are currency in circulation and bank deposits.

·      To increase its liability, Reserve Bank of India requests to consistently increase its assets as well. RBI assets are forex assets (foreign currency asset), gold, rupee securities (domestic assets).

·      When there is dollar inflows from foreign investors, Reserve Bank of India buys dollars and sells rupee to the market, thus making reserve money by increasing its foreign currency assets (forex intervention).

·      With rise in holding period, risk associated reduces.

Impact of Reserve Money

You must also be aware of the impact of reserve money:

·        Reserve money replicates the liquidity operations of the RBI.

·        Broad money (M3) which is currency in movement Demand and Time deposits with the banks is a manifold of reserve money.

·        Rise in reserve money, upturns broad money (money supply) in that way creating liquidity in the economy.

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