ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Stymied at Every Step

Stymied at Every Step

the process increase its deposits as well. The increase in the assets of the commercial banking system could be either in the form of credit to the private sector or in the form of credit to the Government sector. When the demand for credit from the private sector is being only inadequately met by the commercial banks, an increase in commercial banks' holdings of Government securities may be interpreted as being at the cost of a potential increase in credit to the private sector. In other words, in this situation it is net Reserve Bank credit to the Government which constitutes the determinant of the final increase in money supply. Increased holding of Government securities by the commercial banks merely denotes a changed division of the deposits created in the commercial banking system as between the private sector and the public sector. In fact. the greater the share of such secondary increase in money supply which the Government is able to claim the less will be the requirement for Government to increase its access to Reserve Bank credit, and this in turn would hold in check the overall increase in money supply in the economy. Thus, given that the commercial banks would be able to exercise in full their credit creating potential without raising their investment in Government securities, increase in commercial bank credit to the Government sector would really be on balance contractionary in its impact on total money supply. Assume, for instance, that current deposits of commercial banks will increase by Rs 40 for every Rs 100 in currency in circulation. If Government raises Rs 100 from the Reserve Bank and Rs 30 from the commercial banks during a particular year, the net increase in money supply would be Rs 130. If the entire Rs 130 is raised from the Reserve Bank the banks would create deposits of Rs 50 by lending an- equivalent amount to the private sector thereby leading to a total increase in money supply of Rs 180, though net bank credit to the Government sector would be Rs 130 in both cases. Thus Government borrowing from commercial banks has the effect of mopping up funds which accrue to them from the Government's initial borrowings from the Reserve Bank, and the overall impact of such borrowing would thus be contractionist.

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