Why does RBI issue or buyback government bonds?
Sam replied quickly, ‘Just like corporate, they also need money.’ ‘You are partially right,’ I continued ‘RBI can also control our economy to an extent through issuing or buying back bonds. Just see if it doesn’t follow from simple logic and common sense. ’ • When RBI issues (or re-issues) bonds, money flows from primary dealers to RBI. This decreases money in the hands of the banks, and hence open money in the system, and hence reduces liquidity in various markets. • When there is less amount of money in the hands of the banks, they will be less willing to lend, and more willing to borrow. So, the lenders will charge more from the borrowers. So, the call money market rate will increase. Call money market rate in India is the interest rate charged against call money (money lent for 1 day). • Similarly, other short term interest rates will also increase. Because of the increase in short term interest rates, long term rates will go up according to both pure expectation theory and liquidi
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