Role of RBI in Inflation and Deflation

The Reserve Bank of India plays the most crucial role in managing the economy of India, keeping a stable economic balance, and maintaining the cash and finance flows in the country. While it may sound like only a small task list, every decision that RBI takes impacts every individual of the nation directly. But how are inflation and deflation impacted by RBI?

Reserve from every bank

Every commercial bank keeps a certain cash reserve with the RBI and this reserve is used by the RBI to increase or decrease the reserve requirement depending upon whether the RBI wants to increase or decrease the money supply.

How RBI tackle inflation?

Inflation is the reduction of purchasing power per unit of money and is certainly not good for the economy. RBI sells securities held with it, from the commercial banks. This reduces the cash lending and credit creation capabilities of the banks, and hence the interest rates spike, and the demand decreases as people start saving money instead of spending it.

How is deflation managed?

Deflation is the opposite of inflation, in this case, the demand is less and supply is more, and hence the purchasing power per unit of money increases. This increase might seem to be a good thing in the short term but affects the economy negatively. To overcome this, RBI buys the securities from the commercial banks, and hence the cash lending capacities increase and the interest rates go down. As a result, people start spending money instead of saving it.

Hence, the Reserve Bank tackles the inflation and deflation in the economy through the cash reserve that it keeps as security. The money supply-demand balance is managed only through the Cash Reserve Ratio, also called CRR.

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